On August 26, the Public Company Accountability Board (“PCAOB”), the China Securities Regulatory Commission, and the Ministry of Finance of the People’s Republic of China signed a Statement of Protocol Agreement (“Protocol Agreement”) that provides a framework for the PCAOB to investigate and inspect PCAOB-registered public accounting firms in China and Hong Kong.1 The deal is potentially the first step in bringing PCAOB-registered public accounting firms in China and Hong Kong into compliance with US law, and preventing the delisting companies listed on US exchanges under the Holding Foreign Companies Accountable Act of 2020 (“HFCAA”) for employing such firms to conduct their audits. However, US regulators have signaled that only full compliance with the Protocol Agreement will prevent delistings, and that they will be watching very closely to see if the Chinese government will permit unimpeded investigations and inspections by the PCAOB.

Background on the PCAOB and the Holding Foreign Companies Accountable Act

The PCAOB was established by the Sarbanes-Oxley Act to oversee the audit of US public companies. The Sarbanes-Oxley Act required auditors of US public companies to register with the PCAOB and charged the agency with establishing standards for the preparation of audits.2 The PCAOB is also required to conduct inspections and investigations of PCAOB-registered accounting firms to ensure compliance with the law and the PCAOB’s implementing regulations. These inspections and investigations are intended to protect investors by ensuring that financial information provided by publicly-listed companies is informative and accurate.3

Chinese authorities, however, prevented PCAOB-registered public accounting firms in China and Hong Kong from providing the PCAOB with access to their audit work papers. In response, the US Congress passed the HFCAA. Under the HFCAA, the Securities and Exchange Commission (“SEC”) is required to prohibit the trading of securities on US exchanges of any issuer that, for three consecutive years, uses for the preparation of its financial statements a PCAOB-registered public accounting firm that (1) has a branch or office in any foreign location and (2) the PCAOB has determined that government authorities in that jurisdiction prevent it from completely inspecting or investing PCAOB-registered public accounting firms.4 The trading prohibition applies to securities traded on national securities exchanges and any other trading method within the jurisdiction of the SEC to regulate (including “over-the-counter”).5

In 2021, the first year after the HFCAA’s passage, the PCAOB determined that Chinese authorities had prevented the PCAOB from inspecting and investigating PCAOB-registered public accounting firms in China.6 Subsequently, the SEC has identified more than a hundred companies located in China and Hong Kong that have used such PCAOB identified public accounting firms to audit their financial statements.7

The New Agreement

The August 26 agreement has four main provisions:

  • “The PCAOB has sole discretion to select the firms, audit engagements and potential violations it inspects and investigates – without consultation with, nor input from, Chinese authorities.
  • Procedures are in place for PCAOB inspectors and investigators to view complete audit work papers with all information included and for the PCAOB to retain information as needed.
  • The PCAOB has direct access to interview and take testimony from all personnel associated with the audits the PCAOB inspects or investigates.”8
  • The PCAOB has the unfettered ability to transfer information to the SEC, in accordance with the Sarbanes-Oxley Act.9

While officials at the PCAOB and SEC welcomed the development, they emphasized it was only a first step, as China will need to comply with the terms of the agreement.10 Indeed, SEC Chair Gary Gensler said, in response to the signing of the agreement:

“While important, this framework is merely a step in the process. This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China. If it cannot, roughly 200 China-based issuers will face prohibitions on trading of their securities in the US if they continue to use those audit firms.”11

The PCAOB intends to have auditors on the ground in Hong Kong in September to begin audits of PCAOB-registered public accounting firms.12 In accordance with the HFCAA, the PCAOB will also reassess its determination that Chinese government authorities prevent it from completely inspecting or investing PCAOB-registered public accounting firms.