(Adds data on Chinese manufacturing survey in paragraph 8, updates to close)
By Rodrigo Campos
NEW YORK Jan 23 A judge's move to sanction auditors of U.S.-traded Chinese stocks at best muddies the picture of investing in those companies, not long after a period when accounting scandals hit many of the shares hard.
The stocks ended sharply lower on Thursday, after a U.S. Securities and Exchange Commission judge ruled that the Chinese units of the world's top accounting firms should be suspended from auditing U.S.-listed Chinese companies.
The market value of Chinese companies listed on the New York Stock Exchange and Nasdaq Stock Market comes to more than $1.4 trillion, according to data from the exchanges and Thomson Reuters.
The ruling, issued Wednesday, raises the possibility that companies could see their listings temporarily suspended if the accounting giants fail to appeal successfully. It also could short-circuit forthcoming U.S. listings from China.
Whether it will have a continuing effect on the stocks is another matter. The suspension does not take effect immediately, and the "Big Four" have said they will appeal, so some investors are likely to use the selloff as a buying opportunity.
"I don't think this has changed the risk that has existed. It has brought it more to light and put it more on the forefront," said Malcolm Polley, president and chief investment officer of Stewart Capital Advisors in Indiana, Pennsylvania.
"People were willing to look past the potential issues with the stamp of a 'Big Four' firm, (but) you can't do that," he said.
An index of stocks of Chinese companies traded on U.S. exchanges fell 3.6 percent to its lowest in two months. A private-sector survey showing China's factory sector contracted in January for the first time in six months contributed to the selling.
Among the biggest losers were Internet services provider Baidu Inc, down 6.2 percent, and SINA Corp, down 5.9 percent, on heavier-than-usual volume. The U.S. shares of Petrochina , the country's largest stock by market value, fell 3.1 percent.
Securities and Exchange Commission Administrative Law Judge Cameron Elliot censured the Chinese affiliates of KPMG , Deloitte, 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.
Market insiders, however, say that despite the selling, the risk for investors is minimal.
"At the earliest it would be May 2015 for these companies to start to delist, so there's a long time between now and then, and we think the parties reaching a deal within that time is reasonable," said a trader in Asian ADRs for a top Wall Street bank, who declined to be named because he is not authorized to speak to the media.
"Fast money, retail money, is selling, and institutional money is going to view this as an opportunity to buy and add to positions," he said. "The institutions we speak to share the view there's no real risk of delisting."
Shares of Chinese companies listed in the United States through reverse takeovers - popular during the last decade as a way to list in U.S. exchanges with fewer regulatory hurdles - were hit hard.
Shares of Tal Education Group fell 8.2 percent in their largest decline since August 2012. Online dating platform Jiayuan fell 7.8 percent.
SECRECY LAW IN CROSSHAIRS
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.
"This is going to put more pressure on the firms but will not help resolve the real issue," said James Lee, regional director for Greater China at the Institute of Chartered Accountants in England and Wales.
"Any firm taking over the existing audits will face exactly the same impasse."
For years, the SEC had little success in gaining access to audit work for U.S.-listed Chinese companies. Several companies have since been hit by accounting scandals.
"I suspect this will be the start of a new round of negotiations. The SEC is making its intentions clear but has not taken any action yet," said Paul Goodwin, chief analyst for Cabot China & Emerging Markets Report, an investment letter specializing in emerging market equities.
"This is raising the stakes in this long-running skirmish between China and the SEC," said Goodwin.
"Trying to pressure the auditors to make their audits more rigorous is an excellent way and perhaps a more effective way for the SEC to try to eradicate fraud in the marketplace as opposed to the SEC trying to decide individually which companies are frauds or not," said Sahm Adrangi, chief investment officer at Kerrisdale Capital in New York, a hedge fund that has in the past bet against U.S. listed Chinese companies." (Reporting by Rodrigo Campos, Dena Aubin and Daniel Bases; Editing by Steve Orlofsky, Rosalind Russell and Jonathan Oatis)