Can the Accounting Derail Alibaba's Massive IPO?

Let’s get this straight. We’re not saying that there’s something wrong with the financial statements and other information in Alibaba’s multi-billion dollar initial public offering, which promises to be one of the largest the world has ever seen.
It will be the US Securities and Exchange Commission (SEC) that will determine whether this is the case, in a series of reviews that is required before Alibaba’s American Depositary Shares, which can potentially raise as much as US$23 billion, could start trading.
But there is a chance that Alibaba’s financial statements “could be determined to not be in compliance with the requirements of the Exchange Act,” the company acknowledges in its prospectus. “Such a determination could ultimately lead to a delisting of our ordinary shares from the New York Stock Exchange or Nasdaq Global Market or deregistration from the SEC, or both.”
There is already a whiff of controversy around Alibaba’s auditor of record, PwC
Not only Alibaba, but many other China companies listed in the United States, would be affected. This situation would arise if the ruling by Cameron Elliot, Administrative Law Judge of the SEC, comes into force. In January, Elliot banned the Big Four accounting firms in China plus BDO China Dahua CPA from practicing before the SEC for six months.
The suspension will not come into force until the Commission enters an order of finality, notes Paul Gillis, Professor of Practice at Peking University’s Guanghua School of Management. The ruling is on appeal and the SEC has seven months to reconsider or confirm it.
If the SEC does impose the ban, the firms could appeal to the courts for a stay of the order. “That could delay the problem for a long time, but that may not be the best outcome for the firms or their clients,” says Gillis, whose book, The Big Four and the Development of the Accounting Profession China, was published in March.
Gillis believes that the overhang could impose a “China discount” on Alibaba’s valuation. As Alibaba itself warns, “any negative news about the proceedings against these audit firms may adversely affect investor confidence in companies with substantial mainland China based operations listed in the US.”
Who Did the Audit?
There is already a whiff of controversy around Alibaba’s auditor of record, PwC. The audit opinion in the prospectus is signed by PricewaterhouseCoopers Hong Kong, not the mainland China member firm, PricewaterhouseCoopers Zhong Tian CPAs, which is one of the five firms covered by Elliot's ruling.
“This is kind of an anomaly,” says Gillis. “You’ve got a large mainland company with all of its operations in the mainland and PwC says it’s their Hong Kong affiliate that’s auditing it. That may be the truth, but it seems a highly inefficient way to audit a mainland company.”
He thinks the odds are that Zhong Tian had done the bulk of the audit work and arguably should have been the one that signed the audit opinion. Zhong Tian has an office in Hangzhou, where Alibaba is headquartered and where most of its facilities are located.
The Hong Kong firm could have sent its own staff to Hangzhou, concedes Gillis. But why do that when Zhong Tian is already in Hangzhou and has its biggest office in nearby Shanghai?
In any case, the prospectus implies that Zhong Tian did play a role. “If the affiliate of our independent registered public accounting firm were denied, temporarily, the ability to practice before the SEC,” Alibaba wrote, “we would need to consider with our Hong Kong based auditor the alternate support arrangements they would need in their audit of our operations in mainland China.”
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