SEC Chair Issues Statement On Investor Protection Related To Developments In China

Published date04 August 2021
Subject MatterAccounting and Audit, Corporate/Commercial Law, Accounting Standards, Corporate and Company Law, Securities
Law FirmWilmerHale
AuthorMr Alan Wilson

On Friday, SEC Chair Gary Gensler issued a statement concerning investor protection related to recent developments in China. The statement summarizes risks to US investors as a result of recent government-led developments in China and outlines new requests to the SEC staff to seek certain disclosures with respect to these risks. The new directives to the SEC staff build on the November 2020 guidance issued by the Division of Corporation Finance - CF Disclosure Guidance: Topic No. 10, "Disclosure Considerations for China-Based Issuers" (Nov. 23, 2020).

Chair Gensler summarized that "the government of the People's Republic of China provided new guidance to and placed restrictions on China-based companies raising capital offshore, including through associated offshore shell companies. These developments include government-led cybersecurity reviews of certain companies raising capital through offshore entities." Most notably, Chair Gensler's statement focuses on the risks related to the China-based Variable Interest Entity (VIE) structure, in which investors invest in the stock of a shell company that has "exposure" to the China-based operating company through a series of contractual arrangements that enable the shell company to consolidate the China-based operating company into its financial statements for accounting purposes. These structures are put into place in light of Chinese prohibitions against foreign ownership of certain sectors in China and prohibitions on listing Chinese companies on exchanges outside of China.

To ensure US investors are aware of these risks, Chair Gensler has instructed the SEC staff to "seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective," including "prominent and clear" disclosure:

  • 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...

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