The Situation: The U.S. Public Company Accounting Oversight Board's ("PCAOB") ability to inspect and investigate PCAOB-registered public accounting firms in mainland China and Hong Kong was previously restricted by Chinese regulators. The U.S. Holding Foreign Companies Accountable Act ("HFCAA"), adopted in 2020, mandated that following three consecutive years of restricted access, companies audited by such firms would be subject to a trading prohibition in U.S. capital markets.
The Result: The PCAOB signed a Statement of Protocol with the China Securities Regulatory Commission ("CSRC") and the Ministry of Finance of the People's Republic of China ("PRC"), establishing a framework for the PCAOB to conduct required inspections and investigations of China-based accounting firms.
Looking Ahead: While the signing of the Statement of Protocol is a welcome first step, compliance with the agreement will ultimately determine the risk of delisting faced by hundreds of companies audited by China-based accounting firms pursuant to the HFCAA.
On August 26, 2022, the PCAOB signed a Statement of Protocol with the CSRC and the Ministry of Finance of the PRC, forging a pathway for the PCAOB to fully inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong.
U.S. and Chinese officials have negotiated the issue of PCAOB access to China-based accounting firms for years, after a 2013 memorandum of understanding on enforcement cooperation failed to result in a final agreement. In 2020, the U.S. Congress passed the HFCAA, which, as addressed in our July 2020 White Paper, requires enhanced disclosure from companies whose auditors are unable to be inspected by the PCAOB and subjects such companies to mandatory delisting from U.S. stock exchanges if the PCAOB is unable to inspect their audit firms for three consecutive years. In 2021, the PCAOB and the U.S. Securities and Exchange Commission ("SEC") began implementing the HFCAA by identifying public companies engaging auditors that the PCAOB has determined it was unable to inspect or investigate completely under the requirements of PRC regulators.
The Statement of Protocol marks the latest step toward resolving the more than a decade-long effort to close the gap on the inspection of China-based PCAOB-registered accounting firms. It comes shortly after five U.S.-listed Chinese state-owned companies identified under the HFCAA took action to voluntarily delist from U.S. stock exchanges.
The Statement of Protocol establishes a comprehensive framework for the PCAOB to inspect and investigate PCAOB-registered accounting firms in mainland China and Hong Kong. The Statement of Protocol, which the SEC labelled as the most detailed, prescriptive arrangement the PCAOB has reached with any country, addresses several areas of prior contention. In particular, the Statement of Protocol allows the PCAOB to (i) exercise its sole discretion to select any issuer audits for inspection or investigation, (ii) receive redaction-free and complete audit work papers for use by its inspectors, (iii) obtain direct access to interview all personnel of the target audit firms, and (iv) transfer information about its findings to the SEC in accordance with the Sarbanes-Oxley Act.
In its statement, the CSRC emphasized the fully reciprocal nature of the Statement of Protocol and highlighted that the two sides will coordinate in advance to plan for inspections and investigations, with materials to be reviewed by the PCAOB—including audit work papers—being obtained by and transferred to the PCAOB through the Chinese regulators. The CSRC also highlighted the participation of Chinese regulators in the interviews and testimony of relevant audit firm personnel when requested by the PCAOB.
The PCAOB has begun preparations for PCAOB inspection teams to be on the ground in mainland China and Hong Kong by mid-September, with the expressly stated goal of putting the Statement of Protocol "to the test." Both the PCAOB and the SEC highlighted that the Statement of Protocol is only a first step, with the critical next step being assessment of whether the written framework translates into complete access for the PCAOB.
The Statement of Protocol marks an important and positive development and strikes a note of cautious optimism for the nearly 200 public companies with PCAOB-registered accounting firms based in mainland China and Hong Kong. However, significant uncertainty remains as to whether on-the-ground implementation will satisfy both U.S. and Chinese regulators. Jones Day will continue to monitor subsequent developments regarding the implementation of the Statement of Protocol so that we may assist our clients in managing any uncertainty until further clarity is available.
Three Key Takeaways
- The Statement of Protocol is an important and positive development that, if successfully implemented, would mitigate the delisting risk faced by nearly 200 public companies as a result of the HFCAA.
- Uncertainty remains as to whether the framework created by the Statement of Protocol will be implemented to the satisfaction of U.S. and Chinese regulators.
- Until greater certainty emerges, it is likely that some public companies with auditors based in mainland China and Hong Kong will continue to engage in contingency planning.
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