U.S. audit watchdog in tentative deal to observe in China: official By Dena Aubin NEW YORK (Reuters) - U.S. authorities have reached a tentative agreement to observe official auditor inspections in China, moving a step closer to better oversight in that country, an official at a U.S. audit watchdog group said on Friday. The plan to allow U.S. observers in China will be a "trust-building exercise" that could lead to more cooperation, Lewis Ferguson, a board member of the Public Company Accounting Oversight Board, said in prepared remarks. The PCAOB announced in May that it was close to an agreement to observe audit inspections in China. The watchdog has been trying for years to gain access to China to address a rash of accounting scandals at Chinese companies listed on U.S. stock exchanges. Since 2010, U.S. investors have lost billions of dollars on China-based companies listed on U.S. exchanges after questions were raised about the companies' accounts. "We are working toward and have tentatively agreed on observational visits," he said, without spelling out when the tentative agreement might become final. The observers will watch Chinese officials' examination of audit firms' quality controls, but not detailed reviews of specific audits, he said. The PCAOB still faces some hurdles before it is allowed to participate in joint inspections in China, Ferguson said in the remarks to a financial reporting conference in Irvine, California. China wants the PCAOB to rely on Chinese inspectors, arguing that any action by a foreign regulator on Chinese soil raises sovereignty concerns, he said. Talks have been complicated by attempts by the PCAOB and U.S. Securities and Exchange Commission to get documents from China for ongoing investigations, Ferguson said. Auditors in China say this would be a violation of Chinese state secrets law to turn them over. If no agreement on inspections is reached, audit firms in China could be subject to sanctions, including losing their PCAOB registration, Ferguson said. Audit firms that register with the PCAOB are legally obligated to cooperate with inspections, Ferguson said. Even if their local laws restrict such cooperation, they can still be sanctioned, he said. "We believe the Chinese authorities are aware of the seriousness of this matter and we are hopeful that we will be able to work out satisfactory arrangements," he said. The PCAOB, created by the 2002 Sarbanes-Oxley law after accounting scandals at Enron and WorldCom, inspects and disciplines auditors of companies listed on U.S. exchanges, including offshore-based companies. Separately, Ferguson said audit firms outside the United States are making basic errors and relying too much on corporate managers' estimates for their audits, he said. "Auditors are supposed to challenge management, and the PCAOB would like to see more auditors do so," he said. After seven years of international inspections, the PCAOB has also found problems in global firms' quality controls, he said. Quality controls have come under scrutiny following accounting scandals at clients of the Big Four accounting firms that include Japan's Olympus Corp, India's Satyam Computer Services and Italy's Parmalat. The four biggest audit firms - Deloitte, Ernst & Young KPMG and PwC - audit most of the world's large multinational companies and market their ability to provide uniform quality across the globe. BDO, RSM International and Grant Thornton also operate large global audit networks. Editing by Howard Goller and Tim Dobbyn