Foreign Companies May Lose Access to U.S. Capital Markets Under Just-Passed Senate Legislation

Brownstein Hyatt Farber Schreck
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Brownstein Hyatt Farber Schreck

A recently passed Senate bill would eliminate the ability of a company to access U.S. investors through the public capital markets if the company uses an auditor in a foreign jurisdiction that does not permit inspection by U.S. regulators. Under the bill, public companies that are based in or have affiliates in China, France or Belgium could be banned from having their stock and bonds traded within the U.S.

On Wednesday, with little fanfare and amidst the congressional debates on how to address the economic downturn induced by the coronavirus, the U.S. Senate turned their focus to China and passed without objection the Holding Foreign Companies Accountable Act (S.945). That bill, which was introduced by Sens. Kennedy and Van Hollen over a year ago, is designed to address concerns by the U.S. capital markets regulators that certain foreign authorities, namely the Chinese, Belgian and French authorities, prevent or otherwise inhibit oversight over the audits by non-U.S. audit firms.

According to the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB), the U.S. regulators charged with overseeing and regulating those audits, inspection of the principal auditor’s work of 224 companies that are listed and traded on a U.S. stock exchange faces obstacles. The PCAOB is unable to fully inspect another 207 U.S. exchange traded companies. (The PCAOB maintains a list of all of these companies here.)

The Holding Foreign Companies Accountable Act attempts to address this lack of oversight, and lack of parity with other U.S. companies, whose audits of financial statements must be subject to PCAOB oversight by taking a sledgehammer approach. Specifically, the bill bans the securities of public companies that use an auditor in a foreign jurisdiction, which prevents complete inspection by the PCAOB for three consecutive years, from “being traded” in the U.S. This ban applies to trading within the U.S. on an exchange, over-the counter or “through any other method that is within the jurisdiction of the Commission to regulate,” which could include trading through or by SEC registered entities, such as private equity and hedge funds, exchange traded funds and mutual funds. This bill also requires these companies to disclose share ownership by foreign government entities, as well as to identify each Chinese Communist Party member on their or their parent companies’ board.

The bill’s drastic approach is designed to, in particular, get the Chinese authorities to the table to negotiate inspection rights with U.S. regulators. However, there is no indication that the Chinese authorities would, contrary as intended, view this as a welcome development that requires companies to list and trade more actively in Hong Kong or Shanghai, where U.S. persons could freely purchase these securities. In addition, the bill seems to apply broadly, beyond those foreign companies already identified by the PCAOB, to any U.S. public companies whose affiliates are in China, Belgium or France.

Having already passed the bill in the Senate without objection, the fate of the Holding Foreign Companies Accountable Act lies in the House of Representatives, where it was introduced by Rep. Sherman, the chairman of the Subcommittee on Investor Protection, Entrepreneurship and Capital Markets of the Financial Services Committee. Previously the subcommittee held a hearing to examine the bill in June 2019, during which, Republicans questioned its drastic nature. Going forward, whether the bill becomes law, depends on the willingness of the House to take up this measure, which is completely unrelated to the current economic crisis and priorities of leadership. As this is being contemplated, it is important that relevant stakeholders engage now or risk losing access to trading and investment in the largest and most liquid capital markets in the world.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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