- Law intended to force China to permit PCAOB inspection of accounting offices located in China
- Clients of audit firms not adequately inspected may have to document ownership or control by foreign governmental entities
- Ongoing audit inspection problems may lead to US trading ban
On December 18, 2020, the Holding Foreign Companies Accountable Act became law. The new law targets foreign public companies whose financial statements are audited by firms with branches or offices in a foreign country that the PCAOB cannot inspect or investigate “completely.” Historically, the PCAOB has noted inspection challenges with accounting offices located in China. Some of the requirements of the new law, however, extend to all public companies and, depending on future SEC rulemaking, could result in the delisting of some US public companies.
Restrictions on PCAOB Inspections; Disclosure of Foreign Government Control
The new law requires the SEC to identify audit firms with foreign branches or offices that it cannot adequately inspect or investigate because of local governmental policy. The SEC must then “identify” the issuers audited by any of those firms (a “non-inspection year,” in the terminology of the new law) and require those issuers to provide documentation establishing that they are not “owned or controlled” by a governmental entity in the relevant country. The law does not require the issuer to have any operations in that country, nor does the law expressly limit the documentation requirement to foreign issuers.
Instead, the law focuses on the PCAOB’s ability to inspect the foreign branch or office of the audit firm, rather than on the accuracy of the issuer’s financial statements. Accordingly, even US companies with no foreign operations could – if they select a global audit firm with operations in a problematic foreign country – potentially find themselves required to document whether they are owned or controlled by a foreign government.
We anticipate that the SEC will try to use the rulemaking process to narrow the scope of the documentation requirement, but the SEC often struggles to do that when faced with a statutory mandate.
It is not clear what form the documentation of ownership and control will take, nor whether the documentation will be publicly available.
Potential Ban on US Trading
More significantly, the law requires the SEC to prohibit US trading of securities issued by companies with problematic audits three years in a row, including any trading in the over-the-counter market. The trading ban is not limited to companies owned or controlled by foreign governments or even to foreign issuers. It is unclear how far the ban on “trading” will extend or whether it will prohibit, for example, mundane transactions like direct sales between individuals or transfers by will or inheritance.
While…
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