SEC requires Chinese companies seeking U.S. listing to make additional disclosures
China-based companies must make VIE structure clear to investors, disclose whether China has granted permission to list in U.S., delisting risks under U.S. law
Following actions by the Chinese government to put restrictions on China-based companies raising capital offshore, the U.S. Securities and Exchange Commission (“SEC” ) is requiring China-based companies and associated offshore shell companies seeking a U.S. listing to make certain disclosures regarding: their Variable Interest Entities (“VIE”) structure; whether the Chinese government has given permission for a U.S. listing; and the risk of delisting under the Holding Foreign Companies Accountable Act (the “HFCA Act”). The SEC staff will also be engaging in targeted additional reviews of filings for companies with significant China-based operations.
In a Statement on Investor Protection Related to Recent Developments in China, SEC Chair Gary Gensler said that he has asked the SEC staff to ensure that offshore shell companies associated with China-based operating companies structured as VIEs make the following disclosures before their registration statements are declared effective:
- 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.
Further, the SEC staff will also be asking all China-based operating companies seeking to register securities with the SEC, either directly or through a shell company, to make the following disclosures, clearly and prominently:
- 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 the existence of a duty to disclose if approval is subsequently rescinded; and
- That the HFCA Act may result in the delisting of the operating company in the future if the PCAOB is unable to inspect the firm.
The HFCA Act, which was adopted last year, requires the SEC to prohibit from trading, on a U.S. securities exchange or “over-the-counter,” the securities of SEC-reporting issuers whose financial statements have not been audited, for three consecutive years, by accounting firms subject to inspection by the U.S. Public Company Accounting Oversight Board (the “PCAOB”). It also requires non-U.S. issuers that use accounting firms not subject to PCAOB inspection to disclose ownership and control by non-U.S. governmental entities, and to identify Chinese Communist Party officials on their boards of directors.
In March 2021, the SEC adopted an interim final rule implementing the HFCA Act’s disclosure provisions, although the SEC has yet to identify the affected issuers. The SEC has also not yet acted on the HFCA Act provisions that would require trading prohibitions on the securities of these companies.
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We will continue to monitor developments in this area and welcome any queries you may have about the SEC Chair’s statement, the HFCA Act and your listing options.