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UPDATE 1-Audit ruling scares investors out of U.S.-traded China shares

Rodrigo Campos
Thursday, 23 Jan 2014 | 1:13 PM ET

(Adds details, background, quote)

NEW YORK, Jan 23 (Reuters) - U.S.-traded Chinese stocks slumped on Thursday after a U.S. judge suspended the Chinese units of the world's top accounting firms from auditing U.S. listed companies for six months.

The ruling, issued Wednesday, raises the possibility that companies could see their listings temporarily suspended if the accounting giants fail to successfully appeal the court ruling. It also could short-circuit forthcoming U.S. listings from China.

Among the biggest losers were Internet services provider Baidu Inc, down 5.3 percent, and SINA Corp, down 5.3 percent. Both were moving on heavier-than-usual volume on Thursday.

In a strongly worded 112-page ruling, Securities and Exchange Commission Administrative Law Judge Cameron Elliot censured the Chinese affiliates of KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst and Young.

Baidu is audited by Ernst & Young's China unit, while SINA is audited by PWC's China unit.

"I believe this is the primary reason why U.S.-listed China companies' shares are down today," said Carson Block, head of Muddy Waters Research and a short-seller who has exposed several accounting frauds at Chinese firms.

The decision is not yet expected to disrupt the U.S. listings, but if the firms are unsuccessful in their appeal, which could take years, the companies would need to find a new auditor during the suspension period or else be unable to file accounts, which could then cause their shares to be suspended.

The ruling may also affect a wave of Chinese listings in the United States that were expected to return this year. Last year's U.S. market rally re-ignited a push by China-based companies to seek stock offerings on U.S. exchanges.

In his ruling, Elliot said the companies "willfully" failed to give U.S. regulators the audit work papers of certain Chinese companies under investigation for accounting fraud. Auditors have refused to turn over these papers for fear of violating Chinese secrecy laws, but Block suggested this ruling could move Beijing to revisit such rules.

"I believe that if the SEC holds firm, which it ought to do, the (Chinese) PRC government will relent on its quixotic insistence that audit papers are 'state secrets'," said Block.

Chinese companies listed in the U.S. as a result of reverse takeovers were hit hard. Shares of Tal Education Group fell 7.3 percent in their largest decline since August 2012. For years, the SEC has had little success in gaining access to audit work for U.S.-listed Chinese companies. Several companies have since been hit by accounting scandals.

Chinese data also weighed on shares as a preliminary survey showed that activity in China's factory sector contracted in January, for the first time in six months.

An index of stocks of Chinese companies traded on U.S. exchanges fell 3.3 percent to its lowest in two months.

(Reporting by Rodrigo Campos and Dena Aubin; Editing by Steve Orlofsky and Rosalind Russell)

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BIDU
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SINA
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