On April 21, 2020, in a Statement by SEC Chair Jay Clayton, PCAOB Chair William Duhnke and senior SEC officials here, the SEC and the PCAOB called attention to the special risks of “emerging markets” investing, particularly in foreign and U.S. companies with significant operations in China. This follows guidance issued earlier this year by the SEC’s Division of Corporation Finance regarding enhanced disclosure of risks to intellectual property and technology from foreign operations. Our prior discussion of this guidance can be found here.
The new Statement addresses concerns specific to issuers, auditors, index funds that invest in emerging market companies, and financial professionals. This discussion focuses on the considerations for emerging markets issuers – i.e., foreign and U.S. public companies based in or with operations in emerging markets. Among the specific problem areas identified by the Statement are the following:
- The adequacy of disclosure by emerging market issuers, especially regarding the greater risks and uncertainties they face operating in these markets and the challenges of maintaining effective disclosure controls and procedures and internal controls over financial reporting.
- Questions about the quality and reliability of financial reporting by emerging markets issuers, especially those in China, and of the auditing standards used in auditing their financial statements. These questions are now heightened due to the difficulties created by the COVID-19 crisis.
- The inability of the PCAOB to inspect the quality of audit work in these jurisdictions, notably in China.
- The limited ability of U.S. regulators to enforce legal standards and bring legal actions in these jurisdictions, including enforcing individual accountability.
- The reduced access of investors to legal recourse and remedies for misleading information under the legal systems of these jurisdictions.
- Weaker corporate governance protections in place for investors in non-U.S. emerging markets issuers, as well as in some U.S. companies that are controlled by or operate as arms of non-U.S. companies and foreign investors.
The Statement emphasizes the importance of robust risk factor disclosure about these problem areas by public companies based in or with operations in emerging markets. Although the Statement notes the importance of disclosure tailored to circumstances of the specific company and observes that the issues vary by industry and jurisdiction, the breadth and generality of the identified problem areas is likely to result more boilerplate disclosures. The challenge for these companies will be to focus their discussion of the problem areas applicable to them with as much specificity as possible so that the disclosures are meaningful.
The Statement is a reminder of the risks inherent in investments in emerging markets issuers and what the Statement describes as the asymmetry between the information presented about these companies compared to U.S. issuers generally, even though the information appears to be similar. Many U.S. issuers, including those with operations in China, already have robust disclosure regarding the risks of those operations. These issuers, nevertheless, will want to review their disclosure to see whether any of the risks applicable to them identified in the Statement should be disclosed. Other emerging market issuers, working with their U.S. lawyers and auditors and with the involvement of their boards and audit committees, will want to pay heed to the Statement and address, in a way that is specific to their circumstances, the issues and disclosures the Statement identifies.