Remarks at the Harvard Law School Program on International Financial Systems, 2024 U.S.-China Symposium

Thank you for the introduction, John [Gulliver], and for letting me be part of the 21^st annual U.S.-China Symposium by the Program on International Financial Systems. The U.S.-China relationship is important to the global capital markets, and I appreciate the participation at this conference by many knowledgeable participants in Sino-American relations, including our distinguished visitors from the People's Republic of China.

Today is a particularly special day for the U.S. Securities and Exchange Commission ("SEC" or the "Commission"). On this date ninety years ago, President Franklin D. Roosevelt signed into law the Securities Exchange Act of 1934 (the "Exchange Act").[1] That legislation created the SEC,[2] and the agency has adapted to nearly a century of changes in the capital markets, technology, and business practices. In Chinese culture, longevity is associated with wisdom. Hopefully, investors and market participants view the SEC as a wiser regulator today than it was in 1934. As the SEC continues to age, I look forward to how future actions by the agency will reflect that increased wisdom.

From the earliest days of the SEC's existence, the agency has recognized the unique nature of foreign companies[3] accessing the U.S. capital markets, and its rules have afforded different treatment to foreign companies. For example, in July 1935, the SEC created separate forms to be used by foreign companies to register a class of securities under the Exchange Act.[4] In creating these different forms, the SEC explained that its requirements for U.S. companies must be adapted to the "peculiar circumstances" of foreign companies and that "[i]n view of the disparity between the laws and practices existing in [different] countries[,] it was necessary to introduce great flexibility in the requirements."[5] Later in 1935, the SEC exempted foreign companies from its rules governing proxy solicitations and trading in a company's securities by directors and officers.[6]

These decisions from the 1930s continue to stand today, but the capital markets are constantly evolving. In 2024, there are significant connections between global capital markets in Europe, Asia, the United States, and elsewhere. As we look to the future of foreign companies accessing the U.S. capital markets, how should the SEC regulate those companies? Today, I will share some thoughts on this subject that reflect my individual views as a Commissioner of the SEC and do not necessarily reflect the views of the full Commission or my fellow Commissioners.

Disclosure by Foreign Companies

The underlying regulatory philosophy of the federal securities laws is truthful disclosure.[7] In recommending legislation for securities laws to Congress, President Roosevelt stated: "[The legislation] puts the burden of telling the whole truth on the seller…The purpose of the legislation…is to protect the public with the least possible interference to honest business."[8]

As the SEC has recognized, foreign companies are different from U.S companies[9] and, accordingly, may bear greater costs to comply with the same disclosure requirements. Thus, a fundamental issue in the SEC's regulation of foreign companies is whether, and to what extent, the substance and frequency of disclosure by foreign companies should differ from that of U.S. companies. At one end of the spectrum, foreign companies would be subject to the exact same disclosure requirements as U.S. companies, with limited exceptions for when following such requirements would violate foreign laws. At the other end, foreign companies would provide only the disclosure required under their home country's requirements.

In addressing this topic today, I will focus on disclosure outside of the financial statements.[10] In considering what the SEC's regulatory philosophy for non-financial disclosure should be in the future, it is important to understand the history of the agency's regulatory approach. I will first discuss the frequency with which foreign companies must provide disclosure, followed by the substance of the disclosure.

Frequency of Disclosure by Foreign Companies

Since 1935, both U.S. and foreign companies have been required to file an annual report with the SEC.[11] Today, this report for foreign companies is referred to as Form 20-F. Beginning in 1967, foreign companies have been required to furnish a report, referred to as Form 6-K, for any material information disclosed by the company under its home country laws, publicly reported pursuant to stock exchange requirements, or provided to its shareholders.[12] Unlike U.S. companies, foreign companies have never been required to file quarterly reports, and unless triggered by Form 6-K, they have never been required to file reports upon the occurrence of a significant corporate event, such as entry into a merger agreement or departure of an executive officer.

For decades, this regulatory approach provided a strong distinction in the reporting frequency between U.S. and foreign companies. However, this approach has begun to change.[13] In 2012, the SEC introduced a new annual filing regarding companies' use of conflict minerals that equally applied to U.S and foreign companies.[14] In 2020, the SEC implemented an annual filing requirement regarding payments made by U.S. and foreign companies engaged in resource extraction.[15] Finally, last year, the SEC issued a rule to require U.S. and foreign companies to provide quarterly disclosure regarding repurchases of the company's own equity securities.[16]

Although the conflict minerals and resource extraction rules were required by Congress,[17] the SEC could have, but decided against using its exemptive authority[18] to exclude foreign companies from the filing requirement. In contrast, the share repurchase rule was not mandated by Congress. Its application to foreign companies represented a significant departure from the SEC's past practice. Ultimately, a court vacated the rule late last year because of procedural violations by the SEC when adopting the rule,[19] and the unprecedented quarterly filing by foreign companies for share repurchases will not occur. Nonetheless, the SEC's decisions with respect to its conflict minerals, resource extraction, and share repurchases rules are departures from the agency's long-standing position in requiring disclosure by foreign companies annually on Form 20-F and when material information is otherwise made public pursuant to Form 6-K.

