Alert December 30, 2021

SEC and PCAOB Prepare to Implement the Holding Foreign Companies Accountable Act

The U.S. Securities and Exchange Commission (SEC) has adopted final amendments that, in conjunction with final rules adopted by the Public Company Accounting Oversight Board (PCAOB) earlier this year and the recent determination by the PCAOB that it is unable to inspect or investigate completely any registered public accounting firm in China and Hong Kong, will set the stage for the SEC to designate companies as “Commission-Identified Issuers” based on annual reports filed for fiscal years beginning after December 18, 2020. This designation triggers a variety of potential consequences under the Holding Foreign Companies Accountable Act (HFCAA). The HFCAA imposes various disclosure obligations on companies after the SEC designates a company as a Commission-Identified Issuer, which would not happen until a company has filed its 2021 annual report in spring 2022. If the SEC determines that the company is a Commission-Identified Issuer for three consecutive years, the HFCAA requires the SEC to issue an order prohibiting trading of the company’s securities on U.S. stock exchanges and in the U.S. over-the-counter securities markets, which currently would not happen until 2024 after a company has been a Commission-Identified Issuer for three consecutive years. For all companies, the SEC final amendments will require changes in Form 10-K, Form 20-F, Form 40-F and other SEC annual reports filed by all companies after January 10, 2022; although, for many companies this will require only adding Item 9C, Item 16I, or Item B(18)(b), as applicable, indicating that this disclosure is “not applicable,” and adding Inline XBRL tagging for certain information related to the company’s independent accounting firm.

What Companies Need to Know Now

As discussed in greater detail elsewhere in this alert, companies should be aware of the following key points before they file their annual reports for the calendar year ended December 31, 2021 (or any fiscal year beginning after December 18, 2020):

  • The SEC has adopted final amendments to Form 10-K, Form 20-F and other SEC annual report forms to add a new disclosure item for HFCAA disclosure regarding foreign jurisdictions that prevent inspections. The new disclosure heading should be included in all annual reports, even if the company’s response is “not applicable” because the company has nothing to disclose in response to the new requirement. Note that the interim final rules adopted by the SEC in March 2021 and effective May 5, 2021 included amendments that were in most respects identical to the final amendments. The amendments apply to all companies, including non-accelerated filers, smaller reporting companies (SRCs), emerging growth companies (EGCs) and foreign private issuers (FPIs).

  • These annual reports also require new Inline XBRL tagging to identify the audit firm that provided the report on the company’s audited financial statements included in the annual report. This tagging requirement applies to annual reports filed by all companies.

  • Companies that expect to file an annual report for a fiscal year beginning after December 18, 2020 that will include an opinion of an audit firm identified by the PCAOB as not being subject to PCAOB inspection should consider how the company will respond. Will the company engage an audit firm that is subject to PCAOB inspection? Are there alternatives that could avoid SEC designation of the company as a Commission-Identified Issuer? What disclosure may be appropriate under these circumstances?

  • If the company does not currently intend to engage an auditor that would avoid triggering the HFCAA, what disclosure may be appropriate under those circumstances?

  • The SEC will begin the process of identifying “Commission-Identified Issuers” pursuant to the HFCAA based on disclosure and Inline XBRL tagging contained in annual reports for fiscal years that began after December 18, 2020. As a result:

    • The first provisional identification of Commission-Identified Issuers will be made by the SEC after companies file their annual reports in 2022 for fiscal years that began after December 18, 2020 — during February, March and April 2022 for most companies that have a December 31 fiscal year end — which will be followed by conclusive SEC determinations that certain companies are Commission-Identified Issuers;

    • Companies designated as Commission-Identified Issuers will first be required to comply with the HFCAA submission (and, if applicable, disclosure) requirements in annual reports filed covering fiscal years that began after December 18, 2022, which will be filed in 2023; and

    • The SEC would issue the first potential SEC orders imposing trading prohibitions under the HFCAA in 2024, after a company has been a Commission-Identified Issuer for three consecutive years, based on annual reports filed in 2022, 2023 and 2024 for fiscal years ending in 2021, 2022 and 2023, respectively.

  • If the Accelerating Holding Foreign Companies Accountable Act is enacted into law, Commission-Identified Issuers would, as discussed below, be subject to trading prohibitions after two consecutive years, rather than the three years currently required by the HFCAA.

Summary History of SEC and PCAOB Actions to Implement HFCAA

  • The HFCAA became law in December 2020, requiring the SEC and the PCAOB to adopt rules to implement the HFCAA.

  • The SEC adopted interim final amendments to certain SEC forms, including Form 10-K and Form 20-F annual reports, to implement the disclosure, document submission and trading prohibition provisions of the HFCAA, in March 2021.

