On November 5, 2021, as part of the implementation of the Holding Foreign Companies Accountable Act (“HFCA”), the SEC approved PCAOB Rule 6100. Rule 6100 establishes a framework for the PCAOB’s determination that it is unable to inspect or investigate completely registered public accounting firms located in foreign jurisdictions because of a position taken by an authority in that jurisdiction. The HFCA was adopted on December 18, 2020 and requires foreign-owned issuers to certify that the PCAOB has been able to audit specified reports and inspect their audit firm within the last three years. If the PCAOB is unable to inspect the company’s public accounting firm for three consecutive years, the company’s securities are banned from trading on a national exchange.
The Sarbanes-Oxley Act of 2002 (“SOX”) mandates that the PCAOB inspect registered public accounting firms in both the United States and in foreign jurisdictions and investigate potential statutory, rule, and professional standards violations committed by such firms and their associated persons. The HFCA requires that the SEC 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. Further, as to a covered issuer, the PCAOB must determine that it is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.
To implement compliance with the requirements of the HFCA, the SEC adopted final interim rules on July 30, 2021 (see HERE). The rules apply to covered companies that the SEC 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.
The SEC rules require identified companies to submit documentation to the SEC, on or before its annual report due date, establishing that it is not owned or controlled by a governmental entity in that foreign jurisdiction. The company will also be required to include disclosure in its annual report regarding the audit arrangements of, and governmental influence on the company. If the company is identified by the SEC (“Commission-Identified Issuers”) for three consecutive years, the SEC will prohibit trading of the company’s securities. The SEC is still considering how to implement the trading prohibition requirement.
Also, Commission-Identified Issuers must include disclosure for each non-inspection year:
- Identifying the registered accounting firm that prepared an audit report;
- the percentage of shares owned by governmental entities where the issuer is incorporated;
- whether these governmental entities have a controlling financial interest;
- information related to any board members who are officials of the Chinese Communist Party; and
- whether the articles of incorporation of the issuer contain any charter of the Chinese Communist Party.
As mentioned, SOX mandates that the PCAOB inspect registered public accounting firms in both the United States and in foreign jurisdictions and investigate potential statutory, rule, and professional standards violations committed by such firms and their associated persons. The PCAOB realized early on that certain aspects of these mandates raised concerns for non-U.S. firms, including potential conflicts with local laws. To address these concerns, the PCAOB worked with international counterparts to develop arrangements and working practices to allow the PCAOB and foreign regulators to achieve their respective requirements.
To ensure that cooperation with foreign regulators maintained the spirit and requirements imposed by SOX, any arrangement with a foreign regulator must allow the PCAOB to: (i) conduct inspections and investigations in accordance with SOX; (ii) select the audit work and potential violations to be examined; and (iii) access firm personnel, audit work papers and other information and documents deemed relevant by the PCAOB.
Although most companies cooperate, not all regulators have despite repeated efforts. Over the years, the PCAOB has maintained a “Denied Access List” which identifies the jurisdictions where the PCAOB cannot conduct inspections because foreign authorities have denied access, and the auditors from those jurisdictions issue audit reports filed with the SEC for U.S.-listed foreign public companies. As of today, the PCAOB can conduct inspections everywhere it needs to do so except in mainland China and Hong Kong. Against this backdrop, Congress enacted the HFCA requiring the PCAOB to determine whether it is unable to inspect or investigate completely a registered public accounting firm that is located in a foreign jurisdiction because it is denied access by one or more authorities in that jurisdiction.
PCAOB Rule 6100 establishes the process for the PCAOB’s determinations under the HFCA; the factors the PCAOB will evaluate and the documents and information the PCAOB will consider when assessing whether a determination is warranted; the form, public availability, effective date, and duration of such determinations; and the process by which the Board will reaffirm, modify, or vacate any such determinations.
Determinations as to Registered Firms Headquartered in a Particular Jurisdiction
A determination by the PCAOB that it is denied access to a firm headquartered in a foreign jurisdiction because of a position taken by one or more authorities in that jurisdiction, applies to all firms headquartered in that jurisdiction. A jurisdiction-wide determination not only assists in the administrative efficiency of the statute, but is also consistent with the HFCA’s language that access must be denied due to a position taken by an authority (regulator/government) in that jurisdiction. Moreover, a jurisdiction wide assessment will allow for consistency.
Rule 6100 provides for jurisdiction wide determinations related to firms headquartered in that jurisdiction. “Headquarters” are defined as where the firm has its principal place of business, including where the firm’s management directs, controls and coordinates the firm’s activities. The PCAOB will make a rebuttable presumption that a firm is headquartered at the physical address reported by the firm as its headquarters to the PCAOB in the firm’s required filings. Where a firm is not headquartered but merely has a presence in the jurisdiction, the PCAOB will consider the extent of the firm’s presence and the nature of the audit work performed. However, based on experience, the PCAOB believes that most determinations will be jurisdiction-wide.
