On July 30, 2021, the Securities and Exchange Commission (the “SEC”) issued a statement on investor protection related to the Chinese government’s recent guidance and restrictions on China-based companies raising capital offshore, setting up additional disclosure requirements for Chinese companies seeking a listing on U.S. stock exchanges. In this statement, Gary Gensler, the chairman of SEC, said that he has asked agency staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective, and to engage in targeted additional reviews of filings for companies with significant China-based operations.
This statement points out potential risks of the arrangement of Variable Interest Entities (VIE) for U.S. investors. The arrangement of VIE is a typical structure used by many China-based operating companies, through which to establish offshore shell companies in another jurisdiction (such as the Cayman Islands) and issue stocks to public shareholders despite government restrictions on foreign ownership and listing directly on overseas exchanges. This arrangement, according to this statement, creates “exposure” for U.S. investors to Chinese companies through contracts with the operating company rather than a direct equity stake, while the average investors may not realize that they hold stock in a shell company rather than a China-based operating company.
In consideration of this risk, the SEC will increase scrutiny of Chinese companies. Specifically,

• For those offshore shell companies, the SEC will require the registration statements:

1. to clearly distinguish the shell company and the China-based operating company in the business description, and clearly disclose that investors are not buying shares of a China-based operating company but the shares of a shell company

2. to provide detailed financial information reflecting the relationship between the China-based operating company and the shell company, and

3. to disclose the uncertainty about future actions by the government of China

• For all China-based operating companies seeking to list on U.S. exchanges, the SEC will require them to clearly disclose:

1. whether they have received permission from Chinese authorities to list on U.S. exchanges

2. the risk that permission might be denied or rescinded

3. a duty to disclose if approval was rescinded, and

4. the possibility that they could be delisted if the Public Company Accounting Oversight Board is unable to inspect their public accounting firm within three years in the future.

As expressed by Gary Gensler in this statement, these new required disclosures are crucial to informed investment decision-making and are the heart of the SEC’s mandate to protect investors in U.S. capital markets.