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E-MailMichael E. Borden and Peter Roskam are partners and Justin Becker is an associate at Sidley Austin LLP. This post is based on their Sidley memorandum.
On May 20, 2020, the U.S. Senate passed S. 945, the Holding Foreign Companies Accountable Act, by unanimous consent. The key effect of S. 945 is that it prohibits certain companies from listing and trading their securities on any U.S. securities exchanges or through any other method regulated by the U.S. Securities and Exchange Commission (SEC) if the Public Company Accounting Oversight Board (PCAOB) is prevented from reviewing the companies’ audits.
After the bill passed, on the same day, a bill with the same language was introduced in the U.S. House of Representatives by Rep. Brad Sherman, D-Calif., chairman of the House Financial Services Committee’s subcommittee on Investor Protection, Entrepreneurship and Capital Markets. Significantly, Rep. Sherman’s subcommittee has jurisdiction over this bill in the House, which could increase the likelihood of its enactment.
Text of both bills, statements by Sens. John Kennedy, R-La., and Chris Van Hollen, D-Md., cosponsors of the Senate bill, and statements by Rep. Sherman, demonstrate that the legislative intent was to address Chinese companies listed on U.S. securities exchanges.
This post provides a summary of the Holding Foreign Companies Accountable Act. The text of the Senate bill is available here, and the text of the draft House bill is available here. Sens. Kennedy and Van Hollen’s statements are available here. Rep. Sherman’s press release is available here.
If enacted, the Holding Foreign Companies Accountable Act would require the SEC to identify issuers of securities on U.S. securities exchanges that
- issue audit reports prepared by registered public accounting firms with offices located in foreign jurisdictions
- fail to allow PCAOB to conduct an audit of the reports prepared by the accounting firm because of a position taken by an authority within the foreign jurisdiction
The SEC would identify such issuers by requiring them to submit disclosures to the SEC.
In addition, all issuers identified by the SEC would be required to submit documentation demonstrating that they are not owned or controlled by a foreign government in the foreign jurisdiction in which the public accounting firm has an office. For example, if the accounting firm has an office in the People’s Republic of China, the issuer would be required to demonstrate that it is not owned or controlled by the Chinese government.
The legislation would require the SEC to issue rules outlining the procedures for submitting such disclosures and government ownership documentation within 90 days after the law’s enactment.
Failure to Comply With PCAOB Audits After Identification
Once identified, an issuer must allow PCAOB to conduct an audit of its reports. If an identified issuer fails to allow PCAOB to conduct such audits for three consecutive years starting from the year in which the SEC identified it, the SEC would prohibit the trading of that issuer’s securities on any U.S. securities exchanges or trading through any method that the SEC regulates including over-the-counter trading.
The SEC would terminate the prohibition if the issuer could certify to the SEC that it had retained a registered public accounting firm that PCAOB has inspected. However, if at any time after certification the issuer did not comply with an audit by PCAOB each year thereafter, the SEC would prohibit trading of the issuer’s securities again for a minimum period of five years. After five years, the issuer could recertify to the SEC that it would retain a registered public accounting firm that PCAOB is able to inspect. The SEC would then end the prohibition. However, if the issuer does not comply again with an annual audit by PCAOB for any year after recertification, the SEC would again prohibit trading of any securities for a minimum period of five years.
These requirements would continue in perpetuity once the issuer fails to allow PCAOB to conduct an audit during any of the three consecutive years after the SEC identified it.
Additional Disclosures
Every issuer that is a foreign government, a foreign national or organized under laws of a foreign country and that uses a registered public accounting firm with a foreign office to prepare an audited report would be required to disclose certain information to the SEC every year in which it is not subject to a review by PCAOB. Specifically, these issuer must disclose
- the identity of the registered public accounting firm that prepared the audit report
- the percentage of shares of the issuer owned by government entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized
- whether the government entities in the foreign jurisdiction of the registered public accounting firm have a controlling financial interest in the issuer
- the name of each Chinese Communist Party official who is a member of the board of directors of the issuer and operating entity of the issuer
- whether the issuer’s articles of incorporation or other organizing document contain any charter of the Chinese Communist Party or text of any such charter
