UPDATE 6-China hits PwC with six month ban and large fine in record penalty over Evergrande audit

Delivering a strong rebuke to the Big Four firm, China's securities regulator said its investigation found that PwC Zhong Tian LLP "turned a blind eye" to and "even condoned" Evergrande's fraud while auditing the annual results of the developer's onshore flagship unit - Hengda Real Estate and assisting its bond issuance - in 2019 and 2020. "PwC's behavior goes beyond mere auditing failure.

Chinese regulators hit PwC's mainland China unit with a six-month suspension and a record fine of 441 million yuan ($62 million) on Friday over the firm's audit of failed property developer China Evergrande Group . Delivering a strong rebuke to the Big Four firm, China's securities regulator said its investigation found that PwC Zhong Tian LLP "turned a blind eye" to and "even condoned" Evergrande's fraud while auditing the annual results of the developer's onshore flagship unit - Hengda Real Estate and assisting its bond issuance - in 2019 and 2020.

"PwC's behavior goes beyond mere auditing failure. It, to a certain extent, covered up and even condoned Hengda Real Estate's financial fraud and fraudulent issuance of corporate bonds," said the China Securities Regulatory Commission (CSRC) in a statement. Chinese authorities have been examining PwC's role in Evergrande's accounting practices since the CSRC accused the developer in March of a $78-billion fraud over a period of two years through 2020.

PwC audited Evergrande for almost 14 years until early 2023. PwC Zhong Tian said in a statement it accepts the audit work on Hengda fell below its own high standards. "We are determined to address the shortcomings and strengthen how we operate going forward."

The business suspension and fines are the toughest ever received by a Big Four accounting firm in China, and come against the backdrop of an exodus of clientele and layoffs at the firm in recent months. In the most recent case of a Big Four auditor being hit with hefty penalties, Deloitte's Beijing branch last year was fined 211.9 million yuan and the branch's operations were suspended for three months after serious deficiencies were found in its audit of China Huarong Asset Management.

The latest move is set to cloud PwC's prospects in the world's No.2 economy. PwC Zhong Tian, the registered accounting entity and the main onshore arm of PwC in China, was the country's top-earning auditor in 2022, according to the latest official data. "The cost is enormous in reputation, affecting the ability to get new business in China beyond the fine," said Gary Ng, Asia-Pacific senior economist at Natixis.

PwC Zhong Tian will be barred from signing off on certain key documents for clients in mainland China such as results and IPO applications for the next six months. The business suspension will also affect the unit as a whole from taking on new state-owned or domestically-listed clients in the next three years, in accordance with Chinese regulations.

Last year, domestic regulators reiterated state-owned firms and mainland China-listed companies should be "extremely cautious" about hiring auditors that have received regulatory fines or other penalties in the past three years. "We are disappointed by PwC Zhong Tian's audit work of Hengda, which fell unacceptably below the standards we expect of member firms of the PwC network," PwC network, the alliance of PwC's global member units, said in a separate statement.

The firm said as part of its "accountability and remedial actions", PwC China's territory senior partner Daniel Li had stepped down two months after taking office given his "former responsibilities" as head of the local auditing business. Li signed off on several Evergrande documents, including one on the developer's onshore bond issuance in 2021 as head of PwC Zhong Tian, according to a Reuters review of the publicly available documents.

PwC and Li did not respond to a Reuters request for comment on Li signing off on Evergrande documents. Hemione Hudson, the firm's global risk and regulatory leader, had taken over from Li, who will remain at the onshore firm as chief accountant, said the PwC statement.

'CONDONED FRAUD' The business suspension was imposed by China's Ministry of Finance (MOF) which also ordered the closure of PwC Zhong Tian's branch in Guangzhou that led the audit work on Hengda.

The MOF said both PwC Zhong Tian and its Guangzhou branch were aware of "material misstatements" in the audit of the developer between 2018 and 2020 but failed to point them out, and even issued false audit reports. The ministry also imposed a fine of 116 million yuan on the firm for its auditing failure of Hengda in 2018.

The CSRC said in its statement it had fined PwC Zhong Tian 325 million yuan, close to the total amount of penalties imposed by the regulator on over 50 auditors in the past three years. The CSRC probe found that 88% of PwC's observation records on Evergrande's real estate projects in 2019 and 2020 were inauthentic or untrue, making its audit working papers "severely unreliable".

The regulator pointed out PwC's on-site inspection of the developer's properties failed to flag problems - some residential properties that the auditor considered ready for home deliveries still remained as "vacant land" when the CSRC inspected later. PwC also deliberately excluded properties that Evergrande marked as "off limits" from audit samples, it added.

A Reuters calculation based on filings showed more than 50 Chinese firms have in recent months either dropped the firm as their auditor or cancelled plans to hire it, following the launch of the regulatory investigation into the firm. ($1 = 7.0942 Chinese yuan renminbi)

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