SEC issues further disclosure guidance to China-based companies

For companies based in China or with a majority of their operations in China, new guidance issued by the U.S. Securities and Exchange Commission (the “SEC”) is an important reminder that the SEC staff continues to pay close attention to China-specific disclosures in SEC filings.

The Sample Letter to Companies Regarding China-Specific Disclosures provides examples of comments that the SEC staff may issue to companies during its review of SEC filings such as annual reports and registration statements. The sample letter focuses on disclosure obligations in three areas: 

• HFCAA disclosures – Public companies identified as “Commission-Identified Issuers” (“CIIs”) under the Holding Foreign Companies Accountable Act (the “HFCAA”) must comply with the submission and disclosure requirements under the HFCAA and SEC rules for each year in which they are identified as CIIs on the SEC’s website. 
  
  For CIIs that are non-U.S. issuers, certain specific disclosures are required relating to matters indicating control by the government of the People’s Republic of China (“PRC”) or the Chinese Communist Party (“CCP”). The sample letter sets out likely requests that the SEC staff will make regarding these HFCAA-mandated disclosures, including:
  • The description of materials the issuer has reviewed and any third-party certifications or legal opinions it is relying on for the documentation it submitted to establish that it is not owned or controlled by a governmental entity in a foreign jurisdiction.
  • The description of materials the issuer has reviewed and any third-party certifications or legal opinions it is relying on for the disclosure regarding the percentage of its shares owned by foreign government entities and whether government entities in the foreign jurisdiction have a controlling financial interest in it.
  • The description of steps the issuer has taken to confirm that none of the members of its board or the boards of its consolidated foreign operating entities are CCP officials, including how board members’ current or prior memberships on, or affiliations with, CCP committees factored into the determination. Issuers may also be asked whether they have relied upon third-party certifications, such as affidavits, as the basis for their disclosure.
  • Confirmation without qualification (such as “to the best of our knowledge”) that, if true, the issuer and its consolidated foreign operating entities’ articles of incorporation do not contain wording from any CCP charter.
• Risk of intervention or control by the PRC government – The sample letter indicates that the SEC staff continues to ask issuers to describe any material impact that intervention or control by the PRC government has or may have on its business or on the value of its securities. The guidance emphasizes that control can be exercised in ways beyond appointing members to the board or having formal powers under the company’s organizational documents, noting that under the U.S. federal securities rules, the term “control” means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.”
• Impact of laws such as the Uyghur Forced Labor Prevention Act (the “UFLPA”) – The sample letter notes that public companies may need to make disclosures related to material impacts of certain statutes. For example, if a company appears to conduct a portion of its operations, or appears to rely on counterparties that conduct operations, in the Xinjiang Uyghur Autonomous Region, the SEC staff will likely ask for a description of how its business segments, products, lines of service, projects, or operations are impacted by the UFLPA, which prohibits the import of goods from the Xinjiang Uyghur Autonomous Region.

In drafting their disclosures, China-based SEC-reporting companies should also review previous disclosure guidance the SEC has issued over the last few years, including: 

• The December 2021 sample letter, which focused on disclosure of the risks of the variable interest entity (“VIE”) structure typically used by China-based companies listing on foreign exchanges, as discussed in our client briefing;
• The July 2021 statement by SEC Chair Gary Gensler regarding the risks of the VIE structure; and
• The November 2020 disclosure guidance setting out disclosure considerations for companies based in or with the majority of their operations in the PRC, as discussed in our client briefing.

China-based registrants should also keep in mind that the PCAOB’s successful 2022 inspection of China- and Hong Kong-based audit firms does not permanently eliminate the delisting risk for China-based registrants under the HFCAA. The PCAOB will be making determinations every year regarding whether it can fully inspect and investigate audit firms in China and Hong Kong. If Chinese authorities obstruct the PCAOB’s access to inspect or investigate completely, China-based registrants may again be at risk of U.S. delisting. 

We will continue to monitor developments in this area and welcome any queries you may have.