In December 2020, the Holding Foreign Companies Accountable Act, co-sponsored by Senators John Kennedy, a Republican from Louisiana, and Chris Van Hollen, a Democrat from Maryland, was signed into law. The HFCAA amended SOX to prohibit trading on U.S. exchanges of public reporting companies audited by audit firms located in foreign jurisdictions that the PCAOB has been unable to inspect for three sequential years. (See this PubCo post.) According to SEC Chair Gary Gensler, “[w]e have a basic bargain in our securities regime, which came out of Congress on a bipartisan basis under the Sarbanes-Oxley Act of 2002. If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the [PCAOB]….This final rule furthers the mandate that Congress laid out and gets to the heart of the SEC’s mission to protect investors….The Commission and the PCAOB will continue to work together to ensure that the auditors of foreign companies accessing U.S. capital markets play by our rules. We hope foreign governments will, working with the PCAOB, take action to make that possible.” Last week, the SEC adopted final amendments to implement the HFCAA. The amendments will be effective 30 days after publication in the Federal Register.
The HFCAA requires the SEC to “identify” each public reporting company that has retained a registered public accounting firm to issue an audit report if that firm has a branch or office in a foreign jurisdiction and the PCAOB has been “unable to inspect or investigate [that firm] completely because of a position taken by an authority in the foreign jurisdiction.” In addition, once a public reporting company has been so “identified” by the SEC, the HFCAA imposes requirements on the company to submit certain documentation to the SEC establishing that it is not owned or controlled by a governmental entity in the foreign jurisdiction and to provide certain disclosures. The HFCAA prohibits trading on exchanges and other markets in the U.S. of companies that have been so “identified” for three sequential years.
In November, the SEC approved the PCAOB’s proposed framework for its determinations under the HFCAA that it is unable to inspect or investigate completely a registered public accounting firm located in a foreign jurisdiction because of a position taken by one or more authorities in that jurisdiction.
In March, the SEC adopted interim final amendments (see this PubCo post) and, on Thursday last week, the SEC adopted final amendments, to Forms 20-F, 40-F, 10-K and N-CSR to implement the submission and disclosure requirements of the HFCAA. In addition, the SEC established procedures to identify companies and prohibit the trading of the securities of these identified companies after three sequential non-inspection years as required by the HFCAA. Essentially, the final amendments conform to the interim final rules with some modifications: they make clear that disclosure requirements apply to variable interest entities and include requirements for data-tagging (Inline XBRL). They also establish new procedures for the SEC to “identify” companies subject to the mandate and prohibit trading in appropriate cases in accordance with the HFCAA.
Documentation. According to the fact sheet and the final amendments, each public reporting company that has been “identified” by the SEC will be required to submit to the SEC, on EDGAR, on or before the company’s annual report due date, documentation that “establishes that it is not owned or controlled by a governmental entity in its public accounting firm’s foreign jurisdiction.” The SEC is not offering up a list of documentation that may be appropriate, but rather permits companies to “determine the appropriate documentation to submit in response to the requirement, based on their organizational structure and other registrant-specific factors.” In addition, the SEC believes that the terms “owned or controlled,” “owned,” and “controlling financial interest” in the HFCAA “reference a person’s or governmental entity’s ability to ‘control’ the registrant as that term is used in the Exchange Act and the Exchange Act rules.”
Disclosures. A company that is also a “foreign issuer,” as defined in Rule 3b-4, will be required to provide specified disclosures in its annual report for the year that the SEC has identified the company, as reflected in the amendments to Form 10-K (which adds new Item 9C to Part II), Form 20-F, Form 40-F and Form N-CSR. The disclosures are to be made by the company “for itself and its consolidated foreign operating entity or entities, including any variable-interest entity or similar structure that results in additional foreign entities being consolidated in the [the company’s] financial statements.” That is, the amendments require the company to “look through a VIE or any structure that results in additional foreign entities being consolidated in the financial statements of the registrant and provide the required disclosures about any consolidated operating company or companies in the relevant jurisdiction.” The required disclosures include:
To help the SEC with it identification process, the final amendments also include a new Inline XBRL tagging requirement related to three additional data elements: identification of the auditor who provided the opinion on the financials in the report, the location where the report was issued and the PCAOB ID number of the audit firm. Once the updated taxonomy is “published, deployed to EDGAR, and announced” as part of the new EDGAR Filer Manual released in December 2021, “all registrants will be required to use the updated taxonomy,…for any annual report filed for a period ended after December 15, 2021.
Timing. Companies will be required to comply with the submission and disclosure requirements in their annual reports for each year that they have been identified by the SEC. The SEC will identify companies under the HFCAA based on the PCAOB’s determination regarding the audit firm and on companies’ annual reports for fiscal years beginning after December 18, 2020, the date of enactment of the HFCAA. The earliest date for identification would be after companies file their annual reports for 2021 and name the accounting firm. Accordingly, if a company is identified by the SEC based on its 2021 annual report filed in 2022, the company will be required to comply with the submission and, if applicable, the disclosure requirements in its annual report for the fiscal year ending December 31, 2022, to be filed in 2023.
SEC identification. The SEC will “identify” a company as early as possible after the company files its annual report and on a rolling basis using Inline XBRL, based on whether the audit report is signed by an audit firm that the PCAOB is unable to inspect because of a position taken by an authority in the foreign jurisdiction. The SEC will “provisionally identify” the company on the SEC’s website at www.sec.gov/HFCAA. For 15 business days after this provisional identification, the company may email the SEC if it believes it has been incorrectly identified, providing evidence supporting its claim. The SEC will review and analyze the information and respond by email as to whether the SEC agrees (and will remove the name from the list) or disagrees, in which case the SEC will “conclusively identify” the company on a separate list. If the company does not contact the SEC to dispute the provisional identification within 15 business days, the identification will become conclusive. The SEC will publish a list on its website identifying these companies, indicating the number of consecutive years the company has been on the list and noting whether the company has been subject to any prior trading prohibitions. The list is intended to provide notice to investors and other market participants regarding whether a security has been issued by an “identified” company and the risk that the security may be subject to a trading prohibition in the future.
Trading prohibition. The HFCAA requires the SEC to prohibit the trading of the securities of a company on the exchanges, OTC or through any other method within the jurisdiction of the SEC to regulate after the company has been conclusively “identified” by the SEC for three consecutive years. To end a trading prohibition, an “identified” company must certify that it has retained or will retain a registered public accounting firm that the PCAOB has determined it is able to inspect or investigate, including by filing financial statements that include an audit report signed by the new firm. Accordingly, the SEC observes, companies will have three years to retain an audit firm that the PCAOB can inspect before a prohibition is imposed. If the SEC ends the initial trading prohibition and then the company is again conclusively identified by the SEC, the SEC will impose a subsequent minimum five-year trading prohibition.