On September 22, 2021, the Public Company Accounting Oversight Board (the “PCAOB“) adopted a final rule (the “Final Rule“) implementing the Holding Foreign Companies Accountable Act (the “HFCAA“), which became law in December 2020 and prohibits foreign companies from listing their securities on U.S. exchanges if the company has been unavailable for PCAOB inspection or investigation for three consecutive years. The Final Rule (available here) requires U.S. Securities and Exchange Commission (the “SEC“) approval before it goes into effect.
In May 2021, the SEC adopted interim final amendments (the “Amendments“, available here) to certain forms, including Forms 20-F and 10-K, to implement the disclosure and submission requirements of the HFCAA. In June 2021, the Senate passed the Accelerating Holding Foreign Companies Accountable Act (the “AHFCAA“), which, if signed into law, would reduce the time period for the delisting of foreign companies under the HFCAA to two consecutive years, instead of three years.
Three aspects of the HFCAA and the PCAOB’s Final Rule should be kept in mind:
1. China and Hong Kong – The Two Jurisdictions Where Registrants Currently Run the Risk of Delisting. The HFCAA requires the SEC to identify registrants (each, a “Commission-Identified Issuer“) that have retained a registered public accounting firm to issue an audit report where that registered public accounting firm has a branch or office that:
- Is located in a foreign jurisdiction; and
- The PCAOB has determined that it is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.
As reflected on the PCAOB’s website, the PCAOB is currently unable to inspect or investigate accounting firms due to a position of the local authority in only two jurisdictions: China and Hong Kong.[1] The PCAOB thus will likely determine that it is unable to inspect accounting firms that are solely based in China or Hong Kong, and as a result, the SEC will identify registrants that retain such accounting firms as Commission-Identified Issuers.
If a registrant is determined to be a Commission-Identified Issuer for three consecutive years, Section 2 of the HFCAA directs the SEC to prohibit trading of the registrant’s securities on the U.S. stock exchanges. The SEC is still considering ways to implement the trading prohibition mandated by the HFCAA. If the AHFCAA is signed into law, the SEC has to prohibit trading of a Commission-Identified Issuer that is identified as such for two consecutive years, instead of three.
2. The PCAOB Affirmed That Its Analysis Applies to Distinct Legal Entities, Not Networks. In its Amendments issued in May, the SEC noted that it would defer to some extent to the PCAOB in determining which firms had a “branch or office” in a particular foreign jurisdiction:
Where a branch or office of an international firm network is a separate legal entity from the U.S.-based or international firm network and that branch or office signs the audit report in its own name, the Commission will look to the PCAOB determination for that branch or office and not apply that determination to the U.S.-based or other branches or offices of that firm network that are not based in the PCAOB-identified foreign jurisdiction.
In response, the PCAOB’s Final Rule makes clear that the “branch or office” concept applies only to a particular firm and will not implicate audit reports issued by other members of a global network:
In some instances, a member firm of an international firm network might be headquartered in a jurisdiction that becomes subject to a jurisdiction-wide determination of the Board. In such a circumstance, if that member firm is a separate legal entity from the other member firms in the network and signs audit reports in its own name, the Board would not treat other member firms in the network as being “located” or having an “office” in that jurisdiction merely because they are part of the same network as a member firm subject to the jurisdiction-wide determination.
Indeed, the PCAOB discarded the term “branch” entirely in the Final Rule, and determined to identify firms based solely on their “office” locations.
3. Commission-Identified Issuers Are Subject to Reporting and Disclosure Requirements. Once identified as a Commission-Identified Issuer, a registrant must, prior to filing its annual report, submit documentation to the SEC that establishes that it is not owned or controlled by a governmental entity in that foreign jurisdiction.
Additionally, a Commission-Identified Issuer will have to disclose the following items in its annual report:
- That, during the period covered by the form, the registered public accounting firm has prepared an audit report for the issuer;
- The percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized;
- Whether governmental entities in the applicable foreign jurisdiction with respect to that registered public accounting firm have a controlling financial interest with respect to the issuer;
- The name of each official of the Chinese Communist Party (the “CCP”) who is a member of the board of directors of the issuer or the operating entity with respect to the issuer; and
- Whether the articles of incorporation of the issuer (or equivalent organizing document) contains any charter of the CCP, including the text of any such charter.
All issuers should note that a new item, Item 9C (“Disclosure Regarding Foreign Jurisdictions that Prevent Inspections”), has been added to Forms 10-K and 20-F. But except for this relatively minor change, registrants who are not identified as a Commission-Identified Issuer will not be impacted by the HFCAA and these recent developments.
[1] See https://pcaobus.org/oversight/international (providing a map of jurisdictions showing where the Board currently is able to conduct oversight of registered firms and where the Board currently is denied the necessary access to conduct oversight activities).
By Michael Scanlon, David Lee, David Ware, and Maggie Zhang