  • The PCAOB adopted a final rule, Rule 6100, in September 2021 that establishes the framework for PCAOB determinations that the PCAOB is unable to inspect or investigate completely registered public accounting firms located in a foreign jurisdiction because of a position taken by one or more authorities in that jurisdiction.

  • The SEC approved PCAOB Rule 6100 in November 2021.

  • The SEC adopted final amendments to its rules and forms after receiving public comments on the interim final amendments in December 2021. The SEC final amendments, together with PCAOB Rule 6100 in September 2021, completed the regulatory framework for PCAOB and SEC action to implement the HFCAA.

  • The PCAOB issued a report on its determination under PCAOB Rule 6100 that it is unable to inspect or investigate completely any audit firm headquartered in mainland China and Hong Kong in December 2021. The report specifically names 15 public accounting firms headquartered in mainland China and in Hong Kong that are currently registered with the PCAOB, although the determination is applicable to any firm headquartered in mainland China or Hong Kong. The PCAOB report states that during the 13-month period ended September 30, 2021, these 15 PCAOB-registered firms signed audit reports for 191 public companies with a combined global market capitalization (U.S. and non-U.S. exchanges) of approximately $1.9 trillion.

  • The U.S. Senate passed the Accelerating Holding Foreign Companies Accountable Act in June 2021, and it was introduced in the U.S. House of Representatives in December 2021. If enacted into law, a Commission-Identified Issuer would become subject to HFCAA trading prohibitions after determination that it was a Commission-Identified Issuer for two consecutive years rather than the current three years.

Timeline for Identification as Commission-Identified Issuer and Trading Prohibitions

Provisional and Conclusive Identification by the SEC as a Commission-Identified Issuer. Starting with annual reports for fiscal years that began after December 18, 2020, companies must file SEC annual reports that comply with Inline XBRL tagging that identifies (1) the audit firm that provided an opinion on the financial statements presented in the annual report, (2) the location where the report was issued and (3) the PCAOB ID number of the audit firm that provided the opinion.

The SEC will review annual reports that contain an audit report signed by a PCAOB-Identified Firm promptly after the company files its annual report, using the Inline XBRL tagging. If a company’s annual report contains multiple accountant’s reports or involves more than one registered public accounting firm, only the registered public accounting firm or firms that serve as “principal accountant” will be deemed retained for purposes of the final rule.

The SEC will “provisionally identify” a company as a Commission-Identified Issuer on the SEC’s HFCAA web page. The SEC process does not currently include notice to companies that the SEC has provisionally identified as a Commission-Identified Issuer. Companies should be able to anticipate the results of the SEC’s review, and in any case should monitor the SEC’s HFCAA web page frequently after filing the company’s annual report because the company has only 15 days to dispute the SEC’s provisional identification. A “Commission-Identified Issuer” is a registrant that has retained a registered public accounting firm to issue an audit report where the registered public accounting firm has a branch or office that is 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 (PCAOB-Identified Firm).

If a company believes that the SEC’s provisional identification was incorrect, the company has 15 business days to email the SEC at hfcaa@sec.gov (or such other email address as the SEC may designate on its HFCAA page in the future) to dispute this identification and provide appropriate documentation that is satisfactory to the SEC under the HFCAA.

If the company does not dispute the SEC’s provisional identification, or if the SEC does not accept the company’s position that the SEC’s provisional identification was incorrect, the SEC will list the company on the “conclusive list of issuers identified under the HFCAA” on the HFCAA web page, which will also list the number of consecutive years for which the issuer has been identified and current and prior trading prohibitions. If the SEC accepts the company’s position, it will remove the company’s name from the HFCAA page.

Disclosure Obligations after Designation as a Commission-Identified Issuer. If the SEC has previously identified a company as a Commission-Identified Issuer, a company that is, in fact, not owned or controlled by a governmental entity in the foreign jurisdiction of its PCAOB-Identified Firm must submit documentation to the SEC establishing that the company is not so owned or controlled. Companies must submit this documentation through EDGAR on or before the due date of the company’s annual report. The company can submit this documentation, which will be publicly available, with its annual report, on a Form 8-K (or Form 6-K if applicable) report, or using another appropriate method. The final amendments include amendments to Forms 10-K, Form 20-F and other forms that implement this requirement. A Commission-Identified Issuer that is owned or controlled by a foreign governmental entity is not required to submit this documentation.

