In the continuing wake of fraud and accounting irregularities at Chinese companies listed on U.S. exchanges, negotiations that began last month between U.S. regulators and their Chinese counterparts (as we discussed in July 2011) are expected to resume in October 2011.

As reported by Reuters, “[p]roblems with reverse mergers have raised the stakes as the SEC and [the Public Company Accounting Oversight Board] try to build a stronger working relationship with the Chinese Ministry of Finance and the China Securities Regulatory Commission.”    We discussed this issue earlier this month, noting that many of the Chinese companies under scrutiny for their accounting practices have used reverse-merger transactions to go public in the United States and that proposed rule changes would make going public through a reverse merger transaction more difficult.

U.S. regulators want to have an agreement in place by next year that would permit inspections of Chinese audit firms – a goal that will require Chinese authorities to yield to global economic pressure and overcome what they  perceive as infringements on national sovereignty.  This protectionism may reflect China’s experiences with accounting scandals.  The Economist, citing a recent academic study (PDF), noted that in less developed markets, such as China, political and social relationships (and not accounting accuracy) are key criteria in determining share priceAs summarized by the Economist:  “companies [traded on the Shanghai and Shenzhen stock exchanges between 1997 and 2005] caught up in mere accounting scandals saw their shares drop by an average of 8.8% over the six months on either side of the incident. In those involving the bribery of government officials or theft of state assets, on the other hand, the stock fell by almost a third.”

OUR TAKE:  China’s emphasis on political credibility, perhaps even over transparent and accurate financial reporting, sets an interesting backdrop for negotiations between U.S. and Chinese regulators, which we will continue to monitor.