Holding Foreign Companies Accountable Act

The Holding Foreign Companies Accountable Act (HFCAA) is a U.S. federal law passed in 2020. Think of it as a “show me your homework” rule for foreign companies listed on American stock exchanges. For years, investors poured money into these companies without a key safeguard: the ability for U.S. regulators to inspect the audits of these firms. The HFCAA changes that. It mandates that foreign companies listed on U.S. exchanges must allow the Public Company Accounting Oversight Board (PCAOB), America's audit watchdog, to inspect their audit papers. If a company's home country, most notably China, blocks these inspections for two consecutive years, the Securities and Exchange Commission (SEC) is required to kick the company's stock off the exchange. This law was a direct response to a long-standing issue where U.S. investors were exposed to potential fraud and accounting irregularities from certain foreign firms without the same level of regulatory oversight applied to domestic companies.

Imagine two restaurants on the same street. One has its kitchen regularly inspected by the health department, ensuring everything is clean and safe. The other refuses entry to the inspector, citing “kitchen secrets.” Which one would you trust with your dinner? For years, this was the situation on Wall Street. U.S.-based companies had their financial “kitchens” (their audit work) inspected by the PCAOB. However, Chinese authorities, citing national security, blocked the PCAOB from inspecting the audit firms that signed off on the books of major Chinese companies listed in the U.S. This created a glaring double standard and put investors at risk. High-profile scandals, like the massive fraud discovered at Luckin Coffee in 2020, highlighted the very real danger. Investors had no way to verify the quality of the audits, leaving them flying blind and vulnerable to major losses. The HFCAA was designed to close this loophole and ensure all companies play by the same rules.

The process is straightforward and acts like a penalty-box rule for non-compliant companies.

1. Step 1: Identification. The SEC identifies companies that use an audit firm located in a foreign country where the PCAOB is unable to conduct a full inspection. These are flagged as “Commission-Identified Issuers” and placed on a public list.
2. Step 2: The Clock Starts Ticking. Once a company is on the list, a countdown begins. Originally, the law gave companies a three-year grace period.
3. Step 3: Delisting. If a company remains on that non-compliant list for two consecutive years (a change made by the Consolidated Appropriations Act, 2023), the SEC is required to prohibit its shares from being traded on U.S. stock exchanges like the NYSE or Nasdaq. This is a formal way of saying the company gets delisted, which is a devastating blow to its stock price and liquidity.

For the value investor, the HFCAA is more than just a piece of legislation; it’s a powerful lesson in risk management and due diligence.

• A Spotlight on Risk: The most obvious takeaway is the massive risk associated with non-compliance. A potential delisting can turn a seemingly cheap stock into a classic value trap, where the price is low for a very good reason. The threat alone can depress a stock's price for years, regardless of the company's underlying business performance.
• Due Diligence Is Non-Negotiable: This act underscores the need to look beyond the balance sheet. Before investing in any foreign company, especially one based in a jurisdiction with a history of regulatory friction, a crucial due diligence step is to check the SEC’s list of Commission-Identified Issuers. Is the company you're looking at on the list? If so, you need to understand the implications and weigh the risk of delisting.
• Geopolitics in Your Portfolio: The HFCAA is a textbook example of how geopolitics can directly impact your investments. The tug-of-war between Washington D.C. and Beijing over audit inspections caused huge volatility in the shares of Chinese companies. In late 2022, an agreement was reached allowing the PCAOB to begin inspections, which sent these stocks soaring. This illustrates that as an investor, you can't ignore the political landscape. A sudden policy shift can be just as impactful as a quarterly earnings report. It’s a reminder that a wide margin of safety is needed not just for business risks, but for political ones, too.