The SEC is sending out new disclosure demands to Chinese companies seeking New York IPOs, report says

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SEC chief Gary Gensler. Photo by Chip Somodevilla/Getty Images

US market regulators have started sending out new disclosure demands to Chinese companies seeking to go public in New York, aimed at clarifying the risks of investing in those types of IPOs, Reuters first reported late on Monday.

The Securities and Exchange Commission has asked some Chinese companies to explain details around their use of offshore vehicles, also known as variable interest entities or VIEs, sources told Reuters. One of the letters requested an explanation of how a VIE structure might affect investors and the value of their investment, how it might be less effective than direct ownership, and the potential costs of enforcing it, Reuters said.

Companies often use VIEs to passively hold financial assets, sometimes as a way to keep securitized assets off their balance sheets, or for research and development purposes. Investors in VIEs do not have voting rights, nor do they directly own stakes in the company. Instead, individual contracts outline the percentage of profits that they can receive, along with other conditions.

In contrast, investors who buy shares typically get a direct claim to a company’s equity, a vote on major corporate decisions, and can buy and sell their stock at the prevailing market price.

Earlier this month, SEC chief Gary Gensler gave his most direct warning yet about investing in US-listed Chinese stocks. He explained that the Chinese government often doesn’t allow foreigners to own or invest in domestic companies, spurring them to set up overseas vehicles such as VIEs.

“So when you think you’re investing in a Chinese company, you’re more than likely actually investing in a shell company in the Caymans or another part of the world,” Gensler said in a video message at the time.

In July, the SEC froze US listings of Chinese companies, announcing they would need to meet new disclosure requirements before going public. For example, they would have to outline the structure of the proposed IPO, and the potential for the Chinese government to meddle in its affairs.

The Chinese government has been cracking down on key sectors, including tech and internet companies, in recent months and has outlined a five-year plan that includes further tightening of regulations. The changes have hammered US-listed Chinese companies and caused major volatility in their share prices.