After months of closed-door negotiations, the Public Company Accounting Oversight Board (PCAOB) announced Friday that it has reached a protocol statement with the China Securities Regulatory Commission (CSRC) and the Ministry of Finance of the People’s Republic of China (PRC). .1 The protocol statement creates a pathway for companies based in China and Hong Kong to remain listed on U.S. exchanges after 2024, notwithstanding the Holding Foreign Companies Accountable Act (HFCAA) passed in 2020.2 Despite this milestone, there are at least three reasons why this deal may not be as big as the news reports suggest.
The HFCAA directs the United States Securities and Exchange Commission (SEC) to halt trading in a registrant’s securities on a U.S. stock exchange if, for three consecutive years, the company has been identified as having appealed to a registered public accounting firm that the PCAOB has determined is unable to fully inspect or investigate due to a position taken by the relevant foreign regulatory authority. In response to concerns about the domestic legal regime regarding the protection of state secrets and data privacy issues, auditors in the PRC and Hong Kong for over a decade have not given the PCAOB full access to their audit working papers, for example by denying or heavily redacting audit working papers and restricting the PCAOB’s ability to select audits of state-owned companies and companies in strategic industries for inspection. Therefore, absent a change in the PCAOB’s ability to inspect PRC and Hong Kong auditors, the HFCAA would cause trading in the securities of PRC and Hong Kong-based companies to cease on US scholarships by 2024.
The protocol statement establishes a framework for the PCAOB to inspect and investigate public accounting firms registered in the PRC and Hong Kong, including all working papers related to audits of U.S.-listed Chinese companies. United.
Three reasons why the PCAOB deal with China may not have changed the landscape
- The protocol declaration is only a first step
Statements by U.S. officials surrounding the protocol statement were uncharacteristically underlined by pointing out that the jury is still out on whether the PRC and Hong Kong will indeed allow the PCAOB to fully inspect and investigate their expert firms- accountants registered with the PCAOB. In particular, while PCAOB Chair Erica Williams said the protocol statement provided the PCAOB with “full access” to audit working papers, audit staff and other information, she said “the real test will be whether the words agreed on paper translate to full access in practice. Similarly, SEC Chairman Gary Gensler said, “The proof will be in the pudding.” The CSRC also issued tempered remarks, calling the protocol statement a “first step.”3
The agreement will be tested soon. Chairman Gensler said “inspectors must be in the field by mid-September if their work has a chance of being successfully completed by the end of this year” – in time for the annual determination to taken by the PCAOB when reassessing whether the positions taken by PRC authorities have once again prevented the PCAOB from fully inspecting and investigating auditing firms in the PRC and Hong Kong. The PCAOB’s annual determination in 2022 would be particularly important if Congress were to pass the expedited legislation referenced below, as it could trigger delistings as early as 2023.
From the perspective of US regulators, it will be incumbent on PRC authorities to comply in all respects with the requirements of US law and the new protocol statement and avoid creating inspection hurdles similar to those in the past. . If such hurdles occur, there is a significant risk that US regulators will see them as undermining the principles underlying the protocol statement.
- Protocol statement will have limited application as Chinese issuers have already exited US markets
Under threat of HFCAA delisting, PRC and Hong Kong-based issuers have already begun their voluntary delisting from US exchanges. For example, earlier this month, five of China’s largest state-owned companies announced plans to pull out of US exchanges. In addition, Alibaba announced its intention to seek a primary listing in Hong Kong, signaling an abandonment of US markets among a significant portion of the total market value at risk of delisting.4 This creates a possibility that the PRC and Hong Kong will become more permissive on PCAOB inspections, given that companies with the most sensitive data have already opted out of US exchanges.
However, while these measures may alleviate some of the PRC’s historical concerns about audit inspections, the PCAOB’s inspection authority is retroactive and audits of these large issuers could still be subject to PCAOB inspection. If that were to happen, it could set the stage for an even tougher test of the PRC’s willingness to fully abide by the terms of the protocol statement.
- Congress continues to take a hard line on China
HFCAA and Ongoing Acceleration Legislation5 are the product of a group of lawmakers who have called on the Biden administration to take a tougher line on China, both on securities regulation and other areas. Some of the HFCAA supporters reacted to the announcement of the protocol statement by urging the SEC and the PCAOB to continue to strictly enforce the HFCAA, even if it would result in delistings. For example, Senator Marco Rubio “urged the PCAOB to accept nothing less than full compliance with the agreement” and expressed his intention to continue working with the PCAOB to ensure full implementation of the HFCAA.6 Senator John Kennedy said, “We have the regulation gavel and we will use it without flinching.seven Senator Kennedy also called on Congress to pass his Accelerating Holding Foreign Companies Accountable Act without delay – as noted above, this act would result in the delisting of PRC and Hong Kong companies whose auditors had not been subject to PCAOB inspection by 2023 rather than 2024, further reducing the full resolution window.8
The risk of delisting PRC and Hong Kong-based companies from US stock exchanges is still present, despite the protocol statement. Similar challenges persist for auditors who are or use audit firms based in the PRC and Hong Kong. In addition to navigating upcoming PCAOB inspections, audit firms may also face other risks, such as scrutiny of the use of other auditors and accounting service providers, including compliance applicable auditing standards of the PCAOB and the consent requirements of Section 106 of the Sarbanes-Oxley Act. It will be essential to follow the progress of the inspection of audit firms based in the PRC and Hong Kong in the coming months.
Press release, Ed. Co. Accounting Oversight Bd., PCAOB signs agreement with Chinese authorities, first step towards full access allowing PCAOB to select, inspect and investigate in China (August 26, 2022), https://pcaobus.org /news-events/ news-releases/news-release-detail/pcaob-signs-an-agreement-with-chinese-authorities-taking-the-first-step-towards-full-access-for-pcaob -to-select-inspect-and-investigate-in-China; Second. and Scale. Comm’n, Fact Sheet: PCAOB Agreement With China on Audit Inspections and Investigations (August 26, 2022), https://www.sec.gov/files/china-sop-fact-sheet.pdf; Second. and Scale. Comm’n, Fact Sheet: Protocol Statement – Questions and Answers (August 26, 2022), https://www.sec.gov/files/china-sop-qa_0.pdf. Public information indicates that the PCAOB inspections will take place in Hong Kong, but official US and Chinese statements are unclear on this point.
Pub. Law No. 116-222 (2020).
In February 2022, as part of a larger legislative package, the United States House of Representatives passed legislation to “accelerate” the HFCAA schedule by three consecutive years without a two-way inspection. United States Innovation and Competition Act of 2021, HR 4521, 117th Cong. § 60301 (2022). Thus, under this legislation, the trade bans would have occurred in 2023 rather than 2024. However, the HFCAA acceleration provisions were omitted from the final legislative package approved by Congress. Additionally, in June 2021, the Senate passed similar, stand-alone fast-track legislation, but the House of Representatives did not pass complementary legislation. S. 2184, 117th Congress. (2021).
S. 2184, 117th Congress. (2021). This bill was passed by the Senate in 2021 and is similar to a provision in the later-passed U.S. Innovation and Competition Act of 2021 that the House passed in 2022. The corresponding version of the law 2021 U.S. Innovation and Competition Policy before the Senate does does not include the fast-track provision.