The Holding Foreign Companies Accountable Act (HFCAA), which was recently passed by the U.S. Senate, requires certain foreign companies listed on U.S. securities exchanges to disclose foreign government ownership or control.
The bill specifically requires certain foreign companies to disclose any board seats held by members of the Chinese Communist Party in their Form 10-K, Form 20-F, and shell company reports.
Companies that use accounting firms that cannot be inspected by the PCAOB for three consecutive years would be de-listed from U.S. securities exchanges.

On May 20, 2020, the U.S. Senate unanimously passed S. 945, the Holding Foreign Companies Accountable Act (HFCAA). If enacted, the bill would amend the Sarbanes-Oxley Act of 2002 (15 U.S.C. §7214) to require additional disclosures from certain issuers regarding foreign jurisdictions that prevent the Public Company Accounting Oversight Board (PCAOB) from performing inspections of auditors of public companies.

Many of the bill’s provisions apply globally, but some apply especially to the Chinese Government and Communist Party.

Rep. Brad Sherman (D-CA) has introduced an identical bill in the U.S. House of Representatives, and House Speaker Nancy Pelosi (D-CA) has confirmed that the relevant House committees would review the bill. Given growing concerns with China’s trade policies, particularly in light of the Luckin Coffee scandal, the bill is likely to receive a vote in the coming weeks, and early indications show bipartisan support for the measure, bolstering the likelihood of the bill also passing the U.S. House of Representatives. 

We summarize the key provisions of the HFCAA below:

Under the HFCAA, issuers that retain a non-inspected, registered public accounting firm in a foreign jurisdiction to prepare its audit report will be required to establish that they are not owned or controlled by a government entity in that jurisdiction.

Under the HFCAA, the Security Exchange Commission (SEC) will be required to identify each issuer that, for the preparation of its SEC reports, retains a registered public accounting firm located outside of the U.S. that the PCAOB is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.

An issuer that is identified by the SEC will be required to submit documentation establishing that it is not owned or controlled by a governmental entity in the foreign jurisdiction where the non-inspected accounting firm is located.

Should the HFCAA be enacted, the SEC will be required to publish rules establishing the manner and form in which such disclosures and government ownership documentation are to be submitted within 90 days.

Covered issuers identified by the SEC would be banned from having their securities listed on U.S. securities exchanges if the public accounting firm preparing their audit reports cannot be inspected by the PCAOB for three consecutive years.

Where the SEC determines that the PCAOB has been unable to investigate the public accounting firm retained by a covered issuer to prepare such issuer’s audit reports for three consecutive years, the SEC would be required to prohibit the issuer from having its securities traded on a national securities exchange or through any other method within the SEC’s jurisdiction, including “over-the-counter” trading.

This trading prohibition may be removed upon submitting a certification to the SEC that the covered issuer has retained a registered public accounting firm that the PCAOB has inspected to the satisfaction of the SEC. Under the bill, if after a prohibition is removed, any new occurrence of a non-inspection year will result in a new trading prohibition that will remain in effect for a minimum five-year period.

Thus, if enacted, the bill would essentially require all foreign issuers to use PCAOB-inspected public accounting firms in order to remain listed on national securities exchanges.

The HFCAA imposes additional disclosures targeted at public companies with ties to the Chinese government.

For each year during which a foreign issuer hires a non-inspected, registered public accounting firm, to prepare an audit report, the issuer must provide the following additional disclosures in Form 10-K, Form 20-F, and shell company reports, among other forms:

  1. State that, during the period covered by the covered form, such a registered public accounting firm has prepared an audit report for the issuer;
  2. The percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized;
  3. Whether governmental entities in the applicable foreign jurisdiction with respect to that registered public accounting firm have a controlling financial interest with respect to the issuer;
  4. The name of each official of the Chinese Communist Party who is a member of the board of directors of a) the issuer or b) the operating entity with respect to the issuer; and
  5. Whether the articles of incorporation of the issuer (or equivalent organizing document) contains any charter of the Chinese Communist Party, including the text of any such charter.

In sum, the HFCAA could potentially result in the de-listing of certain state-owned enterprises as well as certain public companies that are based in or have affiliates in China, France1 or Belgium2 as these countries have laws and regulations that prohibit local auditing firms from turning over accounting documents to foreign regulators like the PCAOB. The impact of HFCAA will be most profound on the U.S.-listed companies that are headquartered or operate principally in China. On March 1, 2020, the amended Securities Law of the People’s Republic of China came into effect to provide reforms in certain areas, among others, investor protection and information disclosure. Most importantly, Article 177 of the Revised Securities Law of the People’s Republic China provides that, without the approval of China Securities Regulatory Commission (CSRC, which is the functional equivalent of the SEC in the United States) and various components of the Chinese government, no entity or individual in China may provide documents and information relating to securities business activities to overseas regulations. If HFCAA is enacted, there will likely be a flurry of de-listing/going-private transactions involving these Chinese issuers as they will not able to both comply with the Chinese law which prohibits them from disclosing certain information and satisfy the requirements of the U.S. law mandating disclosure of the same information.

1 Negotiations are currently underway between the PCAOB and the French audit authority to renew a cooperative arrangement that expired in December 2019.

2 PCAOB is currently negotiating a bilateral cooperative agreement that will permit the PCAOB to commence inspections in Belgium.

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