Op-Ed: Chinese Firms Need to Open Their Books

A prior version of this Op-Ed was published in The Wall Street Journal [1]

The Securities and Exchange Commission may need to prohibit trading in about 270 China-related companies by early 2024. The reason can be traced to the Enron and WorldCom accounting scandals.

Congress passed the Sarbanes-Oxley Act in 2002, mandating inspections of public companies’ auditors by the Public Company Accounting Oversight Board. More than 50 foreign jurisdictions allow the board to “audit the auditors.” Two do not: China and Hong Kong.

Congress acted last year to fill this gap by unanimously passing the Holding Foreign Companies Accountable Act. The law prohibits trading in an issuer’s stock if a foreign jurisdiction prevents our oversight board from inspecting the company’s audit firm for three consecutive years. The SEC has taken all the required steps to implement this law, and the oversight board is on track to finalize its relevant rulemaking before the end of the year. The three-year clock began ticking in 2021.

Now it’s up to Beijing to let the oversight board in so we can ensure the relevant audits are up to U.S. standards. Early next year I expect we will announce which companies, if any, used an auditor that didn’t open its workpapers to U.S. overseers. If these companies use an audit firm in a noncompliant jurisdiction for two more years consecutively, their shares will be prohibited from trading in our capital markets beginning in 2024.

In June the Senate passed the Accelerating Holding Foreign Companies Accountable Act, which, if enacted, would wind the three-year clock down to two. We welcome discussions with Chinese authorities, but Congress has spoken. Unless China’s companies abide by the rules, their shares won’t be able to trade in the U.S./span>

In addition to ensuring that the Public Company Accounting Oversight Board can “audit the auditors,” we want U.S. investors to be fully aware of risks with respect to these companies. We’ve put a pause on new offerings from both Chinese operating companies who list directly and their shell-company affiliates. We are working with them to ensure they clearly disclose relevant risks.

To explain why, let’s take a step back. In response to the Great Depression, President Franklin Roosevelt and Congress established a basic bargain. Investors get to decide what risks they wish to take. Companies that are raising money from the public must make full and fair disclosures to investors. This bargain has been a source of America’s economic success for 90 years.

I don’t believe China-related companies currently are providing adequate information about the risks they face—and thus the risks that American investors in these businesses face. This summer Beijing clamped down on some China-related companies raising capital in the U.S. These companies became subject to new rules, ranging from data-privacy regulations to restrictions on business models.

In certain sectors, the Chinese government doesn’t allow foreign ownership. To raise capital on U.S. exchanges, many Chinese companies employ a structure called variable-interest entities that establish contractual relationships with shell companies in foreign jurisdictions, like the Cayman Islands. These shell companies then raise capital on U.S. exchanges, but the contracts don’t actually confer ownership of the operating company to American investors. I worry that some investors don’t realize they’re putting their money into a Cayman shell rather than a company operating in China.

I directed the SEC’s staff in July to ensure that these companies provide full, fair and transparent disclosure of their risks and corporate structures, among other factors, if they wish to offer securities in U.S. markets.

Whether in California, the Cayman Islands or China, all companies that seek to raise money in the deep and liquid U.S. capital markets should play by America’s rules. The steps that Congress, the SEC and the Public Company Accounting Oversight Board are taking to protect investors aim to do just that. The clock is ticking.

[1] See “SEC Chair: Chinese Firms Need to Open Their Books” (Sept. 13, 2021), available at https://www.wsj.com/articles/china-accounting-standards-shell-company-vie-investment-sarbanes-oxley-sec-gensler-11631563524.