SEC seeks more risk disclosures from China-based companies

SEC Chairman Gary Gensler issued a statement Friday saying the regulator will place more stringent disclosure requirements on Chinese-based public companies seeking to raise money in U.S. markets.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” he wrote, adding he has further instructed staff to “engage in targeted additional reviews of filings for companies with significant China-based operations.”

Gensler and the SEC have become concerned Chinese companies regularly flout the agency’s rules about transparency and full disclosure of all risks related to a company’s financial performance. The result is an uneven playing field where most of the world’s publicly traded companies adhere to one set of rules while Chinese-based companies adhere to another less stringent and less rigorously enforced regime.

The SEC is also concerned the structure of many Chinese companies can create confusion for investors if not thoroughly disclosed. The Chinese government prevents some sectors of its economy from raising money from investors based outside of China. Companies will instead set up offshore shell companies, which then issue shares on a foreign exchange. Without fully disclosing this structure, U.S.-based investors might think they are buying shares in the Chinese-based company rather than its offshoot shell company.

“I worry that average investors may not realize that they hold stock in a shell company rather than a China-based operating company,” Gensler wrote.

The SEC will require Chinese-based companies to disclose these arrangements, including the fact the issuer was barred by the Chinese government from listing its stock on foreign exchanges; that “future actions” by the Chinese government could significantly affect the company’s financial performance and ability to fulfill contracts; and detailed information about the financial relationship between the Chinese-based company and its shell company.

In addition, the recently passed Holding Foreign Companies Accountable Act requires the Public Company Accounting Oversight Board (PCAOB) be permitted to inspect the issuer’s public accounting firm within three years, something the Chinese government has prevented the PCAOB from accomplishing with certain companies. If a company refuses to grant such access to the PCAOB for three consecutive years, the company could be kicked off U.S.-based exchanges, according to the law.

“I believe such disclosures are crucial to informed investment decision-making and are at the heart of the SEC’s mandate to protect investors in U.S. capital markets,” Gensler said.

In response to Gensler’s comments, the China Securities Regulatory Commission (CSRC) released a statement pledging to “continue to enhance communication with the principle of mutual respect and cooperation, and properly address the issues related to the supervision of China-based companies listed in the U.S.”