The House of Representatives joined the Senate in passing the Holding Foreign Companies Accountable Act (S.945), which would require a "foreign issuer" (as defined in SEA Rule 3b-4), subject to periodic reporting under the Securities Exchange Act, to disclose if its registered public accounting firm is located in a foreign jurisdiction that prevents the Public Company Accounting Oversight Board (the "PCAOB") from conducting audit inspections.

Under the bill, if the issuer has three consecutive "non-inspection years," the issuer's securities may not be traded on a national securities exchange or "through any other method that is within the jurisdiction of the Commission to regulate, including 'over-the-counter' trading of securities." The bill is now awaiting an expected signature by the President. (The term "inspection year" refers to the authority of the PCAOB to inspect public accounting firms. See, e.g., PCAOB Rules regarding Inspections - in particular, Rule 4003(b).)

Under the process established by the bill, the SEC is required to determine those SEC-registered issuers that engage an accounting firm located in a foreign jurisdiction that the PCAOB is not able to inspect. The SEC is then required to obtain from each such registered issuer "documentation that establishes the covered issuer is not owned or controlled by a governmental entity in the foreign jurisdiction" of the relevant accounting firm.

The bill sets out additional disclosure requirements for foreign issuers preparing an audit report during a non-inspection year, including:

  • the percentage of the issuer's shares owned by governmental entities in the foreign jurisdiction of the issuer; and
  • whether foreign governments in the jurisdiction of the relevant accounting firm have a controlling financial interest in the issuer.

There are several provisions in the bill that are China-specific. Specifically, covered issuers may be required to disclose:

  • the names of Chinese Communist Party "officials" who are members of the board of directors, of the company or of an operating entity with respect to the issuer; and
  • whether the issuer's articles of incorporation contain any Chinese Communist Party charter, including the text of any such charter.

Commentary Steven Lofchie

Assuming that the Chinese government does not agree to allow U.S. regulators access to accounting firms based in China, the logical next step would be for Chinese issuers to deregister under the Exchange Act. In addition to delisting, which will be mandatory under the bill as passed, deregistration may also require Chinese issuers to seek to reduce the number of their U.S. holders, perhaps by conducting buybacks.

There are a number of interpretive points in the bill that are worth noting:

  • there is no definition of "over-the-counter trading"; presumably, the term is intended to include "inter-dealer quotation systems" as defined in SEA Rule 15c2-11(e)(2), but it could be interpreted expansively to include any off-exchange trading; a broad interpretation of the term would hit the institutional trading markets by potentially preventing any involvement by U.S. broker-dealers in trading;
  • as the bill applies only to issuers registered under the Exchange Act, the bill would not prevent the issuance of securities sold under Securities Act Rule 144A by issuers that are not subject to registration under the Exchange Act (subject to the breadth of the definition of "over-the-counter trading");
  • although the bill requires the SEC, in certain circumstances, to obtain documentation that an issuer is not "controlled" by a foreign government, there is no provision as to what follows from the inability of the issuer to provide such documentation; and
  • the term "official" of the Chinese Communist Party is not defined.

There is also the possibility that additional rule making action relating to issuers of Chinese securities could follow. For example, the SEC or the DOL could adopt regulations that might discourage investment companies or plans, respectively, for making investments in Chinese issuers.

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