Recent measures from U.S. lawmakers and Nasdaq to impose additional requirements on U.S.-listed China-based companies could have wider implications.

On May 20, 2020, the U.S. Senate unanimously passed the Holding Foreign Companies Accountable Act ("Act"), which could have significant implications for China-based companies that are publicly listed in the United States, including possible mandatory delistings for companies that fail to comply. The Act focuses on the inability of the U.S. Public Company Accounting Oversight Board ("PCAOB") to inspect auditors based in China and Hong Kong as part of their regular review of auditors of publicly listed companies. Companies whose auditors fail to be inspected by the PCAOB for three consecutive years will be subject to mandatory delisting.

In early June 2020, the Securities and Exchange Commission published Nasdaq rule proposals that would apply additional restrictions on companies from so-called "restrictive markets" that have laws or regulations restricting access to information by regulators of U.S.-listed companies in such jurisdictions.


U.S. securities laws generally require auditors of U.S.-listed public companies to submit to regular review and inspection by the U.S. Public Company Accounting Oversight Board ("PCAOB"), which serves as an "auditor of auditors." In this capacity, the PCAOB reviews the financial statements of the companies audited by such audit firms as well as the related audit work papers.

Many of the auditors of China-based U.S.-listed public companies are located in mainland China and Hong Kong, a territory of the People's Republic of China ("PRC"). For several years, the PRC government has resisted allowing the PCAOB to inspect auditors on Chinese soil on the grounds that such inspections would violate China's sovereignty, national security, and State secrets laws.1 The PCAOB, the China Securities Regulatory Commission ("CSRC"), and China's Ministry of Finance have been discussing and negotiating this issue for years. They even entered into a Memorandum of Understanding on Enforcement Cooperation ("MOU") in 2013 that was meant to pave the way for a mutually agreeable resolution. However, that MOU lapsed without any final agreement having been reached.

This stalemate is not immaterial in terms of the scope of its impact. Indeed, the PCAOB reported that in the year ended December 31, 2019, 17 PCAOB-registered firms in mainland China and Hong Kong signed audit reports for 188 U.S.-listed or reporting companies that had a combined global market capitalization of approximately $1.9 trillion.

Moreover, the underlying issue is not limited to China. Two other jurisdictions, France and Belgium, also currently restrict the PCAOB from conducting auditor inspections within their respective borders. The PCAOB has stated, however, that it expects "to enter into bilateral cooperative arrangements soon that will permit the PCAOB to commence inspections in Belgium and resume inspections in France."2


On May 20, 2020, the U.S. Senate passed the Holding Foreign Companies Accountable Act ("Act"). If signed into law, the Act would require enhanced disclosure to the Securities and Exchange Commission ("SEC") by SEC-reporting issuers that have retained a registered public accounting firm with a branch or office located in a foreign jurisdiction that prevents the PCAOB from performing inspections on that branch or office. Furthermore, if the PCAOB is unable to perform these inspections for a period of three consecutive years, the issuer's securities will be banned from trading on all national securities exchanges in the United States as well as through the U.S. over-the-counter or "OTC" market. In late May, a similar bill was introduced in the U.S. House of Representatives. It is unclear when the House may pass this bill, or when a reconciled Senate and House bill may reach the desk of the President for signature into law.


Disclosure Requirements

The Act requires the SEC to identify any SEC-reporting issuer that uses a registered public accounting firm that has a branch or office: (i) located in a foreign jurisdiction; and (ii) where the PCAOB is unable to fully inspect the auditor of such issuer due to a position taken by a governmental authority in that jurisdiction. If an issuer falls into these categories (thereby becoming a "covered issuer" under the Act), the SEC will require it to submit documentation establishing that the covered issuer is not owned or controlled by a governmental entity in the foreign jurisdiction. The Act requires the SEC to adopt rules to establish the manner and form in which a covered issuer can meet these requirements within 90 days of the Act's passage into law.

The Act would also require each "covered issuer" that files with the SEC an audit report that has not been inspected by the PCAOB, to disclose the following in its annual report filed with the SEC:

  • The fact that, for the duration of the period detailed in the annual report containing such financial statements, such 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 where the issuer is organized;
  • Whether governmental entities in the foreign jurisdiction have a controlling financial interest in the issuer;
  • The name of any official of the Chinese Communist Party who is a member of the board of directors of the issuer or an operating entity of the issuer; and
  • Whether the articles of incorporation of the issuer contain any charter of the Chinese Communist Party (including the text of any such charter).

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Originally published July 1, 2020.

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