On July 30, 2021, Securities and Exchange Commission (“SEC”) Chair Gary Gensler issued a public statement announcing that he has asked SEC staff to require additional disclosures from offshore issuers with ties to China-based operating companies.1 Gensler’s announcement builds on recent legislative efforts to regulate Chinese companies seeking to raise capital in the United States from a public issuing.
The announcement came on the heels of a letter from a group of Republican U.S. senators demanding the SEC enforce the Holding Foreign Companies Accountable Act (“HFCAA”) and investigate U.S.-listed Chinese companies for lack of transparency.2 The HFCAA, which was passed with bi-partisan support in December 2020, is primarily focused on increasing the access of the Public Company Accounting Oversight Board (“PCAOB”) to Chinese companies.3 The HFCAA requires foreign companies to comply with PCAOB audits or risk being barred from listing on U.S. exchanges, and it also mandates that all public companies disclose if they are owned or controlled by a foreign government.4
In his announcement, Gensler explained that many China-based operating companies are structured as Variable Interest Entities (“VIEs”) in order to establish offshore shell companies that can issue stock to public shareholders in other jurisdictions. Gensler noted that this arrangement only “exposes” U.S. investors to China-based operating companies through a series of service and other contracts, and expressed concern that “average investors may not realize that they hold stock in a shell company rather than a China-based operating company.”
Accordingly, the SEC will now seek additional disclosures from offshore issuers associated with China-based operating companies before their registration statements are declared effective. These companies will have to 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.”5
Furthermore, any China-based operating company wishing to register securities with the SEC, either directly, or through a shell company, will have to 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; and
- That the Holding Foreign Companies Accountable Act, which requires that the Public Company Accounting Oversight Board (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.”6
The SEC’s increased disclosure requirements are precipitated in part by two recent actions of the Chinese government. First, Chinese authorities have proposed a new rule that would require a cybersecurity review of almost any Chinese company that wishes to list in a foreign jurisdiction, dramatically increasing Chinese government oversight over private business.7 Second, the Cyberspace Administration of China (“CAC”) opened an investigation of Didi Global Inc. (“Didi”), a ride-hailing company, for potential violations of Chinese privacy and national securities laws just days after Didi held its initial public offering on the New York Stock Exchange. Pursuant to that investigation, the CAC removed Didi’s apps from Chinese mobile stores and stopped Didi from registering new users, which caused a sell-off of Didi shares.
Chinese authorities are working to contain the fallout from the Didi sell-off. In a statement made on August 1, 2021, the China Securities Regulation Commission (“CSRC”) asked for increased communications with the SEC in order to find a collaborative resolution to the SEC’s increased disclosure requirements for offshore issuers with ties to China-based operating companies.8 The CSRC explained that its scrutiny of certain industries is focused on promoting development and safety, and that it will work to further improve the transparency and predictability of its policies going forward.9
Gensler’s statement represents the SEC’s latest move in a push to regulate Chinese corporations that wish to raise funds from U.S. investors. The CSRC has long pledged to open up China’s financial industry,10 but U.S. lawmakers have expressed frustration with the lack of transparency from corporate China for years. The SEC’s announcement demonstrates that it is now willing to take a tougher stance against Chinese corporations that flout SEC disclosure and auditing standards.
1 Chair Gary Gensler, Sec. & Exch. Comm’n, Statement on Investor Protection Related to Recent Developments in China (July 30, 2021), https://www.sec.gov/news/public-statement/gensler-2021-07-30?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosprorata&stream=top.
2 See Senator Tom Cotton, et al., letter to Gary Gensler, Chair, U.S. Sec. & Exch. Comm’n (July 28, 2021), https://www.kennedy.senate.gov/public/_cache/files/a/9/a9cbd3a8-2381-441d-bdca-ea6dbd1c5599/4803CA1066F482213CBDDF0E68B88310.sullivan-kennedy-letter-to-sec-re-us-listed-chinese-companies.pdf.
3 See Richard Smith and Jinsong Zhang, The Holding Foreign Companies Accountable Act is Signed into Law, JD Supra (Jan. 22, 2021), https://www.jdsupra.com/legalnews/the-holding-foreign-companies-5211670/.
4 See Eric Beech, Trump Signs Bill that could Kick Chinese Firms Off U.S. Stock Exchanges, Reuters (Dec. 18, 2020), https://www.reuters.com/business/finance/trump-signs-bill-that-could-kick-chinese-firms-off-us-stock-exchanges-2020-12-18/.
5 Gensler, supra at n.1
6 Id.
7 China Seeks More Communication with U.S. on Overseas IPOs, Bloomberg News (Aug. 1, 2021), https://www.bloomberg.com/news/articles/2021-08-01/china-calls-for-more-communication-with-u-s-on-overseas-ipos.
8 Id.
9 Id.
10 Id.
