Securities Regulation Daily SEC chair vows hard line on China-based companies
News
Friday, July 30, 2021

SEC chair vows hard line on China-based companies

By Amanda Maine, J.D.

Gensler warned that China-based issuers must disclose that they face delisting if they do not comply with PCAOB inspections.

SEC Chair Gary Gensler fired back at the People’s Republic of China, which recently placed restrictions on China-based companies raising capital offshore. Gensler stated that in light of these developments, the SEC will be reviewing certain disclosures from offshore issuers associated with China-based operating companies before their registration statements are declared effective. In his statement, Gensler also advised that under the Holding Foreign Companies Accountable Act (HFCAA), public companies, including those based in China, may be delisted from U.S. markets if the PCAOB is unable to inspect firms that audit those companies’ financial statements.

VIE concerns. Gensler called attention to the fact that in a number of sectors in China, companies are prohibited from having foreign ownership and cannot directly list on exchanges outside of China. To get around this restriction, Gensler pointed out that many China-based operating companies are structured as Variable Interest Entities (VIEs). This arrangement involves a China-based operating company establishing an offshore shell company in another jurisdiction such as the Cayman Islands, Gensler explained. The shell company, which can issue stock to public shareholders, can enter into contracts with the China-based company and issue shares on an exchange like the New York Stock Exchange. Gensler pointed out that even though the shell company does not have equity ownership in the Chinese company, it is still allowed to consolidate the company into its financial statements for accounting purposes.

Enhanced disclosure for China-based companies. Gensler expressed concern that "average investors" may not be aware that they hold stock in a shell company rather than the Chinese company itself. In an attempt to allay these concerns, the chair said that the SEC staff will be seeking disclosures from offshore issuers associated with China-based offering companies before the Commission declares the companies’ registrations effective.

In particular, these issuers must disclose that investors are not buying shares in the company but instead are purchasing shares in a shell company. As such, in the business description, the issuer must clearly distinguish the shell company’s management services from those of the China-based company. The registration statement must also clearly state that the China-based company, its shell company issuer, and investors face uncertainty about future actions by the Chinese government that could affect the company’s financial performance.

The staff will also review whether the financial information detailed in the registration statement includes qualitative metrics allowing investors to understand the financial relationship between the VIE and the issuer.

Delisting threat. Gensler also advised that all China-based operating companies seeking to register securities with the SEC, either directly or through a shell company, will be subjected to heightened scrutiny by SEC staff. These companies must clearly disclose if they were denied permission to list on U.S. exchanges and the risks associated with that action.

These companies must also disclose that the HFCAA may result in the company being delisted from U.S. exchanges if the PCAOB is prevented from inspecting the issuer’s public accounting firm. The HFCAA, which was approved by the Senate last May, the House in December, and signed shortly thereafter, grants the SEC the authority to delist foreign companies’ stocks from U.S. exchanges if those companies are based in foreign jurisdictions that bar PCAOB audit inspection, legislation widely seen as targeting China.

Gensler’s statement also warned that the SEC staff will be targeting filings of companies with significant China-based operations. According to Gensler, the SEC’s targeted approach will enhance the overall quality of disclosure of registration statements of offshore issuers.

MainStory: TopStory AccountingAuditing ExchangesMarketRegulation FormsFilings GCNNews InternationalNews PublicCompanyReportingDisclosure SECNewsSpeeches

Back to Top

Interested in submitting an article?

Submit your information to us today!

Learn More

Securities Regulation Law Daily: Breaking legal news at your fingertips

Sign up today for your free trial to this daily reporting service created by attorneys, for attorneys. Stay up to date on securities regulation legal matters with same-day coverage of breaking news, court decisions, legislation, and regulatory activity with easy access through email or mobile app.