On Friday, December 18, 2020, President Trump signed into law new legislation that prohibits non-US issuers, particularly Chinese issuers, from trading on any US stock exchanges if they do not comply with US auditing requirements. In effect, this could result in delistings of Chinese issuers from US stock exchanges and also discourage new listings by Chinese companies on US stock exchanges. Additionally, on the same day the new law was enacted, the US Department of Commerce, Bureau of Industry and Security (BIS) published a final rule adding fifty-nine (59) Chinese entities to the Entity List. These two developments represent the latest in a series of actions taken in recent months by the outgoing administration against Beijing.
This new legislation, the Holding Foreign Companies Accountable Act (the Act), bars securities of non-US issuers from being listed on any US national securities exchanges or being traded through other methods, such as “over-the-counter” (OTC) trading, if the non-US company fails to adhere to the audit requirements of the Public Company Accounting Oversight Board (PCAOB) for three (3) consecutive years. The enactment of this law follows President Trump’s issuance of Executive Order (EO) 13959 on November 12, 2020, discussed in our previous briefing, which targets securities investments that finance Communist Chinese military companies. Unlike EO 13959, which will prohibit, beginning on January 11, 2021, the trading of publicly traded securities (or their derivatives) of any Communist Chinese military company, the Act does not expressly target Chinese companies that are key to the development of China’s military, intelligence, and other security apparatuses. While the Act applies to all non-US issuers, it is specifically meant to focus on Chinese firms and is aimed at addressing the limitations China has placed on the PCAOB’s ability to inspect public accounting firms in relation to their audits of Chinese issuers.
The Act requires the US Securities and Exchange Commission (SEC) to identify any issuer of SEC-registered securities whose audited financial reports are prepared by an accounting firm that the PCAOB is unable to inspect or investigate completely because of a position taken by an authority in the jurisdiction where the audits are performed.
If the SEC determines that the PCAOB is unable to inspect the auditor for three (3) consecutive years, the SEC must prohibit the securities of such reporting company from being traded on a US securities exchange (or through any other method within the SEC’s jurisdiction, e.g., OTC trading). This prohibition would be lifted if the reporting company certifies to the SEC that it has retained an auditor that the PCAOB has inspected. If the SEC subsequently determines that the PCAOB is again unable to inspect the company’s auditor, it must prohibit the issuer’s securities from trading on a national securities exchange for a minimum of five (5) years. The SEC can lift the five-year prohibition only if the reporting company certifies to the SEC that it will retain an auditor that the PCAOB is able to inspect.
The Act also subjects an identified SEC reporting company to certain disclosure requirements, including submission to the SEC of documentation that establishes that the covered issuer is not owned or controlled by a government entity in the jurisdiction. In addition, covered issuers are required to disclose, for each year that the PCAOB is unable to inspect its auditor, the following information:
- the percentage of its shares owned by government entities where it is incorporated or otherwise organized;
- whether government entities in the foreign jurisdiction where its retained public accounting firm has a branch or office 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 of the issuer (or equivalent organizing document) contains any charter of the Chinese Communist Party, including the text of any such charter.
New export restrictions
In addition, nearly five dozen additional Chinese entities have now joined over 300 Chinese entities on the Entity List, as we have detailed here and in other updates. The Entity List comprises individuals, organizations and companies that are reasonably believed to be involved, or that pose a significant risk of becoming involved, in “activities contrary to US national security and/or foreign policy interests.” While this action does not constitute an outright ban on all dealings with these entities, it prohibits, absent a license, the export, reexport, or transfer (in-country) of any items subject to the Export Administration Regulations (EAR) to these entities. These requirements are supplemental to those found elsewhere in the EAR. The prohibition applies only to entities specifically named on the list, but BIS also urges caution in dealing with entities affiliated with those entities identified on the list as there is a risk that items subject to the EAR can be diverted to those entities. Therefore, companies need to ensure that they have appropriate procedures in place, including, at a minimum, conducting screening and due diligence, to minimize the risk of unauthorized exports, reexports, or transfer (in-country) to these listed Chinese entities.
The newly added entities include China’s largest chipmaker, the Semiconductor Manufacturing International Corporation (SMIC), and the drone manufacturer DJI, as well as over two dozen research institutes affiliated with China’s shipbuilding industry and various Chinese state-owned enterprises. According to the final rule, the addition of SMIC to the Entity List is due to “China’s military-civil fusion (MCF) doctrine and evidence of activities between SMIC and entities of concern in the Chinese military industrial complex.” For SMIC (and certain other entities), BIS imposes a license review policy of presumption of denial for items uniquely required for production of semiconductors at advanced technology nodes (10 nanometers and below, including extreme ultraviolet technology) and case-by-case for all other items.
Further, according to BIS, four of the newly added entities, including DJI, have “enabled wide-scale human rights abuses within China through abusive genetic collection and analysis or high-technology surveillance, and/or facilitated the export of items by China that aid repressive regimes around the world[.]” Additionally, in BIS’s view, several of the newly-added entities “systematically coordinated and committed more than a dozen instances of theft of trade secrets from U.S. corporations” and impair US efforts to “counter illicit international trafficking in nuclear and other radioactive materials.” According to BIS, several of the other entities have been added due to “acquiring and attempting to acquire U.S.-origin items in support of programs for the People’s Liberation Army” while another entity was added due to its role in enabling China “to reclaim and militarize disputed outposts in the South China Sea[.]” A full list of the entities that have been added to the Entity List is available here.
We will continue to monitor these developments and issue briefings as warranted.
*Our thanks to Eddie Skolnick for his contributions to this legal update.