Senate Bill Would Deny U.S. Securities Trading to Chinese Companies
By Andrew N. Vollmer
Senior Affiliated Scholar, Mercatus Center at George Mason University. Former Professor of Law, General Faculty, University of Virginia School of Law; former Deputy General Counsel of the Securities and Exchange Commission; and former partner in the securities enforcement practice of Wilmer Cutler Pickering Hale and Dorr LLP.
On May 20, 2020, the Senate passed legislation to address a long simmering dispute over the integrity of financial statements of companies from China and a few other countries. The bill would prohibit the securities of those companies from being traded on U.S. exchanges or other U.S. trading venues if those countries continue to block U.S. oversight of the auditors of the companies’ financial statements. The bill might add to economic frictions between China and the United States, but it in fact seeks to vindicate long-standing and important policies of the U.S. securities laws.
The saga began with the Sarbanes-Oxley Act of 2002. One target of the Act was repeated failures in the effectiveness of audits of the financial statements of companies making public disclosures to the U.S. securities markets. Congress wanted to improve the accuracy and reliability of audited financial statements and therefore created the PCAOB to oversee the conduct of auditors of public companies. Accounting firms that prepare or play a substantial role in the preparation of an audit report of a company, whether U.S. or foreign, that sells securities to the U.S. public, is listed on a U.S. exchange, or is obliged to make periodic public disclosures to U.S. securities markets must register with and be inspected by the PCAOB. This applies to U.S. and foreign accounting firms.
Many Chinese companies have tapped the U.S. securities markets, but China does not permit PCAOB inspections of its accounting firms. The Securities and Exchange Commission and the PCAOB have been concerned about this for years and have made several attempts to resolve the problem. The efforts to find a solution with China have not been successful.
The Senate legislation, like an earlier House bill, is an approach to break the impasse. S. 945 would prohibit the securities of a company from being traded on a U.S. securities exchange or through any other method of trading subject to U.S. regulation if the auditors of the financial statements of the company have not been subject to inspection by the PCAOB for three consecutive years.
The bill is not simply retribution. The goal is to protect the U.S. capital markets from an increased risk of faulty audited financial statements. PCAOB inspections of auditors are one way Congress sought to improve the accuracy and reliability of corporate disclosures under the securities laws. As long as PCAOB inspection of auditors is an important part of maintaining confidence in the financial statements of companies that file public reports under U.S. securities laws, the obligation should be applied uniformly and consistently.
Permitting the stock of Chinese companies, whose auditors are not subject to U.S. regulatory oversight, to trade in the United States creates doubt about the trustworthiness of the financial statements of those companies and adds unacceptable danger for investors. It creates a two-tiered system of disclosure quality in the United States and is not fair to the many U.S. and foreign companies that play by the rules and use auditors that are subject to PCAOB inspection. Chinese companies are able to shirk valuable compliance procedures and avoid costs that other companies have.
Some Chinese companies are attractive investment opportunities, but denying them U.S. trading privileges would not deny those opportunities to U.S. investors. U.S. investors would still be able to invest in companies that do not use auditors subject to PCAOB inspections. The companies could list and trade in a foreign market. U.S. investors could buy the securities in foreign markets, but they would know that the entire system of securities regulation is different. That would be the individual investor’s choice and not the choice of U.S. policy makers.
In June 2019, a subcommittee of the Committee on Financial Services of the U.S. House of Representatives held hearings on a bill similar to the Senate bill. I testified at the House hearing and submitted a written statement that elaborates on some of the points here.