In making a jurisdiction-wide determination, the board will consider laws that restrict access, not whether the accounting firms are abiding by or availing themselves of those laws. For example, foreign laws may only deny access for certain business sectors or companies with specific business models. Even if only a few registered firms in that jurisdiction presently are auditing issuers in that sector or with that business model, the PCAOB would assess whether its access would be equally impaired should any registered firm in the jurisdiction perform the restricted engagements. Moreover, the PCAOB will consider restrictions by any regulator or governmental authority in that jurisdiction.
Determinations as to a Particular Firm with an Office in a Foreign Jurisdiction
Although as of now the PCAOB believes all determinations with be jurisdiction-wide, to account for unforeseen circumstances, Rule 6100 provides for a scenario in which the problem is with a particular firm and allows the PCAOB to make a determination of denied access on a firm-by-firm basis. For example, although it is not the case today, a foreign jurisdiction could impose rules that apply to registered accounting firms headquartered in its jurisdiction but not to firm’s that merely have an office there.
Apart from the determination being directed to a firm as opposed to a jurisdiction, the standards for making a determination are exactly the same under the Rule. Also, if a firm is a member of an international network but a separate legal entity, the other member firms will not be effected by a PCAOB determination of denied access.
Factors for Board Determinations
In determining whether it can inspect or investigate completely in a particular jurisdiction or as to a particular firm, the PCAOB will assess whether “the position taken by the authority (or authorities)” in the jurisdiction “impairs the PCAOB’s ability to execute its statutory mandate with respect to inspections or investigations.” The HFCA does not define “inspect or investigate completely.” The PCAOB defines the term broadly and includes when it is not able to commence an inspection or investigation or when, based on the PCAOB’s knowledge and experience, it has concluded that commencing an inspection or investigation would be futile as a result of the position taken by a foreign authority.
Rule 6100 ties the PCAOB’s ability to “inspect or investigate completely” to three core principles that guide the PCAOB’s framework for international cooperation. Specifically, the PCAOB will consider whether it: (i) can select the audits and audit areas it will review during inspections and the potential violations it will investigate; (ii) has timely access to firm personnel, audit work papers, and other documents and information relevant to its inspections and investigations, and the ability to retain and use such documents and information; and (iii) can otherwise conduct its inspections and investigations in a manner consistent with SOX and the PCAOB’s rules.
In making a determination, the PCAOB does not have to find that all three considerations are present. Impairment in any one respect may be sufficient under the circumstances to support a PCAOB determination. Similarly, the PCAOB does not need to conclude that it has been impaired as to both its inspections and its investigations.
Timing of Board Determinations
To begin, the PCAOB will make any determinations promptly upon the Rule’s effectiveness. Thereafter, the PCAOB will make an annual review of its findings to see if any changes in facts and circumstances warrant an adjustment to a determination, or if new jurisdictions or firms should be added. In addition, the Rule allows the PCAOB to make interim determination whenever it deems appropriate.
Basis for Determinations
Rule 6100 provides that when assessing whether its ability to execute its mandate has been impaired, the PCAOB may consider “any documents or information it deems relevant.” From there, the rule specifies three non-exclusive categories of documents and information that the PCAOB can rely upon when making a determination, but stresses that the PCAOB can consider anything it deems relevant.
The three non-exclusive categories include: (i) a foreign jurisdiction’s laws, statutes, regulations, rules, and other legal authorities as well as relevant interpretations of those laws; (ii) the entirety of the PCAOB’s efforts to reach and secure compliance with agreements with foreign authorities in the jurisdiction, including whether an agreement was reached, the terms of the agreement, interpretation and performance under the agreement; and (iii) the PCAOB’s experience with foreign authorities’ other conduct and positions relative to PCAOB’s inspections or investigations.
Form and Publication of Board Determinations
When the PCAOB makes a determination, it will issue a report to the SEC. The PCAOB’s report will describe its assessment of whether the position taken by the foreign authority (or authorities) impairs the PCAOB’s ability to execute its mandate with respect to inspections or investigations. The report will analyze the relevant factor(s) and describe the basis for the PCAOB’s conclusions. The PCAOB will identify the firm(s) subject to the PCAOB’s determination by the name under which the firm is registered with the PCAOB, and by the firm’s identification number with the PCAOB.
Promptly upon furnishing the report to the SEC, the report will be published on the PCAOB website. If necessary, the report will be redacted if it contacts private personal information that is confidential as a matter of law. A copy of the report will also be sent to the effected firm(s) by email.
Effective Date and Duration of Board Determinations
A determination becomes effective upon the PCAOB’s delivery of a report to the SEC and will be re-assessed at least annually.
Reassessment of Determination
The PCAOB will consider whether changes in facts and circumstances warrant a reassessment of a determination that is in effect. If the PCAOB concludes that a reassessment is warranted, the PCAOB will analyze the same factors as when making an initial determination and decide whether to leave its determination undisturbed or issue a new report modifying or vacating the determination. Apart from that annual process, the PCAOB also can reassess a determination on its own initiative or at the SEC’s request at any time.