INSIGHT: Mitigating Increased Enforcement Risks by U.S. Regulators on Chinese, Non-U.S. Companies

Over the past few months, we have seen unprecedented scrutiny by the U.S. government against non-U.S. companies, and China-based companies in particular.

This is not new, of course—the U.S. Department of Justice announced the “China Initiative” in November 2018, and has maintained restrictions on exports of military and dual-use items to China for years. What is new, however, is the increased focus on Chinese companies as “perceived threats” to U.S. national security and economic interests. Just the last few months have seen a raft of new measures targeting China-based companies, government entities and officials, all which increase the risk of regulatory scrutiny and enforcement against China- and non-China-based companies, financial institutions, and individuals across certain sectors.

Enhanced Scrutiny of U.S.-Listed Chinese Companies

For the first time, there are serious proposals in the U.S. which could have the effect of cutting Chinese companies off from U.S. capital markets.

On April 21, 2020, the U.S. Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) published a statement emphasizing disclosure risks caused by PCAOB’s inability to inspect audit work papers in China.

On May 20, 2020, the U.S. Senate unanimously passed the Holding Foreign Companies Accountable Act (HFCAA). If passed by the U.S. House of Representatives and signed into law by President Trump, HFCAA will apply to all U.S.-listed Chinese companies requiring them to disclose foreign government ownership or control and their auditors to be inspected by PCAOB. Failure to comply may trigger mandatory delisting.

On Aug. 6, 2020, the President’s Working Group on Financial Markets released a report aiming to address risks posed by the inability of the PCAOB to inspect audit firms of U.S.-listed companies in “non-cooperating jurisdictions” like China.

Should these proposals and initiatives become law in the U.S., they could severely restrict Chinese companies’ access to U.S. capital markets.

U.S. Trade Controls / Financial Sanctions on Chinese Technology and Other Companies

In addition, the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) has continued to add Chinese companies to its Entity List.

On April 28, 2020, BIS published rules that eliminate the license exception for civil end-users in China, Russia and Venezuela, and expand military end-user restrictions on these countries. On May 22, 2020, BIS added 24 organizations to the Entity List, claiming that they “represent a significant risk of supporting procurement of items for military end-use in China.”

On June 5,2020, and July 22, 2020, BIS successively put 20 Chinese companies on the Entity List for acting contrary to U.S. foreign policy interests. And, on Aug. 26, 2020, BIS added another 24 companies to the Entity List, this time relating to their island-building activities in the South China Sea. The U.S. Treasury Office of Foreign Assets Control (OFAC) also has placed certain Hong Kong SAR officials on the Specially Designated Nationals (SDN) list. Entity List designations can result in prohibition of the export, re-export, or in-country transfer of items subject to the Export Administration Regulations (EAR) to designated entities without authorization. SDN designations can result in an inability for the designated party to transact in U.S. dollars, among other consequences.

Apart from the Entity List, the International Emergency Economic Powers Act (IEEPA) authorizes the U.S. President to ban transactions between U.S. and certain foreign entities. On Aug. 6, 2020, President Trump issued executive orders prohibiting U.S. persons from relevant transactions with Chinese parent companies of specific software apps. That situation continues to unfold.

These are truly uncertain times, and there may be even more instances of U.S. trade controls imposed by the U.S. administration to follow.

Preparing for Additional Regulatory Risk

We advise many Chinese and other non-U.S. companies and financial institutions facing these risks, and offer the following thoughts.

1. Take a good look internally to identify potential vulnerabilities. Oftentimes Chinese companies invest in the U.S. without protecting themselves against worst-case scenarios. Supply chains; distribution channels; identity of customers, account holders and business partners; location and control of, and access to, personal data collected on U.S. citizens; market share and other business decisions need to be made along these lines. Many Chinese companies are now undertaking a U.S. trade controls and regulatory risk assessment.
2. Look around to monitor specific sub-sector enforcement trends. While a particular Chinese company may not yet be targeted by the U.S. administration, there is every likelihood the scope of regulatory restrictions—and corresponding enforcement—will continue to widen. Companies should monitor trends in the particular space in which they operate, be it technology manufacturing, financial services, software app or others.
3. Have an in-house and external U.S.-China specialist team ready to act. While nobody knows for sure what the coming weeks and months may bring, once a Chinese company is subject to an investigation by the DOJ, SEC, BIS, or OFAC, the company will have a limited amount of time to react and act accordingly. The sooner the company has counsel in place to lead them through an unexpected situation and its global risks and consequences, the better it will fare with a solution.

The U.S. has a presidential election in November. We believe that uncertainty and U.S. regulatory risks for Chinese and other non-U.S. companies will exist regardless of the outcome. Many Chinese companies are preparing themselves by evaluating their operations for U.S. regulatory and enforcement risks. It is a new era of U.S. enforcement activity, and companies worldwide would be prudent to identify and deal with potential operational risks.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Shaun Wu is a partner in the Litigation Department of Paul Hastings. Based in the firm’s Hong Kong office, he leads the Investigations and White Collar Defense practice in Greater China. He has extensive experience advising corporate clients across the Asia-Pacific, focused on the U.S. Foreign Corrupt Practices Act, bribery, corruption, sanctions, fraud, misconduct and other enforcement matters in which clients rely upon his deep experience in China and across Asia.

Tom Best is an international investigations, enforcement defense and compliance lawyer, and a partner in the Investigations and White Collar Defense and Global Trade Controls practices based in the Paul Hastings’ Washington, D.C. office. He advises senior management and boards of directors on complex investigations, enforcement, and compliance issues arising under the U.S. Foreign Corrupt Practices Act and other countries’ anti-corruption laws, economic sanctions and export controls, the U.S. securities laws, and other legal regimes affecting major multinationals’ operations.