The SEC has taken a heightened interest in US-listed companies using the Variable Interest Entity (VIE) structure, according to Paul Boltz, a partner at Ropes & Gray in Hong Kong.
The SEC has been sending comment letters to a range of US-listed VIE companies, requesting clarifications and additional disclosure. “They’re getting scrutinized in a way they weren’t before,” Boltz said. “It’s now penetrating and very specific.”
He believes the SEC and the China Securities Regulatory Commission (CSRC) have joined forces. “Because the SEC is much more interested in the subject, it suggests someone is educating them on how VIEs work.”
The VIE allows foreign investors to circumvent restricted sectors in China such as the internet and telecommunications. Using this structure, foreign investors can control companies operating in China without actually owning them.
Internet firms Baidu, Sohu, Tudou and Netease are among the US-listed companies taking advantage of the VIE.
Last September, concerns arose after the leak of an 11-page document requesting China’s State Council take action against VIEs. Many believe it was drafted within the CSRC, although it was not on official letterhead.
The leaked report expressed shock that VIEs expanded out of restricted industries and into a variety of others including mining and education, said Marcia Ellis, a partner at Ropes & Gray in Hong Kong, who spoke at a recent webcast on private equity in China.
The disclosure caused concern in the industry and drove down the share prices of the dozens of VIEs listed in the US.
Several Chinese ministries are now reviewing the VIE, Boltz added. But he believes the impact of the leaked document may have tempered the regulatory approach.
“Our assessment is that the plug is not pulled on VIEs, but over time [China] will reign them in so they’re not applicable to every industry under the sun,” Boltz said.
In Hong Kong, listing a VIE in non-restricted industries is not a viable option because the Hong Kong Stock Exchange now has an explicit policy.
“If you come in with a VIE in a non-restricted industry, the case is immediately referred to the listing committee,” which can be taken to mean the listing application will be rejected, Ellis said.