SEC Tightens Disclosure Rules for Chinese Companies
The SEC issued a statement that will require additional disclosure from Chinese companies that wish to list on US exchanges or are currently listed. The information that the SEC is requesting relates to a practice used by some Chinese companies to avoid Chinese government restrictions about foreign ownership or direct listing on foreign exchanges. In order to avoid the restriction, Chinese companies set up what is called a VIE (Variable Interest Entity) in an offshore location. The offshore entity enters into contracts and agreements with the Chinese operating company and is able to consolidate the operating company for accounting purposes. By listing the shell corporation on foreign exchanges, investors would believe they are directly investing in the Chinese operating company, however they actually only own shares in the ‘shell’, which has no ownership in the Chinese operating company, only service contracts.
The SEC believes that the average investor would not realize that the ownership in such a listed entity does not represent ownership in the Chinese entity due to the accounting consolidation and is now requesting information from such VIEs on registration and will force full disclosure to investors about the lack of direct ownership in the Chinese operating entity, particularly in light of tighter restrictions and examinations I China itself, which could change the relationship between such entities and the operating company. Taking it one step further, the SEC will require that the PCAOB (Public Company Accounting Oversight Board) must be able to examine the issuing entities public accounting firm for the previous three years or face delisting.
Given the popularity of the more speculative Chinese markets, the relatively opaque accounting of same, and the use of social media as an information source both in China and in the US, we see this as a good rule but one that will meet with considerable opposition from the Chinese government that will likely claim it has already put in place the necessary safeguards, and from Chinese companies themselves, at least those that are a bit lax in disclosure, financial accuracy, or just don’t want to give accurate information to those outside of China, despite their willingness to use same for financing. We expect the majority of Chinese companies that are seeking or have US listing are legit or open about actual disclosure, but it certainly won’t hurt to get a bit more transparency from some of the smaller companies, many of whom use social media as their ‘disclosure’ platform, where there is far less consequence for inaccurate promotion or incomplete disclosure.
The SEC believes that the average investor would not realize that the ownership in such a listed entity does not represent ownership in the Chinese entity due to the accounting consolidation and is now requesting information from such VIEs on registration and will force full disclosure to investors about the lack of direct ownership in the Chinese operating entity, particularly in light of tighter restrictions and examinations I China itself, which could change the relationship between such entities and the operating company. Taking it one step further, the SEC will require that the PCAOB (Public Company Accounting Oversight Board) must be able to examine the issuing entities public accounting firm for the previous three years or face delisting.
Given the popularity of the more speculative Chinese markets, the relatively opaque accounting of same, and the use of social media as an information source both in China and in the US, we see this as a good rule but one that will meet with considerable opposition from the Chinese government that will likely claim it has already put in place the necessary safeguards, and from Chinese companies themselves, at least those that are a bit lax in disclosure, financial accuracy, or just don’t want to give accurate information to those outside of China, despite their willingness to use same for financing. We expect the majority of Chinese companies that are seeking or have US listing are legit or open about actual disclosure, but it certainly won’t hurt to get a bit more transparency from some of the smaller companies, many of whom use social media as their ‘disclosure’ platform, where there is far less consequence for inaccurate promotion or incomplete disclosure.
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