US regulators step up scrutiny of IPO hopefuls from China before listing

Chinese companies hoping to sell their shares in the United States must start making more disclosures about their potential risks before U.S. regulators will allow them to list their stock.

The Securities and Exchange Commission announced the move Friday after Beijing said it would step up its supervision of Chinese companies listed overseas, including reviews of their cybersecurity.

SEC Chair Gary Gensler pointed in particular to Chinese businesses that use shell companies to get around Chinese rules blocking foreign ownership for their industries.

Under these deals, the Chinese business forms a shell company in the Cayman Islands or somewhere else. The shell company then sells its stock to investors after listing in New York.

The shell company has no ownership of the Chinese company. Instead, it has service contracts with it. These arrangements are called variable interest entities, or VIEs.

I worry that average investors may not realize that they hold stock in a shell company rather than a China-based operating company, Gensler said.

Gensler said he asked the SEC's staff to makes sure such companies make several disclosures before an initial public offering of stock. Among them: They must make clear investors are buying shares of the shell company, not the China-based operating company, and that future actions by the Chinese government could significantly affect financial performance.

Gensler also said that all Chinese companies trying for a U.S. IPO must disclose risks that approvals from Chinese authorities to list on a U.S. exchange could be rescinded, among other things.

Several big-name Chinese companies have seen their stocks tumble recently as Beijing has stepped up regulation of their data protection and security.

U.S.-listed shares of ride-hailing company Didi Global, for example, have been falling since they began trading at the end of June. They dropped nearly 20% in their fourth day of trading after the company was ordered to stop signing up new users and remove its app from online stores while it increases security for customer information.