On the evening of July 30, Beijing time, the U.S. Securities and Exchange Commission officially announced it would temporarily halt the acceptance of IPO registration applications from Chinese companies seeking to list in the U.S., pending the issuance of new guidance policies by the U.S. side to inform investors about the associated risks.

U.S. Securities and Exchange Commission (SEC) Chairman Gary Gensler stated in a release that the agency must ensure Chinese companies seeking U.S. listings disclose the risks associated with Beijing's "regulatory environment" before applying for an IPO in the U.S. Additionally, as required by law, U.S. regulators will have the authority to review these companies' audit records within a three-year period.

Here is the full text of the SEC Chair's statement, along with a reference Chinese translation:

Statement on Investor Protection in Response to Recent Developments in China

Recently, the government of the People’s Republic of China issued new guidelines and imposed restrictions on Chinese companies raising capital offshore, including through affiliated offshore shell companies.

For U.S. investors, this arrangement creates "exposure" to the China-based operating company—albeit only through a series of service contracts and other agreements. To be clear, however, neither the investors holding shares in the shell company’s stock nor the offshore shell company itself actually owns equity in the China-based operating company. I’m concerned that average investors may not realize they’re actually holding stock in a shell company rather than the China-based operating entity.

In light of recent developments in China and the overall risks associated with the China-based VIE structure, I have instructed staff to request specific disclosures from offshore issuers linked to China-based operating companies before their registration statements are approved for effectiveness. Specifically, I’ve asked staff to ensure that these issuers clearly and prominently disclose:

● Investors are not purchasing shares of a China-based operating company but are instead buying shares of a shell company issuer that maintains service agreements with the associated operating company. Therefore, the issuer’s business description should clearly differentiate between the management services provided by the shell company and the operations of the China-based operating company.

● That the China-based operating company, the shell company issuer, and investors face uncertainty regarding future actions by the Chinese government that could significantly impact the operating company’s financial performance and the enforceability of the contractual arrangements; and

● Detailed financial information, including quantitative metrics, enabling investors to understand the financial relationship between the VIE and the issuer.

Additionally, for all China-based operating companies looking to register securities with the SEC—whether directly or through a shell company—I have instructed staff to ensure that these issuers prominently and clearly disclose:

● Whether the operating company and the issuer, where applicable, have received or been denied permission from Chinese authorities to list on U.S. exchanges; the risks that such approval could be denied or revoked; and a disclosure obligation in the event approval is withdrawn; and

● The Holding Foreign Companies Accountable Act, which mandates that the Public Company Accounting Oversight Board (PCAOB) be allowed to inspect the issuer's public accounting firm within three years, could lead to the delisting of the operating company in the future if the PCAOB is unable to conduct the inspection.

In addition to this specific guidance, we will continue to hold all companies accountable to the securities laws' high standards for complete and accurate disclosure.

Additionally, I have also instructed staff to conduct targeted, additional reviews of filings for companies with substantial China-based operations.

I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies. This work builds on the SEC’s Division of Corporation Finance’s previous guidance on disclosure considerations for companies based in or with significant operations in China.[1]

I believe such disclosures are crucial for informed investment decision-making and lie at the heart of the SEC’s mission to protect investors in U.S. capital markets.

[1] See CF Disclosure Guidance: Topic No. 10, "Disclosure Considerations for China-Based Issuers" (Nov. 23, 2020), available at https://www.sec.gov/corpfin/disclosure-considerations-china-based-issuers.

Investor Protection Statement Related to Medium- and Near-Term Developments

July 30, 2021

Recently, the Chinese government has introduced new guidelines and restrictions on how Chinese companies can raise capital overseas, including through affiliated offshore shell companies. These developments also include government-led cybersecurity reviews of certain firms that are raising funds via offshore entities.

This involves U.S. investors. In many industries in China, companies are prohibited from having foreign ownership and cannot directly list on exchanges outside of China. To raise capital on such exchanges, numerous Chinese-operated companies have adopted the Variable Interest Entity (VIE) structure.

Under this arrangement, a Chinese operating company typically sets up an offshore shell company in another jurisdiction, such as the Cayman Islands, and issues shares to public investors. The shell company then enters into service agreements and other contracts with the China-based operating company before listing its shares on foreign exchanges like the New York Stock Exchange. Although the shell company holds no equity stake in the Chinese operating company, for accounting purposes, it can consolidate the operating company into its financial statements.

For U.S. investors, this arrangement creates "exposure" to the China-based operating company—albeit only through a series of service and other contractual agreements. However, it’s important to clarify that neither the investors holding the shell company’s stock nor the offshore shell company itself owns any equity in the Chinese operating firm. I’m concerned that ordinary investors may not realize they’re actually holding shares in a shell corporation, rather than in the actual Chinese operating company.

Given the recent developments in China and the overall risks associated with China’s VIE structures, I have instructed staff to seek certain disclosures from offshore issuers linked to Chinese operating companies before their registration statements become effective. In particular, I’ve asked staff to ensure that these issuers clearly disclose, in a prominent and easily visible location:

● Investors are purchasing shares of a shell company issuer that maintains a service agreement with the relevant operating company, rather than the stock of the Chinese operating company itself. Therefore, the issuer’s business description should clearly distinguish between the management services provided by the shell company and the operations of the actual Chinese entity.

● Chinese operating companies, shell company issuers, and investors face uncertainty regarding future actions by the Chinese government, which could significantly impact the financial performance of operating companies and the enforceability of contractual arrangements; and

● Detailed financial information, including quantitative metrics, to help investors understand the financial relationship between the VIE and the issuer.

Additionally, for all Chinese operating companies seeking to register securities with the U.S. Securities and Exchange Commission—whether directly or through shell companies—I have instructed staff to ensure that these issuers clearly disclose in a prominent location:

Whether the operating company and the issuer (if applicable) have been granted or denied approval by Chinese authorities to list on U.S. exchanges; the risk that such approvals could be rejected or withdrawn; and the obligation to disclose in the event of a withdrawal of approval; and

The Public Company Accounting Oversight Board (PCAOB) may require inspections of issuers' accounting firms under the Holding Foreign Companies Accountable Act within three years, potentially leading to delisting of operating companies in the future if the PCAOB is unable to conduct these inspections.

In addition to this specific guidance, we will continue to require all companies to adhere to the securities law's high standards for full and accurate disclosure.

Additionally, I’ve also instructed employees to conduct targeted, additional reviews of applications from companies with significant operations in China.

I believe these changes will enhance the overall quality of disclosures in registration statements by offshore issuers associated with Chinese operating companies. This effort builds upon the U.S. Securities and Exchange Commission’s Division of Corporation Finance’s earlier guidance on disclosure considerations for companies based in China or with significant operations there. [1]

I believe that such disclosures are critical for making informed investment decisions and lie at the heart of the SEC’s mission to protect investors in U.S. capital markets.

[1] See the CF Disclosure Guide: Topic No. 10, "Disclosure Considerations for Chinese Issuers" (November 23, 2020), available at https://www.sec.gov/corpfin/disclosure-thoughtations-china-based-on-issuer.