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Trust but verify: A regulatory response to the Holding Foreign Companies Accountable Act (HFCAA) noncompliance

Joshua Cohen  Senior Editor, Checkpoint

Joshua Cohen  Senior Editor, Checkpoint

“Trust but verify” is a phrase that was introduced into US politics by then-president Ronald Reagan during the signing ceremony of a nuclear disarmament treaty with the former Soviet Union.  It did seem to capture the tricky balance required where both sides begin to reduce the number of their own nuclear warheads while also reassuring each other that the other side was complying as well. Over three decades since then, the phrase appears to be a very apt way to describe the Holding Foreign Companies Accountable Act (HFCAA) and the subsequent responses by the SEC and PCAOB.

The HFCAA was enacted as a way to work through concerns around the inability of the PCAOB to conduct inspections of People’s Republic of China-based auditors of companies listed on US stock exchanges—especially given US investors’ increased exposure to China-based issuers over the past decade. The interplay between the HFCAA, SEC and PCAOB addresses these concerns, seemingly embracing that “trust but verify” concept.

Overview of the HFCAA

The HFCAA, which became law on December 18, 2020, enables the SEC to identify each issuer that retains a registered public accounting firm as an auditor in a foreign jurisdiction where the PCAOB is unable to thoroughly inspect or investigate due to a position taken by a local authority (Commission-Identified Issuer). The HFCAA provides that each identified issuer is required to submit documentation to the SEC establishing that it is not owned or controlled by a governmental entity in the applicable foreign jurisdiction. It also provides that each identified issuer that is also a foreign issuer disclose the following information in its annual report on Form 20-F or, as applicable, Form 10-K or Form 40-F:

  • The fact that a registered public accounting firm prepared an audit report covering the issuer’s financial statements (or a portion thereof);
  • The percentage of the issuer’s shares owned by governmental entities in the jurisdiction in which the issuer is incorporated or otherwise organized;
  • Whether governmental entities in the registered public accounting firm’s applicable jurisdiction hold a controlling financial interest in the issuer;
  • The name of each Chinese Communist Party (CCP) official who is a member of the issuer’s board of directors or operating entity; and
  • Whether the issuer’s articles of incorporation (or equivalent organizing document) contain a charter of the CCP, including the text of any such charter.

Regulatory response to suspect HFCAA-related financial reporting

Following passage of the HFCAA, the SEC issued Final Interim Rulemaking Release No. 34-91364, Holding Foreign Companies Accountable Act Disclosure (and subsequently made the disclosures permanent, with some minor tweaks, in identically-titled Final Rulemaking Release 34-93701), to turn the HFCAA into actionable steps for filers. Together, these two releases amended Forms 10-K, 20-F and 40-F by adding the following disclosure items:

  • Form 10-K, Item 9C: Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
  • Form 20-F, Item 16I: Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
  • Form 40-F, Paragraph B18: Disclosure Regarding Foreign Jurisdictions that Prevent Inspections

Note that the SEC’s determination as to which companies are Commission-Identified Issuers and, thus, subject to these disclosures is informed by the PCAOB’s identification of registered public accounting firms that it is unable to inspect or investigate completely because of a position taken by an authority in a foreign jurisdiction.

Get expert guidance on complying with HFCAA rulemaking and guidance

As these additional reporting items recently became effective, SEC Expert on Checkpoint Edge is ready to assist you in navigating the new disclosure requirements:

As rulemaking and guidance evolve in this space, our SEC Expert product and tools is quickly updated to capture the developments, so that you can track and stay on top of your compliance requirements.


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