Substance of Disclosure by Foreign Companies

Turning to the substance of the disclosure requirements for foreign companies, we begin in 1979 - the year in which the SEC introduced Form 20-F.[20] In adopting the new form, the agency stated that "[U.S.] investors in foreign securities should be supplied with information equal as nearly as possible and practicable to that provided to investors in securities of domestic issuers."[21] However, the SEC also recognized that "there are differences in various national laws and businesses and accounting customs which the [SEC] should take into account when assessing disclosure requirements for foreign [companies]."[22] In balancing these two considerations, the agency adopted annual disclosure requirements for foreign companies that were based on the requirements for U.S. companies,[23] but did not make the requirements "substantially similar," as was proposed.[24]

The next comprehensive update to Form 20-F was in 1999.[25] That year, the agency revised the annual report's disclosure requirements to conform to the international disclosure standards endorsed by the International Organization of Securities Commissions ("IOSCO"). In explaining its rationale for changing Form 20-F's disclosure requirements to match IOSCO's standards, the SEC explained that "issuers would find it easier to offer or list securities outside their home country by preparing a core disclosure document that, with a minimum of national tailoring, may be accepted in multiple jurisdictions [and that] [t]his disclosure document would serve as an 'international passport' to the world's capital markets by reducing the barriers to cross-border offerings and listings."[26] The SEC also reiterated striking a balance between "expanding the investment opportunities available to U.S. investors" and "ensuring that [investors] receive a high level of information comparable to that provided by U.S. companies."[27]

Since 1999, changes to the disclosure requirements for foreign companies have largely been piecemeal.[28] These changes generally fall into three categories. First, for disclosure mandated by Congress - particularly from the Sarbanes-Oxley Act[29] and the Dodd-Frank Act[30] - the SEC has been reluctant to exercise its general exemptive authority and instead, has chosen to apply disclosure requirements equally to U.S. and foreign companies.[31] Second, where the SEC has exempted foreign companies from disclosure obligations, the requirement is part of the proxy statement, which does not apply to foreign companies, or relates to executive compensation.[32] Third, in recent disclosure rulemakings that were not mandated by Congress and that do not relate to proxy materials, the SEC has generally required the same disclosure from U.S. and foreign companies alike.[33] In explaining its decisions, the SEC stated that the required disclosure is just as important for investment decisions in foreign companies as it is in U.S. companies[34] and the agency's desire for consistent and comparable information across all companies.[35]

Need for a Consistent Regulatory Philosophy for Disclosure by Foreign Companies

Given the history of the SEC's regulatory approach, the agency's recent decisions to mostly treat U.S. and foreign companies alike with respect to disclosure requirements are confusing and have led to inconsistency.

For example, is share repurchase information more important than earnings information, such that quarterly disclosure was necessary for it but not earnings? Why is there deference to foreign companies' home country requirements for executive compensation disclosure but not to other areas, such as recoupment of executive compensation[36] or disclosure of climate-related risks? What is the standard for when the SEC will exercise its authority to exempt foreign companies from general disclosure requirements mandated by Congress, in light of the agency's historical considerations of differences in laws and business customs[37] and increasing investment opportunities for U.S. investors?[38]

The lack of a clearly articulated regulatory philosophy for aligning foreign companies' disclosure obligations with that of U.S. companies hurts both investors and companies over the long term. As the SEC stated in 1979 when it adopted Form 20-F, "[t]he examination of…securities regulation in international markets…should be…continuing and evolutionary…"[39] However, in the past 45 years, the agency has undertaken only one comprehensive review of its disclosure requirements for foreign companies.[40]

To eliminate the confusion and inconsistency that plagues the SEC's recent decisions on foreign company disclosure, the agency should consider publishing its views in a white paper or concept release, and soliciting public feedback, on what principles should guide future rulemakings. The historical SEC approach of different disclosure standards for U.S. and foreign companies has not resulted in large scale market failures. To the extent that there have been issues with foreign companies' disclosure, they often involve outright fraud and material misstatements and omissions,[41] which are concerns that would occur regardless of whether a company is filing on forms applicable to foreign companies or U.S. companies. The SEC should incorporate this important consideration when developing its principles on foreign company disclosure requirements.

Definition of Foreign Private Issuer

If the SEC conducts this undertaking, then one question that should also be examined is which foreign companies should qualify for the disclosure regime afforded by Form 20-F and Form 6-K.

Currently, a foreign company can use Form 20-F and Form 6-K if it meets the test for a "foreign private issuer." Generally, the conditions for a foreign private issuer are based on whether a majority of U.S. residents hold the company's voting securities and whether a majority of the company's operations are in the United States.[42] Whether a company's operations are in the United States is based on the following factors: (1) whether its directors or executive officers are U.S. citizens or residents; (2) whether its assets are located in the United States; or (3) whether its business is administered principally in the United States.[43]

This test for foreign private issuer traces back to at least 1983.[44] At the time, the SEC stated that "[f]oreign [companies] that generally are owned and managed by U.S. persons are considered to be essentially U.S. [companies]"[45] and were therefore excluded from qualifying as foreign private issuers. While a test based on ownership and management may have been sufficient back then, it may not reflect the realities of today's global capital markets, corporate structures, and business practices.

