The Securities and Exchange Commission (SEC) on 5 Nov. approved a framework to determine which US-listed Chinese companies will be delisted from American capital markets by failing to allow auditing inspection fully, SCMP reported. None of the roughly 270 Chinese companies listed on U.S. exchanges obey the rule.
The new guidelines established a straightforward process of what information and documents would go into assessing whether a foreign company complies with U.S. securities law, the U.S. securities watchdog said.
It will permit the Public Company Accounting Oversight Board (PCAOB), a nonprofit corporation established by Congress to oversee the audits of publicly traded companies listed on U.S. exchanges, to decide whether a delisting process needs to be activated.
The framework will also help determine the effective date and duration of such determinations and circumstances under which the oversight board will reconfirm or change the findings, SCMP added.
US-listed Chinese companies: Lack of transparency
Although the statute adopted by the SEC did not mention China, the PCAOB and the U.S. SEC have repeatedly expressed their concern regarding obstacles to PCAOB inspection of auditors based in the PRC and Hong Kong. According to a 2020 report of the U.S.-China Economic and Security Review Commission, the PCAOB maintains a list of 260 companies worldwide where it is unable to conduct inspections: 238 of these companies are based in China and Hong Kong.
That report also highlighted the case of Luckin Coffee in illustrating the risks of investing in those companies. “In presenting information to support its initial public offering, Luckin manipulated critical revenue, operations and customer traffic data. During its IPO, shares traded at $17 raising $561 million in capital. Luckin’s peak market capitalization was $12 billion, with shares trading at just over $50.9. Within weeks of the disclosure of falsified information, the stock collapsed ultimately leading to losses for investors and its delisting from NASDAQ”, the report revealed.
For decades, there has been a conflict over how much information American regulators require and how much the Chinese government allows its companies to provide, saying such business information contains state secrets.
Risks associated with VIEs
The PRC makes foreign direct investments in specific industries, including many high-tech sectors, illegal; and maintains strict controls on foreign exchange and capital flows. Therefore, mainland Chinese companies interested in raising funds on U.S. exchanges create offshore corporate entities for foreign investment using a complex structure called a variable interest entity (VIE).
While having helped companies bypass Beijing’s restrictions, the VIE structure is risky for U.S. investors as they were buying securities from overseas entities that did not own the underlying assets. In the case of financial restructuring, investors in the U.S. could have limited recourse to obtain their assets and be reimbursed.
In July, the SEC put a “pause” on Chinese VIE, according to SCMP.
National security risk posed by Chinese firms
What is more, the report mentioned above emphasized that investors in Chinese companies may support activities that are contrary to U.S. national interests, including the development of technology used for censorship and surveillance and in support of the military.
The report put forward the example of Weibo Corporation, which works under government direction to censor posts on its blogging platform and is used by the central and local governments to surveil and censor public protests.
Private companies in China face pressure and control by the communist regime. China’s 2017 National Intelligence Law states, “any organization or citizen shall support, assist, and cooperate with state intelligence work.” The 2017 Cybersecurity Law requires companies to “provide technical support and assistance to public security organs.”
On Sept. 15, 2020, the CCP released “Opinion on Strengthening the United Front Work of the Private Economy in the New Era,” stressing the importance of CCP control over the private economy, including private entrepreneurs. According to Beijing-based political analyst Wu Qiang, the opinion “serves as a reminder for the firms that they are always affiliates of the Party, which has firm control over them.”
Now, the SEC requires the listing firms to clarify their financial connections to investors and state the risks they might face in the event of regulatory pressure from the Chinese government.
The adoption of the framework was another step closer toward implementing the Holding Foreign Companies Accountable Act, which became law at the end of last year. The law specifies that any foreign companies listed on U.S. exchanges will be delisted if they fail to turn over audit results for three straight years.
With this rule, the commission, which adopted interim final regulations in March, is on track to finalize rules to start implementing the delisting legislation before the end of the year, SEC Chairman Gary Gensler said.