- President Donald Trump issued a memorandum requesting the President's Working Group on Financial Markets (PWG) to study ways to protect U.S. investors from significant risks from Chinese companies listed on the U.S. stock exchange and the Chinese government's practice of denying access to audit work.
- The President's Memorandum was triggered by financial statement fraud committed and self-disclosed by Luckin Coffee Inc., a Chinese coffee chain company listed on Nasdaq, in early April 2020.
- This is another action taken by the Trump Administration against Chinese companies at a time of rising tensions between the United States and China.
President Donald Trump on June 4, 2020, issued the Presidential Memorandum on Protecting United States Investors from Significant Risks from Chinese Companies. It directs the President's Working Group on Financial Markets (PWG) to propose the following recommendations within 60 days to President Trump:
- actions that the executive branch may take to protect investors in U.S. financial markets from the failure of the Chinese government to allow Public Company Accounting Oversight Board (PCAOB)-registered audit firms to comply with U.S. securities laws
- inspection or enforcement actions that the U.S. Securities Exchange Commission (SEC) or PCAOB should take with respect to PCAOB-registered audit firms that fail to provide requested audit working papers or otherwise fail to comply with U.S. securities laws
- for actions that federal agencies should take to protect U.S. investors in companies from China or other countries that do not comply with U.S. securities laws and investor protections
The President's Memorandum is better understood in the context of the background information provided below, triggered by the financial situation surrounding Luckin Coffee.
On April 2, 2020, Luckin Coffee Inc., a Chinese coffee chain company listed on Nasdaq (Nasdaq: LK) disclosed to the SEC that it had launched an internal investigation and discovered that its chief operating officer had fabricated 2019 transactions by around 2.2 billion renminbi (approximately $313.5 million).1 Investors were told not to rely on its financial statements and other communications relating to its financials starting the second quarter of 2019. The company's stock price plummeted more than 80 percent from the previous day's closing price of $26.20 to April 2's opening price of $4.91. 2
On April 21, 2020, the SEC issued a public statement "Emerging Market Investments Entail Significant Disclosure, Financial Reporting and Other Risks; Remedies are Limited" listing certain risks that the disclosures by Chinese companies may be "incomplete or misleading." One of the major risks mentioned is the PCAOB's lack of access to inspect audit work and practices of PCAOB-registered accounting firms in China with respect to their audit work of U.S. reporting companies.
On May 18, 2020, Nasdaq proposed three new rules to the SEC targeting companies principally administered in a "restrictive market": 1) a proposal to adopt a new requirement related to the qualification of management for certain companies, 2) a proposal to apply additional initial listing criteria for companies primarily operating in a jurisdiction that has secrecy laws, blocking statutes, national security laws or other laws or regulations restricting access to information by regulators of U.S.-listed companies, and 3) a proposal to apply additional and more stringent criteria to an applicant or listed company based on the qualifications of the company's auditor.3 A "restrictive market" refers to "a jurisdiction that has secrecy laws, blocking statutes, national security laws or other laws or regulations restricting access to information by regulators of U.S.-listed companies in such jurisdiction." There is little doubt that China would be deemed a restrictive market under this definition.
On May 20, 2020, the Senate passed the Holding Foreign Companies Accountable Act by unanimous consent to amend the Sarbanes-Oxley Act of 2002 to impose more requirements and restrictions on certain companies in a foreign jurisdiction that prevent the PCAOB from performing inspections or investigations. If the bill is approved by the House and signed into law by President Trump, it could effectively ban certain companies from being listed on U.S. stock exchanges and give the SEC more leverage in gaining access to inspect audit work and practices of PCAOB-registered audit firms in China, as such information often has been withheld as state secrets.
On June 4, 2020, the same day that President Trump issued the Presidential Memorandum, Secretary of State Mike Pompeo issued a press statement applauding the proposed rules from Nasdaq and stating that "Nasdaq's action should serve as a model for other exchanges in the United States, and around the world." The statement emphasizes the Trump Administration's intent to make it difficult for Chinese companies to be listed and traded in exchanges in the United States and around the world.
Conclusion and Considerations
The series of proposed rules, laws, U.S. government actions and the existing tensions between the two countries have led a number of U.S.-listed Chinese companies to seek a secondary listing in Hong Kong. It is expected that this trend will continue until after all the rules are finalized and U.S.-listed Chinese companies make a determination as to whether it is advisable to remain in the U.S. market.
The Trump Administration's foreign policy toward China remains hostile and fast moving, exposing companies and organizations engaging in U.S.-China businesses to significant uncertainty.
1 Luckin Coffee Announces Formation of Independent Special Committee and Provides Certain Information Related to Ongoing Internal Investigation, Globe Newswire, April 2, 2020
2 Luckin Coffee Historical Data, Yahoo Finance (as of July 28, 2020)
3 Nasdaq Proposes to Adopt Additional Initial Listing Requirements for Restrictive Markets Companies, Nasdaq, May 19, 2020