Imagine two entrepreneurs, one in the United States and one in China. Each starts an artificial intelligence company. After years of successful growth, both entrepreneurs make the same decision to list their company's stock solely on Nasdaq but retain majority voting power. However, the similarities end there. The U.S. founder has incorporated his company in Delaware, with all of its employees, assets, and operations in the United States. The Chinese founder has incorporated his company in the Cayman Islands, with all of its employees, assets, and operations in China. In this example, the United States is the sole capital market and source of public company disclosure requirements for both companies. The two companies compete for U.S. investors' capital. The U.S. company is required to comply with the full scope of the U.S. federal securities laws, including publicly disclosing financial information on a quarterly basis, complying with the proxy solicitation rules, and reporting certain material events within four business days. In contrast, the Chinese company must only file a Form 20-F annually and a Form 6-K in potentially limited circumstances. Is this outcome appropriate?

If you believe that the answer is "no," then this example demonstrates a potential pitfall of the test to qualify as a foreign private issuer, as it does not consider whether the foreign company must comply with robust disclosure requirements from a jurisdiction other than the United States. Previously, many foreign private issuers likely had the primary listing of their stock on a foreign exchange, and the listing on the New York Stock Exchange or Nasdaq was secondary. The primary foreign exchange may have had robust disclosure requirements. It was under this scenario that the SEC established the current ways to qualify as a foreign private issuer and the disclosure obligations of Form 6-K.[46] Additionally, the increased use of corporate structures that separate voting power and economic interest may allow more foreign companies to keep a majority of their voting power outside of the United States while having their stock listed solely on a U.S. exchange. Accordingly, more and more foreign private issuers today may list their stock solely on a U.S. exchange. For example, one study suggests that of the 265 Chinese companies listed on a U.S. exchange, 89% were listed on only the U.S. exchange.[47]

This issue deserves attention, and the SEC should consider evaluating whether foreign private issuers should be limited to companies whose securities are also listed on a foreign stock exchange. Consideration should also be given to whether the foreign exchange meets certain quality standards. The goal of studying this issue in more detail is not to limit the number of foreign companies that access the U.S. capital markets. Rather, it is to ensure that the SEC's treatment of foreign companies reflects today's global capital markets, and does not place U.S companies at a competitive disadvantage[48] or deprive U.S. investors from receiving appropriate disclosure.

HFCAA and a Culture of Compliance

Lastly, I will share some thoughts on the impact of the Holding Foreign Companies Accountable Act ("HFCAA"),[49] which was signed into law in December 2020. The HFCAA's general goal is to ensure that the Public Company Accounting Oversight Board ("PCAOB"), which regulates auditors of public companies in the United States, has the ability to inspect audit firms and that no foreign jurisdiction prevents such inspections.[50] Initially, the PCAOB determined that it was unable to inspect audit firms headquartered in mainland China and Hong Kong.[51] However, approximately two years after the HFCAA went into effect, PCAOB received access to conduct inspections.[52]

The initial inspections results showed significant deficiencies at the two firms that were inspected.[53] However, as PCAOB Chair Erica Williams noted, it is not unusual to see high deficiency rates for firms in jurisdictions that are being inspected for the first time.[54] I am hopeful that the PCAOB can continue to inspect audit firms in mainland China and Hong Kong, and that the deficiency rates from such inspections will decline in the future.

A low deficiency rate is one example of a compliance culture at an audit firm. A strong culture may benefit the firm through more audit engagements, stronger employee recruitment and retention, and lower regulatory risk. Additionally, a strong compliance culture may also result in greater detection of errors during the audit engagement, thereby resulting in more accurate financial statements for investors. While the immediate goal of the HFCAA is to give the PCAOB the ability to inspect firms, the ultimate impact of the legislation may be higher-quality firms and more accurate financial statements. These benefits will flow to both foreign companies and U.S. investors alike.

Conclusion

To conclude, the SEC has developed much wisdom over the past ninety years. However, the agency cannot rest on its laurels in a future filled with new innovations and more global markets. This is particularly true for the SEC's regulatory approach to foreign companies seeking capital in the United States. To provide greater certainty to these companies and ultimately to protect U.S. investors, the agency should articulate a philosophy for when disclosure by foreign companies should be equivalent to disclosure by U.S. companies. As part of this process, the SEC should ensure that its "foreign private issuer" definition reflects today's capital markets and corporate structures and captures the appropriate foreign companies.

By modernizing and improving its regulations, the SEC can attract not only more, but also better-quality, foreign companies to list their stock on U.S. exchanges. This ultimately benefits U.S. investors by providing them with the opportunity to further diversity their portfolio through ownership of foreign securities, without the attendant costs of using a foreign broker. Foreign companies would also benefit from access to the capital markets with the most liquidity in the world.

Thank you. I hope that discussions from last night and over the next two days on important issues in the U.S.-China relationship are productive.