The SEC identified risks to be considered by market participants recommending or making investments in emerging markets.
In a joint SEC statement, Chair Jay Clayton, Public Company Accounting Oversight Board ("PCAOB") Chair William D. Duhnke III, Chief Accountant Sagar Teotia, Division of Corporation Finance Director William Hinman and Division of Investment Management Director Dalia Blass highlighted the limitations on the SEC's ability to enforce high-quality disclosure standards in emerging markets.
According to the SEC, such emerging markets, including China, often present disclosures that are in "substantially" the same form as those of U.S. domestic companies. However, the SEC warned that the disclosure information may often be "incomplete or misleading." The SEC identified the below risks and related considerations as to emerging markets.
- Associated Risks and Disclosures. The SEC stated that companies operating in emerging markets experience greater risks, and therefore encouraged (i) issuers to disclose such matters to investors and (ii) funds investing in emerging markets to ensure that their material risk disclosures are in compliance with federal securities laws. The SEC emphasized that boilerplate disclosures are often insufficient in such circumstances.
- Variation in Quality of Financial Information, Requirements and Standards. The SEC recommended that (i) investors and financial professionals examine the nature and quality of financial information (e.g., financial reporting and audit requirements) when considering certain investments to make or recommend and (ii) issuers discuss related financial reporting matters with independent auditors or audit committees, if necessary.
- The Continual Inability of the PCAOB to Assess Audit Work Papers in China. The SEC urged investors to consider the PCAOB's inability to inspect PCAOB-registered accounting firms in China.
- Limitations of U.S. Authorities to Bring Action. The SEC advised issuers to make clear the "substantial" difficulties experienced by U.S. authorities, including the SEC, in bringing enforcement actions against non-U.S. companies or non-U.S. persons.
- Shareholders' Limitation of Rights. The SEC stated that shareholder claims, such as class action securities law and fraud claims, are generally "difficult or impossible" to pursue legally or logistically in many emerging markets. As a result, the SEC noted that issuers should explicitly state such risks to shareholders.
- Passive Investing Strategies. The SEC cautioned investors that index funds typically do not weight securities based on (i) investor protection limitations or (ii) variations in the quality of financial reporting and oversight mechanisms available.
- Considerations Overall. The SEC advised investment advisers, broker-dealers and market participants in general to consider the limitations and risks associated with emerging markets when recommending investments in such markets.
The SEC noted that these considerations, while not an exhaustive list, are often significant, and vary based on jurisdiction.
Commentary
Though the statement concerns emerging markets generally, a quick search turns up 29 references to China and none to Brazil, Russia, or India. Chinese issuers seeking to offer securities in the United States may expect to face closer scrutiny of their offering documents. Firms participating in such offerings must anticipate the risks of review of their diligence should an offering go badly. Likewise, funds that invest offshore should review their disclosures. Advisers and broker-dealers that recommend investments in Chinese issuers should take account of suitability considerations in light of the SEC's statement.
Primary Sources
Originally published 22 April 2020
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