December 08, 2020
On December 2, 2020, the U.S. House of Representatives unanimously passed the bill entitled “Holding Foreign Companies Accountable Act” (the “Act”), the full text of which is available at https://www.congress.gov/bill/116th-congress/senate-bill/945, which had been passed by the U.S. Senate on May 21, 2020 and is now headed to the President for signature. If the Act is signed by the President, as anticipated, it will become law as an amendment to the Sarbanes-Oxley Act of 2002. The Act addresses the issue that the Public Company Accounting Oversight Board (the “PCAOB”) has been unable to inspect audit firms in certain “non-cooperating jurisdiction[s].” The sponsors of the Act have stated that the Act would focus on protecting American investors and their retirement savings from foreign companies that have been operating on U.S. stock exchanges while flouting Securities and Exchange Commission (the “SEC”) oversight.
- Impact on the Initial Public Offerings of Chinese Companies
- Summary of the Act
- Next Steps for the SEC
The Act will likely increase the scrutiny and oversight of Chinese companies on U.S. stock markets. The Act, however, does not block the initial public offerings of Chinese companies whose audit firm the PCAOB is unable to inspect and, more importantly, it does not impact Chinese companies who employ audit firms that are subject to PCAOB inspection. A list of the audit firms that are not subject to PCAOB inspection can be found at https://pcaobus.org/oversight/international/international/inspections/notyetinspected. In addition, most of the Chinese companies seeking to be listed in the U.S. are already providing disclosures highlighting the risks associated with China-based issuers regarding financial reporting, access to information/regulatory oversight, organizational structure, and regulatory environment, as specified in the recent guidance published by the SEC on November 23, 2020 (https://www.sec.gov/corpfin/disclosure-considerations-china-based-issuers).
- Trading prohibition after 3 years of non-inspections
- Disclosure of relationship with governmental entities
Where the SEC determines that the PCAOB has been unable to inspect the public accounting firm retained by a covered issuer to prepare such issuer’s audit reports for three consecutive years, the SEC is required to prohibit the issuer from having its securities traded on a national securities exchange (such as Nasdaq or the NYSE) or any over-the-counter (the “OTC”) markets in the United States. Under the Act, the three-year period will start with 2021 if the Act is enacted before the end of 2020, and therefore the earliest flurry of delisting/going-private transactions is expected to start in 2024.
In addition, the Act requires the identified issuer to provide additional disclosures with respect to foreign government control and ownership, which appears largely duplicative of existing SEC disclosure requirements for foreign companies.
The Act offers the SEC actions that it has not taken with respect to listed companies before. How this Act will influence the expected proposal on this topic from the SEC still remains to be seen.
If the Act is executed by the President, the SEC will then have 90 days to adopt regulations to implement the law, which regulations are expected to provide more clarification of the provisions and might address the following ambiguities:
- Term “owned or controlled by a governmental entity”
- Involuntary delisting procedures
- OTC market
- Identification of issuer
The term “owned or controlled by a governmental entity” is not fully defined, which might lead necessarily to banning the public trading of the securities of all state-owned or controlled issuers.
Normally, involuntary delisting procedures are carried out by a stock exchange instead of the SEC. Whether the SEC would come up with any rule requiring stock exchanges to delist companies or create a separate process for it to be able to carry out de-listings directly is ambiguous.
The SEC is required under the Act to block trading in relevant securities in the OTC market, which the SEC often regulates through actions affecting registered broker-dealers. Rules might be adopted in the future to bar U.S. registered broker-dealers from effecting transactions in such securities.
The SEC is required under the Act to identify issuers as to which the PCAOB has been unable to conduct a thorough audit firm inspection. The details as to how this identification procedures will be performed are ambiguous.
We will continue to closely follow developments on the Act.
If you have any questions or concerns about the matters above, you can contact us via email firstname.lastname@example.org or phone +1(212) 530-2210.
DISCLAIMER: Hunter Taubman Fischer & Li LLC assumes no responsibility for the accuracy or timeliness of any information provided herein. The information contained herein is for informational purposes only and is not legal advice or a substitute for legal counsel. The information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.