House Passes Bill to Delist Foreign Companies from U.S. Securities Exchanges, Outlines Guiding Principles for Implementing Rules

On December 2, 2020, the U.S. House of Representatives passed S 945, the Holding Foreign Companies Accountable Act, by voice vote. The language of the bill is the same as that passed by the U.S. Senate on May 20, 2020. The bill is now cleared for President Donald Trump to sign into law, which he is expected to do.

The key effect of S 945 is that, after a three-year period, it could prohibit certain companies from listing and trading their securities on any U.S. securities exchanges or through any other method regulated by the U.S. Securities and Exchange Commission (SEC) if the Public Company Accounting Oversight Board (PCAOB) is prevented from reviewing the companies’ audits. A summary of the bill and its potential effects are provided in Sidley’s previous update on the bill here.

During the December 2 House debate, the lead House sponsor of the bill, Rep. Brad Sherman, D-Calif., chairman of the House Financial Services Committee’s subcommittee on Investor Protection, Entrepreneurship, and Capital Markets, made remarks that he said were intended to serve as legislative history to demonstrate congressional intent and used by the SEC as guidelines when drafting implementing regulations.

This update provides a summary of Rep. Sherman’s remarks and how they may affect the SEC’s rulemaking.

Rep. Sherman framed the new legislation as “an investor protection bill” and outlined its potential reach, intent, and goals. He highlighted that the legislation has the power to affect approximately 224 companies currently listed on U.S. exchanges with a combined capitalization of $1.8 trillion. Although the legislation’s requirements are not limited to any one country, Rep. Sherman made clear that the primary target is China. Indeed, he said that the ultimate goal of the law will be to provide additional leverage in negotiating with Chinese regulators to reach a cooperative agreement that would allow for PCAOB to conduct inspections of Chinese firms listed on U.S. exchanges. Importantly, Mr. Sherman stated that “this is not anti-China, and it is not designed to prohibit the trading of Chinese companies.”

In addition to explaining the reach, intent, and goals of the new legislation, Rep. Sherman read a joint statement by Sen. John Kennedy, R-La. (the Senate author of the legislation), and him to set its intended bounds and serve as guiding principles for the SEC in its rulemaking process. Despite the legislation’s requirement that the PCAOB be able to “inspect or investigate completely” the preparation of a covered issuer’s audit report on a financial statement, the joint statement suggested there should be a two-thirds safe harbor principle for audit reports. The joint statement said that “It is the intent of this legislation to provide the Securities and Exchange Commission with the discretion necessary to determine how much of a company’s total audit must be performed by a firm beyond the reach of the PCAOB inspections.” Through the joint statement, Sen. Kennedy and Rep. Sherman added that it is Congress’s expectation that “the Commission will not prohibit trading in the securities of companies in this act as long as not more than one-third of the company’s total audit is performed by a firm beyond the reach of the PCAOB inspection.”

The joint statement said that a small portion of a company’s audit may be conducted in China without penalty as long as it does not amount to more than a third of the audit. After reading the joint statement, Rep. Sherman added his belief that a company should be able to continue to maintain affiliations with firms that are not subject to audits within the scope of PCAOB’s oversight authority without penalty. In accordance with the joint statement, the SEC should be left with the discretion to measure what “two-thirds” means under this safe harbor: perhaps based on total revenue, assets, or some other measurable indicia.

In addition, to satisfy this intended safe harbor, the joint statement explained that this principle should not be limited to audits conducted by foreign firms that have an ownership relationship with a PCAOB publicly registered accounting firm. It said it should also include firms with affiliations or that maintain an affiliation agreement with a PCAOB publicly registered accounting firm.

Once enacted, the SEC will have 90 days to issue rules to implement the law. It is not clear whether it will follow the principles that Rep. Sherman outlined in the joint statement.