Scarinci Hollenbeck, LLC
The Firm
201-896-4100 info@sh-law.comFirm Insights
Author: Scarinci Hollenbeck, LLC
Date: April 12, 2021
The Firm
201-896-4100 info@sh-law.comApril 5, 2021, the Securities and Exchange Commission (SEC) adopted interim final amendments to several forms to implement the disclosure and submission requirements of the Holding Foreign Companies Accountable Act (“HFCA”), a new rule designed to address the investment risks associated with China-based issuers. The rule, effective May 5, 2021, mandated under the HFCA requires certain foreign issuers (“Commission-Identified Issuers”) to make mandatory disclosures or risk delisting in the U.S.[1]
U.S. regulators have increased oversight over China-based issuers as U.S. investors exposures to companies based in or with the majority of their operations in China over the past several years have also increased. While other non-U.S. issuers feature additional risks, Issuers based in China can be particularly risky because the SEC has faced challenges in enforcing its disclosure requirements establishing that Issuers are not owned or controlled by a governmental entity, such as the Chinese Communist Party (“CCP”).
As highlighted by the SEC’s new rule, there are additional risks in distributing, trading, or investing in Chinese issuers because the PCAOB has been unable to inspect or investigate accounting- or audit reports. In a report issued in November 2020, the SEC highlighted some of the potential risks associated with investments in China-based Issuers, including:
The SEC’s new Interim Rule aims to hold Commission-Identified Issuers accountable if they flout the disclosure requirements. Section 2 of the HFCA Act amended Section 104 of the Sarbanes-Oxley Act of 2002 to require the SEC to identify each “covered issuer” that has retained a registered public accounting firm to issue an audit report where that firm has a branch or office located in a foreign jurisdiction, and the PCAOB has determined that it is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.
Section 3 of the HFCA Act provides that these Commission-Identified Issuers that are foreign issuers, as defined in Exchange Act Rule 3b-4, are subject to additional specified disclosure requirements, which include the percentage of shares owned by governmental entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized; 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; the name of each official of the Chinese Communist Party who is a member of the board of directors of the issuer or the operating entity with respect to the issuer; and whether the articles of incorporation (or equivalent organizing document) contains a charter of the CCP.
Registrants are required to make disclosures for each year during which the SEC has identified it as a Commission-Identified Issuer-s. Section 3 of the HFCA identifies Form 10-K and Form 20-F, as well as transition reports filed on these forms.
The interim final amendments become effective May 5, 2021, will apply to registrants that the Commission 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 and that the PCAOB has determined it is unable to inspect or investigate completely because of a position taken by an authority in that jurisdiction. Before any registrant will have to comply with the interim final amendments, the Commission must implement a process for identifying such a registrant.
Consistent with the HFCA Act, the amendments will require any such identified registrant to submit documentation to the SEC (i) establishing that the registrant is not owned or controlled by a governmental entity in that foreign jurisdiction, and (ii) requires disclosure in a foreign issuer’s annual report regarding the audit arrangements of, and governmental influence on, such a registrant.
The HCFA has set a “marker” for investors that due to the lack of transparency regarding financial disclosures, investments in certain China-based issuers involve unique risks. More broadly, investors should be able to recognize the dangers inherent in investing in any company that is not current in their reporting filings and/or does not have financials certified by established reputable accounting firms. Transparency is essential when conducting due diligence, and investors should be wary of any investment opportunity that is not supported by sufficient disclosures, especially those relating to an Issuer’s financial condition and control factors.
If you have any questions or if you would like to discuss these issues further,
please contact Paul A. Lieberman or the Scarinci Hollenbeck attorney with whom you work, at (201) 896-4100.
[1] See, 15 U.S.C. 78a et seq.; SEC Rel. 34-91634/IC34227; see Fed. Register, Pub. L. No. 116-122, 134 Stat. 1063 (December 18, 2020).
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