SEC: Offshore issuers must disclose relationships to China-based operating companies
On July 30, SEC Chair Gary Gensler issued a statement instructing staff to seek certain disclosures from China-based operating companies and offshore issuers associated with such companies before their registration statements can be declared effective. Gensler explained that the Chinese government recently provided “new guidance to and placed restrictions on China-based companies raising capital offshore, including through associated offshore shell companies.” This is relevant to U.S. investors, Gensler stated, because a number of Chinese sectors restrict companies from having foreign ownership and prohibit them from listing on exchanges outside of China.
In order to bypass these restrictions, many China-based operating companies are structured as Variable Interest Entities (VIEs), where they establish an offshore shell company in another jurisdiction, such as the Cayman Islands, to issue stock to public shareholders, Gensler said. He expressed concerns that the average U.S. investor “may not realize that they hold stock in a shell company rather than a China-based operating company,” where the investors’ “exposure” to the Chinese company is derived only through a series of contracts between the shell and the operating company, with neither the investor nor the shell company holding any equity in the Chinese company itself.
In light of the overall risks associated with the China-based VIE structure, Gensler asked staff to ensure that offshore issuers associated with China-based operating companies prominently and clearly disclose (i) that investors are buying shares of a shell company issuer; (ii) that “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 (iii) the financial relationship between the VIE and the issuer. In addition, for all China-based operating companies seeking to register securities with the SEC (either directly or through a shell company), Gensler asked staff to ensure these companies disclose, among other things, whether the company and the issuer received permission from Chinese authorities to be listed on U.S. exchanges, as well as the risk that an approval could be denied or rescinded. Gensler further noted that China-based operating companies may be delisted in the future if the Public Company Accounting Oversight Board is unable to inspect an issuer’s public accounting firm within three years, as required by the Holding Foreign Companies Accountable Act.