SEC Takes Action on Holding Foreign Companies Accountable Act

Wilson Sonsini Goodrich & Rosati

Wilson Sonsini Goodrich & Rosati

On March 24, 2021, the U.S. Securities and Exchange Commission (SEC) adopted interim final amendments to implement the submission and disclosure requirements of the Holding Foreign Companies Accountable Act, or HFCA Act, new legislation requiring additional disclosure by certain foreign issuers operating in countries that limit Public Company Accounting and Oversight Board (PCAOB) audit inspections.

The HFCA Act, signed into law by President Trump on December 18, 2020, was approved with bipartisan Congressional support, and was enacted on the heels of an increased focus by the SEC and PCAOB on the issues and challenges faced in inspecting the audit work and practices of PCAOB-registered accounting firms in emerging markets, including The People's Republic of China. Wilson Sonsini's previous client alert discussed some of the recent steps taken by the SEC and PCAOB that address these issues, including the SEC's Division of Corporation Finance's disclosure guidance published in November 2020.

The amendments will apply to registrants that are identified by the SEC as having filed an annual report on Form 10-K, 20-F, 40-F, or N-CSR, with an audit report signed by a registered public accounting firm that (1) is located in a foreign jurisdiction (e.g., The People's Republic of China) and (2) the PCAOB has determined it is unable to inspect or investigate completely because of a position taken by an authority in that foreign jurisdiction. Thus, as a threshold matter, the PCAOB will need to adopt procedures to determine which registered public accounting firms fall within these rules, and the SEC will need to adopt a process for identifying the registrants with a "non-inspection year" (referred to in the amendments as "Commission-Identified Issuers").

Under the HFCA Act, the SEC was required to issue rules relating to the HFCA Act's document submission requirements within 90 days of enactment. Accordingly, the amendments address the HFCA Act's document submission requirements and disclosure requirements, but future rulemaking will be needed to implement the process for identifying Commission-Identified Issuers, as well as other aspects of the HFCA Act. Set forth below is a brief summary of the relevant requirements of the HFCA Act and how those requirements were implemented in the amendments.

  HFCA Act Interim Final Amendments
Submission Requirements Required the SEC to adopt rules within ninety days of enactment that would require Commission-Identified Issuers to submit documentation to the SEC demonstrating that they are not owned or controlled by a governmental entity in the foreign jurisdiction of the registered public accounting firm that the PCAOB is unable to inspect or investigate completely. Amends the relevant forms (i.e., Forms 10-K, 20-F, 40-F and N-CSR) to require submission via EDGAR on or before the due date for the relevant form of documentation establishing that the Commission-Identified Issuer is not owned or controlled by a governmental entity in the foreign jurisdiction of the registered public accounting firm that the PCAOB is unable to inspect or investigate completely.

The SEC does not specify the types of documentation that should be submitted, instead opting to provide flexibility as it gathers public comment on whether it should require specific types of documentation, or whether it should provide additional guidance on this requirement.

Disclosure Requirements Required Commission-Identified Issuers that are foreign issuers (referred to in the amendments as "Commission-Identified Foreign Issuers") to disclose in their annual reports, whether on Form 10-K, 20-F or an equivalent form, (1) that, during the period covered by the applicable form, the registered public accounting firm (which the PCAOB is unable to inspect or investigate completely because of a position taken by an authority in the applicable foreign jurisdiction) prepared an audit report for the foreign issuer, (2) the percentage of the shares of the foreign issuer owned by governmental entities in the foreign jurisdiction in which the foreign issuer is incorporated or organized, (3) whether governmental entities in the applicable foreign jurisdiction with respect to the registered public accounting firm have a controlling financial interest in the foreign issuer, (4) the name of each official of the Chinese Communist Party who is a member of the board of directors of the foreign issuer or the operating entity of the foreign issuer, and (5) whether the certificate or articles of incorporation of the foreign issuer contains any charter of the Chinese Communist Party. Amends Forms 10-K, 20-F, 40-F, and Form N-CSR, to add a disclosure item titled "Disclosure Regarding Foreign Jurisdictions that Prevent Inspections," requiring Commission-Identified Foreign Issuers to disclose the matters set forth in the HFCA Act. This new item will be located in Part II, Item 9C in the Form 10-K.

The SEC expects to make the determination of whether registrants had a "non-inspection year" (and are therefore Commission-Identified Issuers), after the filing of the relevant annual report. Thus, any submission or disclosure requirements applicable to those registrants would apply to the next-filed annual report. For example, if a December 31 fiscal year-end company files its fiscal 2021 annual report on Form 10-K in February 2022, and the audit report is signed by a registered public accounting firm located in a foreign jurisdiction that limits PCAOB inspections, then that company would be a Commission-Identified Issuer for 2022. Thus, when the company files its fiscal 2022 annual report on Form 10-K in 2023, regardless of which registered public accounting firm signs the audit report, it will be required to comply with the applicable submission and/or disclosure requirements.

The HFCA Act also provides that if a Commission-Identified Issuer has three consecutive non-inspection years, then the SEC must prohibit the trading of that registrant's securities. The SEC can remove this prohibition if the registrant certifies to the SEC, and the SEC is satisfied, that the registrant has retained a registered public accounting firm that the PCAOB has inspected. However, if the registrant has another non-inspection year, then the registrant will be delisted again and will need to wait five years before seeking an end to that prohibition. The interim final amendments do not include any rulemaking relating to this "delisting" requirement, with the SEC stating that it "will be addressed separately at a later date."

What to Do Now?

The amendments will be effective 30 days after publication in the Federal Register. However, as discussed above, no submission or disclosure requirements will apply until the SEC implements a process for determining Commission-Identified Issuers, which it expects to do later this year. The SEC is soliciting public comment on this identification process, including, among other things, whether the SEC's review and determination should occur on an annual basis or more frequently, as well as when the determination should occur, whether the SEC should publish a list of Commission-Identified Issuers on its website or otherwise identify these issuers on EDGAR, and whether the SEC should use a structured data tagging requirement for the auditor name and auditor office location on the audit report, as well as other aspects of these rules. Interested parties should submit comments to the SEC here. Meanwhile, any company that may be deemed to be a Commission-Identified Issuer, should, in consultation with counsel, consider the implications of the new submission and disclosure requirements under the interim rules as well as the consequence of continued non-inspection years (which include potential delisting).

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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