On December 18, President Trump signed the Holding Foreign Companies Accountable Act (HFCAA). The legislation, which passed both houses of Congress with bipartisan support, could ultimately result in the delisting of companies that trade on U.S. exchanges and are audited by accounting firms that the PCAOB cannot inspect because of the position of a foreign government. Under the HFCAA, if the SEC determines that the PCAOB is unable to inspect a reporting company’s auditor for three consecutive years, the SEC would be required to prohibit the company’s securities from trading on a U.S. securities exchange (or by any other method within the SEC’s jurisdiction). Even prior to the triggering of the delisting provision, reporting companies with un-inspectable auditors will have to make various disclosures, including the percentage of shares owned by government entities in the company’s home jurisdiction and information about any board members that are Chinese Communist Party officials.
As a practical matter, the HFCAA would affect primarily U.S.-listed Chinese companies. The Chinese government does not permit foreign regulators to access the work papers of Chinese audit firms, and, unlike virtually all other jurisdictions, China has declined to negotiate inspection arrangements with the PCAOB. However, the provisions in the HFCAA that describe the companies that are subject to delisting are broadly written and could encompass U.S.-based companies that have operations in China. As part of the parent company’s audit, the Chinese operations of a U.S. multinational may be audited by an un-inspectable Chinese accounting firm (typically, the Chinese member of the U.S. auditor’s global network). In a statement entered into the Congressional Record, the sponsors of the HFCAA, Senator John Kennedy and Representative Brad Sherman, sought to exempt U.S. companies from delisting by explaining that the Act was not intended to apply where “not more than one-third of the company’s total audit is performed by a firm beyond the reach of the PCAOB inspection” and that the SEC has “authority to determine how the size of an audit would be measured.” Unfortunately, neither this intent nor this SEC authority appears explicitly in the text of the law.
Perhaps the PCAOB will be able to negotiate a solution to the problem of Chinese inspections before the HFCAA delisting provisions are triggered in three years. If not, the SEC will likely find a way to avoid delisting U.S. or foreign companies that have only a limited a portion of their operations audited by un-inspectable firms. Nonetheless, it would be prudent for audit committees to make sure that they are informed of the inspection status of all firms that participate in their audit, particularly any that are based in China.