The Securities and Exchange Commission (SEC) has adopted new rules to implement the Holding Foreign Companies Accountable Act (HFCAA) passed in 2020. The act was passed in response to Chinese regulators thwarting the Public Company Accounting Oversight Board’s (PCAOB) attempts to inspect the audits of Chinese firms listed in America. It permits the SEC to delist foreign public companies that fail to comply with the transparency requirements of America’s regulators.
Transparency Protects Investors
Congress mandates the SEC to protect investors. Accordingly, it has an established history of working with more than 50 foreign jurisdictions to access information about their companies listed in America. However, China and Hong Kong have consistently been less than forthcoming, and the new ruling is expected to hit China the hardest. In designing the new rules, the SEC has dealt with companies registering securities directly in the U.S. and those using a form of shell company called variable interest entities (VIEs).
Under the Sarbanes-Oxley Act of 2002, auditors of public companies listed and trading in the U.S. are subject to inspection by the PCAOB. The SEC’s new ruling says that where the PCAOB isn’t granted access to the required reports for three consecutive years, it can instruct the entity to cease trading and delist from exchanges in the U.S. It also makes it mandatory for public companies to declare if they are owned or in some other way controlled by a foreign government and provide the necessary proof they are not. And it requires public companies to disclose additional information in their annual reports, such as the percentage of shares owned by government entities, controlling financial interest from government entities, and the names of any Chinese Communist Party board members.
China Is Cracking Down on Its Tech Industry
China’s state-run financial system has largely excluded entrepreneurs in the past, leading them to seek funding abroad. The hundreds that found their way to America’s financial markets have successfully raised billions of dollars. But increasingly, Beijing is concerned with data security and trying to tighten control of the country’s tech industry. It is demanding that companies refrain from listing on American exchanges, or in the case of those already listed, encouraging them to delist. In return, it’s promising them more ways to raise funds in China.
Most recently, the Cyberspace Administration of China (CAC) has reportedly asked DiDi, the ride-hailing service, to delist from the New York Stock Exchange, citing concerns over sensitive data leakage. The CAC had earlier launched a cybersecurity review of Didi and removed 25 of its apps from China’s app store after trying to discourage it from listing in America.
Didi, which made its $4.4 billion market debut in New York just five months ago, has issued a one-sentence announcement of its intention to delist and pursue an A-share listing in Hong Kong. Shareholders are expected to be offered a minimum of $14 per share (the IPO price) to avoid shareholder resistance or legal action. Didi’s website recently noted that its shares would be “convertible into freely tradable shares of the company on another internationally recognized stock exchange.” The Nasdaq Golden Dragon China Index, which tracks US-listed stocks exposed to operations in China, including Alibaba Group Holding, dropped 9.1% after Didi’s delisting announcement.
The Response of Stakeholders
In many instances, listed Chinese firms are audited by the Big Four accounting firms, but Chinese regulators are preventing them from making information available to the PCAOB. One view of the situation is that the companies are being held hostage by a clash of Chinese and U.S. law. As a result, some industry actors are calling for involvement above the regulatory level, perhaps at the trade representative level, to depoliticize the matter.
Beijing is openly critical of the SEC's new ruling, saying it's a political attempt to stunt Chinese development. In response, it has warned it might block Americans from investing in China’s fast-growing companies. It denies reports that it is pushing Chinese entities to drop their American listings, saying it respects the rights of Chinese companies to raise funds where they wish. It says the primary purpose behind its tech crackdowns was to ensure data security, control monopolistic behaviors, and protect smaller firms.
As of May, there were just short of 250 Chinese companies with a combined capitalization of $2.1 trillion on the Nasdaq, New York Stock Exchange, and NYSE American (three of the largest U.S. exchanges.) Alibaba’s 2014 New York listing was the biggest IPO globally at the time. Didi’s withdrawal has raised concerns that Beijing’s crackdowns have wiped out nearly $1 trillion in offshore stocks and may extend into broader areas.