SEC interim final amendments signal stricter regulation on Chinese and other emerging market companies

On March 24, 2021, the Securities and Exchange Commission (SEC) adopted interim final amendments to implement congressionally mandated submission and disclosure requirements of the Holding Foreign Companies Accountable Act (HFCA Act) and is also seeking comments on certain open questions related to implementation.  Under the new requirements, certain companies must establish that they are not owned or controlled by a foreign government entity and disclose any foreign government influence.  These requirements signal stricter regulation on Chinese and other emerging market companies by the SEC. 

Once the SEC fully implements the HFCA Act, certain issuers may face a required trading suspension if there are three consecutive years in which the Public Company Accounting Oversight Board (PCAOB) is unable to inspect or investigate an issuer completely due to a position taken by a foreign government authority in the jurisdiction where the issuer’s auditor operates.

Affected entities

The interim final amendments become effective 30 days after their publication in the Federal Register.  They will apply to registrants that (1) the SEC identifies as having filed an annual report on Forms 10-K, 20-F, 40-F, or N-CSR with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction where (2) the PCAOB has determined that it is unable to inspect or investigate completely because of a position taken by an authority in that foreign jurisdiction.  The interim final amendments define such registrants as “Commission-Identified Issuers” (CIIs).

The interim final amendments also apply to “Commission-Identified Foreign Issuers” (CIFIs), a subset of CIIs who are foreign issuers (as defined under the Exchange Act).  CIFIs are subject to additional disclosure requirements under the HFCA Act.

The new requirements for CIIs and CIFIs will be triggered by the identification of affected registrants by the SEC and affected registered public accounting firms by the PCAOB. The PCAOB is still considering its obligations under the HFCA Act, including the process for determining affected registered public accounting firms.

New requirements

Under the interim final amendments, CIIs are required to submit documentation to the SEC establishing that they are not owned or controlled by a government entity in that foreign jurisdiction.  The SEC is currently defining “control” consistently with Exchange Act rules but has asked for comment on whether that approach is appropriate. Once identified, a CII will be required to comply for each fiscal year in which it is identified. 

CIFIs must provide specific, additional disclosures under Section 3 of the HFCA Act as follows:

1. That, during the period covered by the form, a registered public accounting firm has prepared an audit report for the issuer
2. The percentage of the shares of the issuer owned by government entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized
3. Whether governmental entities in the applicable foreign jurisdiction with respect to that registered public accounting firm have a controlling financial interest with respect to the issuer
4. The name of each official of the Chinese Communist Party (CCP) who is a member of the board of directors of the issuer or the operating entity with respect to the issuer  
5. Whether the articles of incorporation of the issuer (or equivalent organizing document) contains any charter of the CCP, including text of any such charter.

The SEC is amending Forms 10-K, 20-F, 40-F and N-CSR to provide for these new disclosure requirements.  Registrants must provide the applicable disclosure for each year in which they are a CII or CIFI. 

Importantly, CIIs and CIFIs are not required to comply with the amendments until the SEC has identified them as having a non-inspection year under a process which the SEC will establish after notice.  And the SEC has indicated that it must wait for the PCAOB to develop its process for determining whether it is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.

The SEC has also indicated that no registrant will be subject to a non-inspection year determination for any fiscal year ending on or prior to December 31, 2020, so no submission or disclosure will be required for those years.  For fiscal years beginning after December 31, 2020, once the PCAOB has developed its process and made its determinations under the HFCA Act, the SEC will identify CIIs, but only after the agency has established its process.

Next steps

The SEC has only just started to implement the HFCA Act.  Before it fully implements the statute, it is seeking comment on a number of topics, including:

• The appropriate process for identifying which registrants are CIIs, including an appropriate definition of “retain” – CIIs are defined to include only those issuers that “retain” a registered public accounting firm that has a branch or office in a foreign jurisdiction where the PCAOB cannot inspect or investigate completely because of a position taken by an authority in that jurisdiction
• How frequently the SEC should make its determination of which issuers are a CII
• Whether the SEC should publish a list of CIIs
• Whether the SEC should require specific types of documentation to demonstrate that a CII is not owned or controlled by a foreign governmental authority or provide additional guidance to registrants and if so, what types of documents
• Whether the SEC should define what it means to be an official of the CCP
• Whether additional guidance is needed to assist registrants in preparing and providing required disclosures
• Whether the SEC should make public the documentation demonstrating that a CII is not owned or controlled by a foreign governmental authority
• Whether the SEC should require CIIs that are owned or controlled by a foreign governmental entity to affirmatively disclose that information
• Whether the SEC should provide additional definitions or guidance to explain what it means to be owned, controlled, or have a controlling financial interest in a CII
• What considerations should the SEC consider in determining how to implement the trading prohibition requirements of the HFCA Act.

Comments are due no later than 30 days after publication of the interim final amendments in the Federal Register.          

Key takeaways

While there are many open questions and it will take time for full implementation of the HFCA Act, the interim final amendments mark another step towards a regulatory regime in which trading in a company’s stock can be suspended if the PCAOB cannot inspect and investigate completely due to a position taken by a foreign government authority. It seems unlikely that the US Congress will reverse course on this issue.  Consequently, we anticipate that the SEC will continue to move forward with implementation.

Companies that are at risk of an SEC determination that they are a CII or CIFI should:

• Consider whether there are aspects of the anticipated rules for which they would like to submit comments prior to the deadline so that the SEC evaluates all relevant issues
• Start to assess how they can comply with the likely disclosure requirements. 

Relevant resources

See the interim final rule at this link. 

Submit comments to the SEC at this link.

See our earlier reporting on this developing trend:

US securities regulators focus on China and emerging markets: Further risk and disclosure considerations are necessary

Chinese and other emerging market companies listed in the US face increased scrutiny from Congress and Nasdaq

If you have any questions regarding the interim final amendments, or if you would like assistance in analyzing these issues, please contact any of these members of our team: