Kennedy bill goes to President’s desk | China Accounting Blog | Paul Gillis

Kennedy bill goes to President’s desk

The House of Representatives today passed the Holding Foreign Companies Accountable Act (The Kennedy Bill) by voice vote. The Senate has already passed the act, so it now goes to the President’s desk to be signed into law.  

The act will kick Chinese companies off of US exchanges after three future audits that cannot be inspected by the PCAOB. That means that the ban will not take place for calendar year companies until April 30, 2023 which is when their Form 20F for the third consecutive year (2022) will be due.  

Certain disclosures are also required, including government ownership, and names of Communists on the board of the company or operating entities, and whether the articles of incorporation contain the charter of the Communist Party.   

The passage of the Kennedy bill likely ends any plan by the SEC to do the same through regulation, as well as the unworkable recommendations of the President’s Working Group. This issue has been in existence since Sarbanes Oxley was passed in 2002. The SEC and PCAOB have always had the ability to do this but lacked the will to do so.  

I do not believe the ban will ever come into effect. China made an offer on April 3, 2020 that the PCAOB rejected but which I believe is a reasonable offer. I fear their response was political and a case of putting the perfect ahead of the good. China has since sent another proposal to the PCAOB in August and has indicated that it is willing to deal.  

I expect the issue will be settled by China agreeing to inspections. Biden has indicated he is not going to repeal Trump’s phase one trade deal immediately, but rather begin a multilateral discussion with former allies. I expect PCAOB inspections will be one of China’s concessions in reaching a new deal. There is no real urgency given the long transition period.  

Inspections are not going to change much. I believe that the Big Four firms in China (which audit substantially every company of any meaningful size) are currently doing the audits under PCAOB standards. They have internal reviews of these audits by teams from outside of China (although I expect these reviews have been suspended under Covid-19).

PCAOB inspections have been tough, with a substantial share of audits found defective. Companies generally learn of problems with their audit when auditors show up to do remediation work, and shareholders rarely learn of problems. PCAOB inspections often result in financial sanctions against audit partners by the firm (the PCOAB itself only sanctions partners for serious offences such as altering working papers). I believe the rules should be amended to require disclosure of any sanctions against the partner (by the firm or regulators).

The fear of financial sanctions may change the behavior of audit partners, who may become more skittish and conservative. While sometimes that may be appropriate, it does undermine the independent judgment of partners.  

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