Hogan Lovells 2024 Election Impact and Congressional Outlook Report
15 November 2024
On 26 August 2022, the China Securities Regulatory Commission (CSRC) and China’s Ministry of Finance (MOF) executed a Statement of Protocol (SOP) Agreement with the U.S. Public Company Accounting Oversight Board (PCAOB), for purpose of setting out a cooperative mechanism between the China and U.S. governments for allowing the PCAOB to perform inspections and investigations against PCAOB registered accounting firms based in mainland China and Hong Kong who provide audit services to the Chinese companies listed in the U.S. stock markets.
As required under the Sarbanes-Oxley Act of the U.S., the registered public accounting firms that audit the books of any issuers (including foreign ones) in the U.S., have to be subject to inspections and investigations by the PCAOB, which includes the inspection of all audit work papers such as the engagement-specific documentation of the audit work related to the issuer’s financial statements. As reaffirmed under the Holding Foreign Companies Accountable Act of 2020 (HFCAA), if the PCAOB is “unable” to inspect or investigate “completely” the registered public accounting firms located in foreign jurisdictions, issuers that use those firms which have been identified by the SEC for three consecutive “non-inspection” years will face prohibitions on their securities trading in the U.S. In 2021, the PCAOB made determinations that the positions taken by Chinese authorities prevented the PCAOB from inspecting and investigating its member firms which have presence in mainland China and Hong Kong completely. On June 22, 2021, the U.S. Senate passed a bill which, if passed by the U.S. House of Representatives and signed into law, would reduce the number of consecutive non-inspection years required for triggering the prohibitions under the HFCAA from three years to two.
As the Securities and Exchange Commission of the U.S. (SEC) and PCAOB have alleged[1], CSRC’s imposition of a cooperative agreement and pre-approval requirement for cross-border data transfer on accounting firms operating in China (including Hong Kong) for more than a decade, impaired their ability to inspect and investigate these accounting firms as mandated under the Sarbanes-Oxley Act and HFCAA. However, as disclosed by CSRC on April 27, 2020, it had provided the PCAOB with audit work papers for a total of 14 US-listed Chinese companies up to that time, in the light of the cooperative framework under the International Organization of Securities Commissions, as well as the Enforcement Memorandum of Understanding in 2013 and the Agreement on Pilot Inspection in 2016 between the PCAOB, CSRC and MOF.
As of 28 September 2022, 163 Chinese issuers have been designated on the conclusive list of issuers identified under the HFCAA, which will be subject to additional submission and disclosure obligations to establish that it is not owned or controlled by a governmental entity in the foreign jurisdiction with respect to that registered public accounting firm, and the percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized, etc.. If the PCAOB continues to be prohibited from conducting complete inspections and investigations of these PCAOB-registered public accounting firms in mainland China and Hong Kong, these China-based issuers may face trading prohibitions in the U.S.
As of the date of this alert, the full text of this SOP Agreement is not publicly available. Set forth below is a summary of the key highlights as respectively outlined in the fact sheets/official statements issued by the SEC, PCAOB, and CSRC, with our notes on the important content introduced therein.
Apart from the uncertainty of the cooperation level contemplated by each party, it is advised to follow up on how would this SOP Agreement be implemented in conjunction with the domestic data protection regulations, such as DSL and PIPL. For instance, whether the data provided under the SOP Agreement via Chinese authorities would still be subject to any prior governmental exportation formalities, and whether the draft cross-border securities regulatory cooperation mechanism[4] that was recently introduced by CSRC would be finalized to include any detailed guidance for domestic accounting firms in this regard.
Separately, PCAOB will reassess its determination by the end of 2022 on account of the Chinese authorities’ performance of the SOP Agreement and whether PCAOB has been granted complete and timely access to jurisdiction-wide information in its work in Hong Kong. Otherwise, as contemplated by PCAOB, the relevant China-based companies will face trading prohibitions and likely delisting in the U.S.
Authored by Roy Zou, Sherry Gong, Stephanie Tang, Flora Feng.
1 See from the HFCAA Determination Report, dated December 16, 2021, at https://pcaobus.org/news-events/news-releases/news-release-detail/pcaob-makes-hfcaa-determinations-regarding-mainland-china-and-hong-kong.
2 See Regulation on Strengthening Confidentiality and Archives Administration Relating to Overseas Issuance and Listing of Securities (Circular [2009] No. 29) (Oct. 20, 2009); Interim Provisions on Auditing Operations Conducted by Accounting Firms Concerning the Overseas Listing of Domestic Chinese Companies ([2015] No. 9) (effective July 1, 2015); Securities Law of the PRC (effective Mar. 1, 2020), etc.
3 Also see in the Draft Regulation on Strengthening Confidentiality and Archives Administration Relating to Overseas Issuance and Listing of Securities by Domestic Enterprises (released on April 2, 2022).
4 See the Draft Regulation on Strengthening Confidentiality and Archives Administration Relating to Overseas Issuance and Listing of Securities by Domestic Enterprises (released on April 2, 2022) and the Draft Provisions of the State Council on the Administration of Overseas Securities Offering and Listing by Domestic Companies (released on December 24, 2021).