Commission-Identified Issuers that are “foreign issuers” must provide additional disclosure in their annual report for the year in which the SEC identifies the company as a Commission-Identified Issuer. As defined in Rule 3b-4 under the Securities Exchange Act of 1934, “foreign issuer” means any issuer that is a foreign government, a national of any foreign country, or a corporation or other organization incorporated or organized under the laws of any foreign country. The additional required disclosure includes the following:

  • That during the period covered by the form, a PCAOB-Identified Firm prepared an audit report for the company;
  • The percentage of the shares of the company owned by governmental entities in the foreign jurisdiction in which the company 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 company;
  • The name of each official of the Chinese Communist Party (CCP) who is a member of the board of directors of the company or the operating entity with respect to the company; and
  • Whether the articles of incorporation of the company (or equivalent organizing document) contain any charter of the CCP, including the text of any such charter.

The final amendments include amendments to Forms 10-K, Form 20-F and other forms to implement this requirement.

Trading Prohibitions. If the SEC identifies a company as a “Commission-Identified Issuer” for three consecutive years, the HFCAA requires the SEC to prohibit the trading of the securities of a company on U.S. national securities exchanges or through any other method within the jurisdiction of the SEC to regulate, including through over-the-counter trading. 

If the company certifies to the satisfaction of the SEC that it has retained a PCAOB-registered public accounting firm that the PCAOB has inspected, the HFCAA provides that the SEC shall terminate an initial trading prohibition.

If the SEC ends the initial trading prohibition and later determines again that the company is a Commission-Identified Issuer, the SEC will impose a subsequent trading prohibition on the company for a minimum of five years. After the end of the five year period of the subsequent trading prohibition, the SEC will end the subsequent trading prohibition if the company certifies that it will retain a public accounting firm that is not a PCAOB-Identified Firm. Initial and subsequent trading prohibitions become effective on the fourth business day after the SEC publishes its order imposing the trading prohibition.

Companies Subject to the Final Amendments

The final amendments apply to all domestic companies and FPIs. There is no exemption for non-accelerated filers, SRCs or EGCs under the HFCAA or the final amendments.

Securities Subject to the Final Amendments

The final amendments apply to all securities issued by a Commission-Identified Issuer, not only securities listed on a national stock exchange or traded over the counter. Because the HFCAA provides that the Commission “shall prohibit the securities of the covered issuer from being traded,” derivative securities issued by a Commission-Identified Issuer that is subject to the HFCAA trading prohibition will also be subject to the trading prohibition. For example, if a Commission-Identified Issuer that is subject to a trading prohibition has issued exchange-listed equity securities and warrants on those equity securities, the trading prohibition would apply to both the exchange-listed equity securities and the warrants. The trading prohibitions would not apply to securities that were not issued by a Commission-Identified Issuer, such as exchange-traded standardized equity options that are issued by the Options Clearing Corporation, rather than the issuer of the underlying equity security.

What All Companies Should Do Now

Form 10-K Item 9C and Related Form 20-F and 40-F Amendments. Every Form 10-K should now include new Item 9C, Holding Foreign Companies Accountable Act Disclosure. Unless the company has received notice that the SEC has determined that the company is a “Commission-Identified Issuer” as discussed elsewhere in this alert, the company should indicate “not applicable” under Item 9C; no further disclosure is required. Form 20-F, Item 16I(b), and Form 40-F, Item B(18)(b), have been similarly amended.

Inline XBRL Tagging Requirement. The final amendments include an amendment to the interactive data requirements that apply to Form 10-K, Form 20-F and Form 40-F under Rule 405 of Regulation S-T. To facilitate SEC identification of “Commission-Identified Issuers,” companies must tag the name of the auditor(s) that provided an opinion on the financial statements included in the annual report, as well as the location where the auditor issued the report and the PCAOB ID number of the auditor(s).

Consequences of Designation or Potential Designation as a “Commission-Identified Issuer.” Companies designated by the SEC as a “Commission-Identified Issuer” will be subject to submission, and in some cases additional disclosure obligations, after the first designation. These companies will also be subject to trading prohibitions after the third consecutive annual designation. There currently appear to be limited ways to avoid the disclosure requirements and trading prohibitions after the first designation.

Companies that have current audit engagements with a public accounting firm headquartered in mainland China or Hong Kong should consult with legal counsel and their auditor to determine what disclosure may be appropriate. Potentially appropriate disclosure could include, among other things, disclosure in the Risk Factors and Management’s Discussion and Analysis sections of the company’s annual report, including disclosure of known trends and uncertainties. It is important that companies do not disclose risks as hypothetical in the Risk Factors section of their annual report if the event described as a risk has actually occurred. Note that many companies already include disclosure concerning the PCAOB’s inability to conduct inspections of the company’s independent audit firm.

Affected companies should also discuss what legally permissible actions may be possible to avoid designation as a Commission-Identified Issuer and, ultimately, SEC trading prohibition orders.

Stacey Harlow Buttrey was a contributing author to this alert.