On December 18, the Holding Foreign Companies Accountable Act was signed into law. The HFCAA, co-sponsored by Senators John Kennedy, a Republican from Louisiana, and Chris Van Hollen, a Democrat from Maryland, amends SOX to prohibit trading on U.S. exchanges of public reporting companies audited by registered public accounting firms that the PCAOB has been unable to inspect for three sequential years. The HFCAA also requires substantial action by the SEC to implement it. As I noted in my previous post about the bill (see this PubCo post), it was unclear how the bill would affect or interact with the proposal on this same topic that the SEC staff have been working on, which had been expected this month (see this PubCo post and this PubCo post). Now, SEC Chair Jay Clayton has issued a statement clarifying the situation.
As you may recall, the HFCAA amends SOX to impose certain requirements on a public company identified by the SEC as a company that files in its periodic reports financial statements audited by a registered public accounting firm with a branch or office located in a foreign jurisdiction that the PCAOB is “unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.” The SEC-identified public company will be required, under new rules to be adopted by the SEC within 90 days after enactment, to submit to the SEC documentation that establishes that the company is not owned or controlled by a governmental entity in the foreign jurisdiction. In addition, if the SEC determines that the public company has three consecutive “non-inspection years,” the SEC “shall prohibit the securities of the covered issuer from being traded” on a national securities exchange, over the counter or through any other method within the jurisdiction of the SEC. If, after a prohibition has been imposed, the company then 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 SEC is then required to end that prohibition, although the ban can be reimposed in the event there is a recurrence of a non-inspection year.
In August, the President’s Working Group on Financial Markets (which includes Treasury Secretary Steven T. Mnuchin, Fed Chair Jerome H. Powell, SEC Chair Jay Clayton and CFTC Chair Heath P. Tarbert) issued a Report on Protecting United States Investors from Significant Risks from Chinese Companies. The Report made five recommendations “designed to address risks to investors in U.S. financial markets posed by the Chinese government’s failure to allow audit firms that are registered with the Public Company Accounting Oversight Board (PCAOB) to comply with U.S. securities laws and investor protection requirements.” (For more details about those recommendations, see this PubCo post.) Among the recommendations was advice to enhance the listing standards of U.S. exchanges to require, as a condition of initial and continued exchange listing, PCAOB access to main auditor work papers either directly or through “co-audits.”
After the Working Group issued its Report, Clayton indicated that he had already “directed the SEC staff to prepare proposals in response to the Report’s recommendations for consideration by the Commission.” (See this PubCo post.) According to the WSJ, that proposal was expected to be issued in December and would have required Chinese companies with shares traded on U.S. exchanges to use auditors overseen by U.S. regulators or risk delisting. The proposal would impose obligations on the NYSE and Nasdaq to require compliance with PCAOB audit inspections or prohibit listing. Chinese-based companies that were already listed would have a “few years to comply before possibly losing their listing.” According to the article, “China has said it is worried about auditors revealing strategic secrets held by domestic firms, some of which are majority-owned by the Chinese government. The country put up a new hurdle this year, implementing a law that prevents its citizens and companies from complying with overseas securities regulators without the permission of its own market supervisor and other components of the Chinese government.” To address that issue, it was anticipated that the SEC would adopt the “co-audit” approach recommended by the Working Group, an audit from an accounting firm based in a country where auditors comply with PCAOB oversight. That is, 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 through a co-audit arrangement. (Just how thrilled the Big Four audit firms are with this aspect of the proposal remains to be seen.) The WSJ reported that the NYSE and Nasdaq declined to incorporate these changes into their listing requirements on their own initiative—which would have been faster—without clearer guidance from the SEC about how co-audits would work.
The question then is how to harmonize the HFCAA mandate with the proposal in process. In his statement, Clayton indicates that the staff have been “actively working on proposals…most notably enhanced exchange listing standards and access to audit work papers” by the PCAOB. In particular, he notes that the staff were considering proposals to amend Reg S-X Rule 2-01(a) “to provide that only U.S. registered public accounting firms will be recognized by the Commission as a qualified auditor of an issuer incorporated or domiciled in non-cooperating jurisdiction (as defined) for purposes of the federal securities laws,” and to enhance U.S. exchange listing standards “to prohibit the initial and continued listing of issuers that fail to timely file with the Commission all required reports and other documents, or file a report or document with a material deficiency, which includes financial statements not prepared by a U.S. registered public accounting firm recognized by the Commission as a qualified auditor.” As Clayton observes, the staff’s proposal would substantially “overlap” with the HFCAA. As a result, Clayton indicated that he has “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.” In addition, he has “asked the staff to consider additional issues relating to the Act’s implementation, including how the Act’s disclosure requirements can be implemented expeditiously and how any actual or perceived uncertainty can be addressed in a manner consistent with congressional intent as well as investor protection and the fair and orderly operation of our markets.” This direction to the staff means, of course, that consideration of the proposal will not occur during his tenure.
Happy holidays everyone! Happy 2021!