On November 23, 2020, the Division of Corporation Finance published CF Disclosure Guidance: Topic No. 10, Disclosure Considerations for China-Based Issuers, which provides the Division's views regarding certain disclosure considerations for companies based in or with the majority of their operations in the People's Republic of China (PRC), referred to as China-based Issuers.
On December 2, 2020, the U.S. House of Representatives passed S.945, the Holding Foreign Companies Accountable Act, which was previously passed in the U.S. Senate by unanimous consent in May 2020. If signed into law by the President, this bill would, among other things, direct the U.S. Securities and Exchange Commission (SEC) to prohibit the securities of any publicly-traded company from being traded on any U.S. securities exchange or over-the-counter market if the Public Company Accounting and Oversight Board (PCAOB) has been unable to inspect the audit work of the company's auditor for three consecutive years. The specific disclosure and related requirements in this bill are discussed in greater detail in our previous Alert.
Background
Over the past couple of years, the SEC and the PCAOB have continued to highlight issues and challenges faced in enforcing disclosure standards and inspecting the audit work and practices of PCAOB-registered accounting firms in emerging markets, including the PRC, and have taken a number of steps to address these issues. The foregoing efforts include, among other things:
Against the backdrop of these efforts, the SEC's Division of Corporation Finance published new disclosure guidance relating to China-based Issuers. This guidance discusses certain risks associated with China-based Issuers and disclosure considerations for China-based Issuers. A summary of this guidance follows.
Risks Associated with China-based Issuers
The guidance discusses several risks associated with China-based Issuers, including:
Disclosure Considerations
The guidance states that "China-based Issuers must fully disclose material risks related to their operations in China." Thus, in assessing material risks related to their operations in China, and their related disclosure obligations, the guidance provides a series of questions, reproduced in their entirety below, for consideration. These questions follow directly from the risks discussed above, and include questions relating to the limitations on PCAOB inspections, the use of the VIE structure, the PRC regulatory environment, differing shareholder rights and remedies, and status as a foreign private issuer, as follows:
What to Do Now?
China-based Issuers should review the Division's guidance carefully together with their existing risk factor, governance, and other disclosures in order to determine whether, and to what extent, additional disclosures may be required. As one example, in the guidance, the Division suggested one possible approach to disclosure relating to status as a foreign private issuer would be to provide a table comparing the differences in corporate governance practices to domestic issuers and to explain how those differences impact investors.
In addition, we are also closely monitoring the legislative developments with respect to S.945, the Holding Foreign Companies Accountable Act, including whether and when the President will sign this bill into law, and when the SEC will issue implementing regulations relating to these new requirements (if signed into law), as well as any new proposals that may be released by the SEC in response to the recommendations made in the PWG Report.
For more information on this latest disclosure guidance and legislative action, or any related matter, please contact any member of the firm's Greater China or capital markets practices.
[1] See SEC Chairman Jay Clayton, SEC Chief Accountant Wes Bricker, and PCAOB Chairman William D. Duhnke III, Statement on the Vital Role of Audit Quality and Regulatory Access to Audit and Other Information Internationally—Discussion of Current Information Access Challenges with Respect to U.S.-listed Companies with Significant Operations in China (Dec. 7, 2018), available here; SEC Chief Accountant Sagar Teotia, Statement in Connection with the 2019 AICPA Conference on Current SEC and PCAOB Developments (Dec. 9, 2019), available here; SEC Chief Accountant Sagar Teotia, Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19 (April 3, 2020), available here; and SEC Chairman Jay Clayton, PCAOB Chairman William D. Duhnke III, SEC Chief Accountant Sagar Teotia, SEC Division of Corporation Finance Director William Hinman, and SEC Division of Investment Management Director Dalia Blass, Emerging Market Investments Entail Significant Disclosure, Financial Reporting and Other Risks; Remedies are Limited (April 21, 2020), available here.
[2] See SEC Chairman Clayton, PCAOB Chairman Duhnke, and Members of SEC Staff Meet With Auditing Firm Representatives to Discuss Audit Quality in Emerging Economics and Markets (Nov. 4, 2019), available here; SEC Chairman Jay Clayton, SEC Division of Corporation Finance Director Bill Hinman, SEC Chief Accountant Sagar Teotia, and PCAOB Chairman William D. Duhnke III, Statement on Continued Dialogue with Audit Firm Representatives on Audit Quality in China and Other Emerging Markets; Coronavirus—Reporting Considerations and Potential Relief (Feb. 19, 2020), available here; and SEC Chairman Jay Clayton, SEC Chief Accountant Sagar Teotia, and PCAOB Chairman William D. Duhnke III, Statement on Third Meeting with Audit Firm Representatives Regarding Audit Quality in Emerging Markets and Recent Developments (Nov. 24, 2020), available here.
[3] See Chairman Jay Clayton, SEC Division of Corporation Finance Director William Hinman, SEC Division of Investment Management Director Dalia Blass, SEC Division of Trading and Markets Director Brett Redfearn, SEC Office of International Affairs Director Raquel Fox, and SEC Chief Accountant Sagar Teotia, Statement on SEC Response to the Report of the President’s Working Group on Financial Markets (Aug. 10, 2020), available here.
[4] See S. 945, Holding Foreign Companies Accountable Act, available here.