Paul Schneider
Associate Editor
Loyola University Chicago School of Law, JD 2022

On Wednesday May 20, the Senate unanimously passed legislation aimed to curb the ability of Chinese companies to avoid audit requirements. The bill was introduced by Republican Senator John Kennedy of Louisiana and Democratic Senator Chris Van Hollen of Maryland. Senator Kennedy provided the following comment in a press release announcing the legislation: “It’s asinine that we’re giving Chinese companies the opportunity to exploit hardworking Americans—people who put their retirement and college savings in our exchanges—because we don’t insist on examining their books. I hope my colleagues in the House will immediately send this bill to the President’s desk so we can protect Americans and their savings.”

What is the proposed legislation?

The Holding Foreign Companies Accountable Act (S.945) seeks to amend a section of the Sarbanes-Oxley Act of 2002. Should the bill become law, foreign companies listed on the U.S. stock exchange that fail to comply with Public Company Accounting Oversight Board (PCAOB) audit requirements for three consecutive years could lose their listing on American stock exchanges. In addition, the proposed legislation requires foreign companies to certify that they are not owned or controlled by a foreign government.

Why now?

Although the legislation could be applied to any foreign company that seeks to access U.S. capital, the bill is clearly targeted at Chinese companies. For years, Chinese companies have raised billions of dollars on American stock exchanges while avoiding compliance with the audit standards that other public companies must withstand. Chinese companies have been able to get away violating the rules because the Chinese government has provided a shield. The Chinese government asserts that compliance with audit requirements violates its sovereignty and puts state secrets at risk. China has never given U.S. regulators routine access to audit records needed to review the quality of financial accounting. These consistent compliance failures have gone unaddressed.

Three main factors provided legislators on both sides of the aisle with the motivation to force Chinese companies to play by the rules. First, the ongoing discussions of fair-trade practices between the U.S. and China has built economic tension between the two global superpowers. Second, China’s role in the spread of the coronavirus has brought the need for accountability to the forefront. Third, after going public on the Nasdaq, Chinese based Luckin Coffee is being investigated by the SEC for fabricating $310 million in revenue, thus defrauding U.S. investors.

Will Chinese companies comply?

If the bill becomes law, U.S. stock exchanges are likely to see an exodus of Chinses companies in three years. Creating financial statements and audit procedures that are in compliance with PCAOB requirements is no easy task. A great deal of work would need to be done. Such work would likely be made more difficult due to resistance from the Chinese government. A more likely outcome is that Chinese companies simply takes their securities elsewhere. Chinese firms could move to stock exchanges that do not require them to change their reporting processes, such as London or Hong Kong.

Has the proposed legislation deterred Chinese startups from raising capital on U.S. exchanges?

Despite the proposed legislation and increased political tension between China and the U.S., Chinese companies continue to flock to American stock exchanges. As of August 14, twenty Chinese companies have gone public in 2020 on the Nasdaq Stock Market or the New York Stock Exchange. These twenty companies have raised $4 billion through their IPOs, already exceeding the amount raised by Chinese companies for the entirety of 2019. Over the course of 2019, twenty-five Chinese companies raised $3.5 billion through IPOs on American exchanges.

According to market analysts, Chinese companies continue to raise funds in the United States because, in many situations, the need for short-term capital outweighs long-term risks. In addition, listing in the world’s largest and most active capital market provides better opportunities for marketing and exposure to a more diverse group of investors. Despite the strained relationship between the world’s two largest economies, the United States seems to continue to be the easiest place for companies in the growth stage to raise capital.