On Friday, SEC Chair Gensler issued a statement highlighting disclosure concerns with China-based companies, prompted by recent actions taken by the government of the People’s Republic of China. In particular, Gensler noted a concern that U.S. investors may not fully understand the risks associated with the typical public offering structure in which China-based companies that are not allowed to have foreign ownership raise capital in the U.S. through variable interest entities (VIEs). In light of these concerns, Gensler announced that he has asked the Staff to request additional disclosure from offshore companies associated with China-based operating companies:
I have asked staff to ensure that these issuers prominently and clearly disclose:
- That investors are not buying shares of a China-based operating company but instead are buying shares of a shell company issuer that maintains service agreements with the associated operating company. Thus, the business description of the issuer should clearly distinguish the description of the shell company’s management services from the description of the China-based operating company;
- That the China-based operating company, the shell company issuer, and investors face uncertainty about future actions by the government of China that could significantly affect the operating company’s financial performance and the enforceability of the contractual arrangements; and
- Detailed financial information, including quantitative metrics, so that investors can understand the financial relationship between the VIE and the issuer.
Gensler has also asked to the Staff to ensure that all China-based operating companies seeking to register securities with the SEC disclose whether the operating company and the issuer, when applicable, received or were denied permission from Chinese authorities to list on U.S. exchanges, the risks that such approval could be denied or rescinded, and a duty to disclose if approval was rescinded. Further, the Staff is directed to seek disclosure that the Holding Foreign Companies Accountable Act, which requires that the PCAOB be permitted to inspect the issuer’s public accounting firm within three years, may result in the delisting of the operating company in the future if the PCAOB is unable to inspect the firm. For more about the Holding Foreign Companies Accountable Act, check out our China practice area.
The Staff will now be conducting targeted additional reviews of filings for companies with significant China-based operations.
-Dave Lynn, TheCorporateCounsel.net August 2, 2021