New SEC regulations on investments related to China

The U.S. Securities and Exchange Commission (SEC) recently released guidance through its Division of Corporation Finance to address the risks of investing in companies that are based in or have a majority of their business operations in the People’s Republic of China. This action continues a trend of expanding regulation of investments related to China, and the SEC’s statement clarifies that the purpose of the disclosures is to protect investors from recently-enacted restrictions by the Chinese government on China-based companies in regard to raising capital from foreign investors. According to a report by PitchBook published earlier this year, venture capital investing in China was on pace to exceed $100 billion in 2021, with foreign investors participating in approximately one-quarter of these deals.

Investment deals between actors within the United States and China are often scrutinized due to national security concerns as well. The Committee on Foreign Investment in the United States (CFIUS) has demanded in many cases that Chinese investors must divest before allowing a deal to go through with a U.S.-based company.

In September 2021, a South Korean semiconductor company known as Magnachip was seeking to be acquired by Wise Road Capital, a Chinese private equity firm. CFIUS referred the proposed transaction to President Joe Biden so that the transaction could be blocked due to national security concerns, as Magnachip is incorporated and listed in the United States. Concerns over intellectual property theft also pose a risk to U.S.-based companies that have operations in China.

The guidance was issued in the form of a "sample letter" that the SEC may provide to an affected company. The sample letter includes 15 requests for further disclosure that may be issued to China-based companies by the Division of Corporation Finance. These requests largely relate to ensuring that these companies provide sufficient information for investors while being compliant with both American and Chinese regulations. For example, a company may be required by the SEC to disclose if they are actually a Chinese operating company, or a foreign holding company that operates in China through a subsidiary with a variable interest entity. This is important information for an investor, as they may not have direct equity within a China-based company, or proper exposure to Chinese markets in the latter case, due to restrictions placed by the Chinese government on direct foreign investment. Therefore, companies must properly disclose their corporate structure and the risks associated with it, as the value of securities offered by the company may decline significantly or become worthless to investors because of various restrictions placed by the Chinese government.

More information on the SEC sample letter can be found here. More information on CFIUS can be found here.