It’s official: Foreign issuers of securities in the United States who were previously beyond the regulation of the SEC are now subject to the same standards as U.S. issuers. Last week, the SEC finalized rules that provide for the inspection of foreign issuers’ books by the Public Company Accounting Oversight Board (PCAOB). This newest rule levels the playing field for foreign and national issuers in line with the Holding Foreign Companies Accountable Act (HFCAA), which passed with bipartisan support in December 2020. With this new rule, the SEC can delist companies listed on U.S. exchanges if they refuse or are unavailable for PCAOB inspections or investigations for three consecutive years starting at the end of 2021.
Through a new disclosure framework, the SEC will identify whether to delist particular issuers. Once identified, issuers will be required to submit documentation to the SEC stating that neither they nor any of their consolidated foreign operating entities were owned or controlled by a foreign government in each year they were identified.
Enhanced disclosures are also required for entities listing in the United States through variable interest entity structures (VIEs). VIEs are contractual agreements mimicking ownership in an underlying company, where an investor has a controlling interest despite not having a majority of voting rights. The SEC has also instituted a pause on the listing of shell companies using this VIE structure.
Until now, the PCAOB has been unable to inspect or investigate public accounting firms registered in foreign jurisdictions because of positions taken by foreign authorities. More than 50 jurisdictions work with the PCAOB to allow inspections; China and Hong Kong do not. Chinese regulators are reluctant in general to allow foreign regulators to inspect local accounting firms because of national security concerns.
Meanwhile, VIEs allow some Chinese companies to circumvent U.S. rules on listing overseas. The structure leads to obscured information on ultimate ownership and more risks for U.S. investors.
As SEC Chairman Gary Gensler said, “If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the PCAOB.”
Gensler emphasized “the SEC’s mission to protect investors.” Under the new rules, investors can more easily identify registrants whose audits are not inspected by the PCAOB. In pursuit of investor protection, even the three-year time frame may be shortened in the near future. The Senate unanimously passed the Accelerating Holding Foreign Companies Accountable Act, which would reduce the time frame to two years instead of three.
With these new rules, foreign issuers could find themselves in the crosshairs of delisting by the SEC. For example, more than 200 Chinese companies may be delisted. Regardless, all foreign issuers should ensure, if they have not done so already, that their auditing and compliance practices are aligned with U.S. regulations.
*The authors of this article thank Eva-Maria Ghelardi, law clerk, for her assistance in its preparation.