Reverse takeover (RTO) advisors are a “often poorly understood” risk for GPs investing in China-based companies listed in the US, warned law firm Ropes and Gray in a client memo.
In exchange for shares, RTO advisors provide Chinese firms hoping to list on a US exchange all the necessary tools (lawyers, accountants, a shell company registered with the US Securities & Exchange Commission, etc.) to facilitate an IPO.
In the memo, Ropes directed their private equity clients' attention to a recent SEC ruling where investment manager Peter Siris – who acted as an RTO advisor for China Yingxia International – was charged with among other things making illegal trades, breaching US securities laws, and filing misleading disclosure documents to the US regulator.
his case is important for GPs because, not only does it show the SEC’s willingness to scrutinise China-based businesses, but also the dangers of RTO advisor involvement
This case is important for private equity firms because not only does it show the SEC’s willingness to scrutinise China-based businesses but also the dangers of RTO advisor involvement, the memo warned.
Without sufficient due diligence on any RTO advisors and the China-based listed company it would be easy to imagine a similar scenario where the company itself and the management are subject to SEC action. This would then significantly reduce the value of any private equity investment in the company, even if the improper conduct was prior to the investment, the memo said.
“There are now several hundred RTO companies with operations in China the shares of which are publicly traded in the US. In many instances, RTO advisors have acquired significant shareholding stakes in these companies.”
In addition, if an RTO company is then taken private that would not end the SEC’s oversight on the entity nor prevent the SEC from pursuing investigations.
An exit for the company could also be put in jeopardy as the SEC has, on similar occasions, taken enforcement actions against private successor entities and former employees involved in improper conduct. This could severely impact the company’s ability to relist in Hong Kong or elsewhere in Asia, both of which are common exit routes for these transactions.
To prevent this Ropes make the case that due diligence should be a two-pronged effort: aimed at both the target company and any RTO advisor. However this is not always straightforward with many RTOs purposely operating under the radar and thus making it difficult to track them down, the memo warned.
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