Does the SEC Have the Guts to Tank Alibaba's IPO?

What's the SEC going to do about Alibaba's accounting firm?
Jack Ma may have to tangle with the SEC. Photographer: Qilai Shen/Bloomberg

Yesterday, Alibaba Group Holding Ltd., China's largest online retailer, filed the registration statement for its initial public offering. One of the risk factors it cites is the possibility that the Securities and Exchange Commission may suspend the mainland Chinese affiliate of its outside auditor, PricewaterhouseCoopers of Hong Kong.

An SEC suspension could trigger all sorts of potential calamities, including the delisting or deregistration of Alibaba's stock in the U.S., the company said.

I seriously doubt that will happen. But the backstory here shows that the U.S. government has as much of a problem with enforcing the law against large accounting firms as it does huge banks. It also shows what a tough spot the SEC is in.

Back in January, an SEC administrative-law judge, Cameron Elliot, ruled that the China-based affiliates of PricewaterhouseCoopers and the other Big Four accounting firms (Deloitte & Touche, Ernst & Young and KPMG) should be barred from performing audit work for U.S.-listed companies for six months. The SEC's enforcement division had sent the firms subpoenas for records related to their audits at a spate of Chinese companies under investigation for accounting fraud. The firms refused to comply, claiming that Chinese law prohibited their cooperation.

The case was a slam dunk: If you want to do business before the SEC, you have to comply with SEC subpoenas. Since the judge's ruling, however, the firms have appealed to the full commission, led by Chairman Mary Jo White. And it isn't at all clear whether the commission will decide the case on the merits -- or make any decision at all.

The judge's decision isn't final until the commission affirms it. And it's possible the SEC might do nothing, because it has no deadline forcing it to act. The commission's guidelinessay that, under normal circumstances, rulings on appeals should be issued within seven months. However, the guidelines also say that "the commission retains discretion to take additional time" in those instances "when the commission determines that extraordinary facts and circumstances of the matter so require." Neither the SEC's enforcement division nor the accounting firms can compel the commission to decide the matter. So the SEC can put off a ruling indefinitely, which lets the firms keep going about their business.

Meanwhile, new IPOs keep coming from companies that rely on Big Four affiliates in China for much of their audit work. Alibaba's IPO puts an extra spotlight on the issue. In its disclosures, Alibaba also notes that its auditor isn't subject to full inspections by the U.S. Public Company Accounting Oversight Board because the board isn't able to conduct inspections within China without approval by Chinese government authorities. As a result, "shareholders may be deprived of the benefits of PCAOB inspections, and may lose confidence in our reported financial information and procedures and the quality of our financial statements."

If the SEC upholds the six-month suspension, it would affect all U.S.-listed companies with significant operations in China, not just Alibaba. The company might raise as much as $20 billion, according to an article today by Bloomberg News, which estimated its market value at $168 billion.

It's hard to believe the SEC would suspend the Big Four audit firms' Chinese affiliates after letting an IPO as prominent as Alibaba's go to market. It's also difficult to imagine that the SEC would do anything to undermine its own subpoena authority, such as overturning the judge's decision. The most alluring option for the SEC's current commissioners might be to do nothing, pray for some diplomatic solution to emerge, and leave the mess for their successors to clean up. While that wouldn't be a good solution, it may be the most expedient one. Should they choose that path, they had just better hope that Alibaba's books are pristine.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.