(July 30, 2021) The U.S. Securities and Exchange Commission (“SEC”) has identified a number of China-based companies raising capital through offshore shell companies. In a number sectors in China, companies are not allowed to have foreign ownership and cannot directly list on stock exchanges outside of China. Some of these companies have gotten around the rules by structuring Variable Interest Entities to list on stock exchanges and raise capital from North American based investors.

The SEC has reported that these structures create exposure to the China-based operating company but investors do not have any direct ownership of the China-based corporation. Gary Gensler, Chairman of the SEC, is directed his staff to seek additional disclosures from these offshore companies that list securities on US stock exchanges concerning:

The business description of the listed company must be clearly articulated as being different than the China-based operating company;

The material facts as to how the government of China could affect the operating company’s financial performance and enforcement of the agreements between the operating company and the North American listed company; and

Detailed financial information between the operating company and the North American listed company so that investor understand what they are actually buying.

Moreover, for all China-based operating companies seeking to register securities with the SEC (www.sec.gov), and the documents are found on EDGAR and, if cross listed on the Toronto Stock Exchange, on SEDAR (www.sedar.com), must “prominently and clearly disclose,” that if the Public Company Accounting Oversight Board (“PCAOB”) is unable to inspect the company’s public accounting firm within 3 years it could result in the securities being delisted from the stock exchange.

It is our opinion, only, that it is also very likely that North American based investors have little protection against corporate wrong-doing, accounting scandals, and misrepresentations. Specifically, investors may only have recourse against the relevant domestic directors and officers insurance. This view appears to be shared with the SEC.

This pronouncement form the SEC echos its CF Disclosure Guidance from November 23, 2020, entitled, “Disclosure Considerations for China-based Issuers,”

Legal claims, including federal securities law claims, against China-based Issuers, or their officers, directors, and gatekeepers, may be difficult or impossible for investors to pursue in U.S. courts. Even if an investor obtains a judgment in a U.S. court, the investor may be unable to enforce such judgment, particularly in the case of a China-based Issuer, where the related assets or persons are typically located outside of the United States and in jurisdictions that may not recognize or enforce U.S. judgments. If an investor is unable to bring a U.S. claim or collect on a U.S. judgment, the investor may have to rely on legal claims and remedies available in China or other overseas jurisdictions where the China-based Issuer may maintain assets. The claims and remedies available in these jurisdictions are often significantly different from those available in the United States and difficult to pursue.

If you purchased securities of a China-based company listed on the Canadian Stock Exchange, Toronto Stock Exchange, or NEO Exchange, and suffered an economic loss because of news that seems to conflict with the company’s prior statements, you are welcome to contact us for a free due diligence session. You may contact at [email protected].

We have one of the most dynamic and active shareholder legal practices across Canada; our lawyers have been involved in most of the published court decisions within the past several yeares relating to the provincial Securities Act claims.