On December 18, 2020, the Holding Foreign Companies Accountable Act (the “Act”) was signed into law by President Trump after it was passed unanimously by the U.S. House of Representatives on December 2, 2020. The Act is identical to the bill the U.S. Senate passed in May 2020. Most significantly, the Act would amend the Sarbanes-Oxley Act of 2002 to require the U.S. Securities and Exchange Commission (the “SEC”) to prohibit the securities of foreign companies from being traded on U.S. securities markets, if the company retains a foreign accounting firm that cannot be inspected or investigated completely by the Public Company Accounting Oversight Board (the “PCAOB”) for three consecutive years, beginning in 2021. The Act would also require foreign companies to make certain disclosures about their ownership by governmental entities.
The enactment of the Act was the latest development of U.S. policy makers’ efforts to address the long-lasting concern with PCAOB’s inability to conduct inspections on foreign companies, especially Chinese companies, whose securities are listed in the U.S. Amid the U.S.-China tensions from the trade war and U.S. national security concerns, the Act was unanimously passed by House and Senate in a campaign that has featured these earlier steps in 2020:
- August 6, 2020 – the President’s Working Group on Financial Markets released a report recommending that the SEC take steps to enhance the listing standards on U.S. exchanges (the “PWG Report”). (More details here).
- July 9, 2020 – the SEC held a roundtable on investing in emerging markets. At the core of the discussion was the regulatory impasse between the U.S. and China over the ability of the PCAOB to conduct inspections and investigations of Chinese accounting firms.
- June 4, 2020 – a presidential memorandum directs federal agencies to develop regulatory measures to protect U.S. investors from “risks from Chinese companies,” calling for “firm, orderly action to end the Chinese practice of flouting American transparency requirements without negatively affecting American investors and financial markets.”
- May 20, 2020 – the U.S. Senate passed the Act by unanimous consent. (More details here).
- April 21, 2020 – the SEC then-Chairman Jay Clayton issued a joint public statement with the chairman of the PCAOB and officials from the SEC regarding possible risks associated with investing in China, including due to the PCAOB’s inability to inspect audit work papers in China.
KEY PROVISIONS OF THE ACT
1. Prohibition on Trading
If the SEC determines that a public company has three consecutive “non-inspection years,” beginning in 2021, the SEC would prohibit the company’s securities from being traded on a U.S. national securities exchange or an “over-the-counter” market subject to SEC regulations.
If, following the delisting of a company for noncompliance, the company certifies to the SEC that it has retained a registered public accounting firm that the PCAOB has inspected to the satisfaction of the SEC, the Act directs the SEC to end the prohibition on trading on U.S. securities markets.
If non-inspection recurs after the SEC ends a prohibition, the SEC will prohibit the company’s securities from being traded on a U.S. national securities exchange for at least five years. Such prohibition could only be removed if, after the end of the five-year period, the company certifies that it will retain an accounting firm that the PCAOB is able to inspect.
2. Additional Certification and Disclosures
If the PCAOB can’t inspect the foreign accounting firm’s work, then the company will be required to submit to the SEC documentation certifying that the company is not owned or controlled by a governmental entity in the foreign jurisdiction in which its registered public accounting firm is located.
In addition, for each year that the PCAOB is unable to inspect a company’s accounting firm, the company will be required to disclose in a form filed with the SEC, among other things, the percentage of the company’s shares owned by governmental entities and its relationship with the Chinese Communist Party.
COMPARISON BETWEEN THE ACT AND THE PWG REPORT
Among the five recommendations made in the PWG Report, the first recommendation is similar to the trading prohibition provision under the Act, except for the following differences:
- The PWG Report recommends enhancing the listing standards of U.S. exchanges, which would be enforced by stock exchanges such as NYSE and Nasdaq as a condition of initial and continued exchange listing on such exchanges; while the Act would apply to all the covered issuers listed on the U.S. capital markets and would be enforced by the SEC.
- The PWG Report recommends a transition period until January 1, 2022, for currently listed companies and suggests applying the new listing standards immediately to new company listings once the necessary rulemakings and/or standard-setting are effective. Under the Act, the SEC shall decide whether listed companies have “non-inspection years” since 2021, but the Act does not appear to impose any additional restrictions on new listings.
- In addition to the delisting provision, the PWG Report also offers a co-audit arrangement. Under the co-audit arrangement, the company would be required to engage an affiliated U.S.-member registered public accounting firm that would serve as the principal auditor of the company’s financials, and supervise the work of the accounting firm in the jurisdiction that do not provide the PCAOB with sufficient access (“NCJ”).
While primarily aimed at China-based companies, the Act would apply to any other non-U.S. companies located in NCJs. A press release from Senator Van Hollen indicates that there are 224 U.S.-listed companies, with a combined market capitalization of more than $1.8 trillion, located in NCJs.
The Act requires the SEC to issue new rules within 90 days of the enactment to implement the Act. In his statement issued on December 18, 2020, the SEC then-Chairman, Clayton observed that the SEC staff’s proposal in response to the PWG Report’s recommendations would substantially overlap with the Act. As a result, Clayton indicated that he had “directed the staff to consider providing a single consolidated proposal for the Commission’s consideration on issues related to the PCAOB’s access to audit work papers, exchange listing standards, and trading prohibitions.”
How the SEC will harmonize the Act mandate with PWG Report’s recommendations in one set of rules, particularly on the following two issues, is worthy of special attention:
- “Co-audit” Arrangement: It was anticipated that the SEC would adopt the “co-audit” approach recommended by the PWG Report. However, it’s unclear whether and how this approach could work in practice as it will be subject to regulation in NCJs such as China. Where there exists regulatory conflict, accounting firms still need regulatory guidance when the NCJ’s rules restrict information flow between a local auditor in the NCJ and the principal auditor located in the United States.
- Enhanced Standard for New Listings: The Act would not apply to initial listings of stock on a U.S. exchange. If the SEC follows the recommendations set by the PWG Report, then the stock exchanges would apply enhanced listing standards for new issuers starting January 1, 2022. This could implicate that if the “co-audit” arrangement cannot work out in practice to the satisfaction of U.S. regulators prior to January 1, 2022, new issuers from NCJs will not be admissible for listing by the U.S. stock exchanges.
It remains to be seen whether the new SEC Chairperson, to be appointed by President Biden, will comply with the priorities set by the PWG Report when promulgating the implementation rules of the Act, or take a more reconciliatory approach with the regulatory counterparts in NCJs.