SEC warns investors of risks of buying stocks of Chinese companies listed in U.S.

The Securities and Exchange Commission (SEC) on Monday issued its latest warning to investors considering buying stocks of Chinese companies listed in the United States exchanges.

In an investor alert, the SEC detailed the potential risks people should weigh when evaluating share purchases of U.S.-listed firms that have contracts with but no control over a Chinese entity, known as a Variable Interest Entity (VIE).

It is a shell-company structure the Chinese firms use to list themselves in the U.S. exchanges.

In July, the regulators said they will not allow new listings of Chinese companies unless they fully disclose their legal structures and the risk of Beijing interfering in business.

Chair Gary Gensler has warned that more than 250 listed companies would also have to disclosure similar requirements.  

Earlier this year, SEC introduced a new law aimed at China that would kick foreign companies off the U.S. exchanges if they do not comply with Generally Accepted Accounting Principles (GAAP), the agency-approved auditing standards.

The U.S.-listed Chinese companies often own a subsidiary in China that was formed to enter into the contractual arrangements with the China-based VIE. The contracts can include powers of attorney, equity pledge agreements, and exclusive services or business cooperation agreements.

The VIE structure is typically used because of Beijing’s restrictions on non-Chinese ownership of companies in key industries in China, the SEC said.

In selling shares to U.S. investors, the firms are raising capital from U.S. investors without distributing ownership of those firms to them.

The SEC warned investors that they are exposed to risk if Beijing determines they violate Chinese law and may also be subject to Chinese jurisdiction in enforcing any contracts.

The investors may be affected by conflicts of interest between the owners of a Chinese operating company and the shell company that trades in the U.S., SEC said.

(With inputs from Reuters)

Picture Credit: CNBC