The Securities and Exchange Commission (“SEC”) has recently increased required disclosures from corporate filers with respect to China-related investments. Both clients and their counsel need to be prepared to disclose additional information surrounding China-based activities and to include further risk disclosures surrounding Chinese operations.
In response to greater investments in the People’s Republic of China (“China”) from special purpose acquisition companies (“SPACs”), the SEC has increased disclosure requirements around China-based investments. Recently, the SEC has been focusing comments and questions around how to target companies with operations in China plan to ensure that their subsidiaries in China function and transfer funds back to their parent company. Because of the Chinese currency and investment controls preventing direct transfers of the RMB to USD and direct foreign ownership of Chinese businesses, many entities with business in China adopt a variable interest entity (“VIE”) format. Under a VIE structure, the primary company will, incorporate a shell corporation and grant that new shell corporation contractual rights to profits and control of assets, bypassing Chinese regulatory issues. This structural arrangement has been prompting the SEC to increase its question checklist around any investment into companies that have VIEs in China. The SEC has specifically been asking for risk disclosures around the contractual framework that VIEs operate within, how companies intend to transfer cash and dividends to United States shareholders, what Chinese regulatory approvals are required, and the risks around each of these areas.
Even where a SPAC may not intend to acquire a target that makes use of VIEs, the SEC has been increasing the number of comments that it has had in advance of effective filings for those companies due to them having dealings in China. With decreasing business combination timelines for SPACs, both targets and SPACs need to consider this increased timeline to clear SEC comments prior to going effective with their filing and build leeway into their planned closing dates.
In order to best deal with increased disclosure requirements, the SPAC and its counsel need to anticipate SEC comments at the drafting stage, scrutinizing client business intentions to determine if increased business disclosures and additional risk factors are necessary. This early-stage preparation may expedite the comment process by reducing SEC comments or limiting the depth of amendments required, providing for a faster revision on the legal side.
As this article series will note, filing confidentially with the SEC is advantageous for several reasons, one of which is being able to get SEC comments on initial disclosures before a public release so that the SPAC is able to tailor its messages to investors before it is asked by the SEC to step back claims and promises in public filings. As SPACs seek out targets in Asia with greater frequency, confidential filings allow SPACs to test investor-focused language before it becomes public and incrementally increase disclosures to protect business intentions.