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US Securities and Exchange Commission

SEC Starts Rulemaking to Address Inability to Inspect Chinese Company Auditors

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

The SEC on March 24, 2021, took the first step in trying to solve the PCAOB’s inability to inspect auditors whose clients are listed publicly on U.S. stock exchanges. The move mainly targets Chinese companies, and the commission adopted interim final changes related to disclosure requirements—not about delisting of those companies yet—under the Holding Foreign Companies Accountable (HFCA) Act, which was signed into law on December 18, 2020.

Under HFCA, such companies must establish that they are not owned or controlled by a foreign government. Companies must also disclose in their annual reports about the audit arrangements of, and governmental influence, on them.

But the SEC must first come up with a process for identifying such a company, and it is seeking comment on this process in Release No. 34-91364Holding Foreign Companies Accountable Act Disclosure. The identified companies then must submit the documentation to the SEC.

Comments are due 30 days after publication in the Federal Register.

The most significant part of the law says that if companies fail to comply with the audit regulatory board’s inspections requirement for three consecutive years, then they will be delisted from exchanges. The audit firm inspections requirement is in the Sarbanes-Oxley Act of 2002, which was enacted into law almost 20 years ago to prevent accounting scandals that led to the collapse of companies like Enron and WorldCom and cost investors about $85 billion. The SEC oversees the PCAOB.

The HFCA Act gave the SEC 90 days to issue rules to establish the manner and form in which companies must comply with the documentation submission requirement. Thus, the commission said that it is issuing the interim final amendments to meet the deadline.

“The Commission staff is actively assessing how best to implement other requirements of the HFCA Act not subject to the 90-day deadline, including the identification process and the trading prohibition requirements,” the SEC said. “The Commission plans to separately address implementation of the trading prohibitions in Section 2 of the HFCA Act in a future notice and comment process.”

Interim Final Rule

In particular, the “Commission-Identified Issuers”—those that are in jurisdictions where local authorities bar PCAOB audit inspections—must submit the documentation on or before the annual report due date.

Under HFCA, the identified company must also provide the following information:

  • During the period covered by the form, the PCAOB-registered accounting firm has prepared an audit report for the company;
  • The percentage of the shares of the company owned by governments in the jurisdiction where it is incorporated;
  • Whether governments in the foreign jurisdiction with respect to the registered public accounting firm have a controlling financial interest in the company;
  • The name of each official of the Chinese Communist Party who is a member of the board of directors of the company or the operating entity with respect to the company; and
  • Whether the articles of incorporation of the company contains any charter of the Chinese Communist Party, including the text of any such charter.

The commission said it wants comments about the implementation of the HFCA submission and disclosure requirements, as well as the best way to determine Commission-Identified Issuers.

A company will not have to comply with the interim rules until the SEC identifies a company as having a non-inspection year under a process to be subsequently established by the commission with public notice.

The effort comes as PCAOB inspections have improved audit quality. This matter has been especially pressing with Chinese companies as there has been a rash of accounting irregularities or outright frauds in the past several years, costing U.S. investors a lot of money.

China has been blocking inspections because of fear that audit work papers may contain state secrets, among other concerns.

 

This article originally appeared in the March 25, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.

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