SEC to Investigate Risks Associated with China-Based Variable Interest Entities

In a recent report to Congress, the Securities and Exchange Commission's (SEC) Office of the Investor Advocate (OIAD) announced its intention to investigate investor protection issues related to China-based variable interest entities (VIEs). This initiative comes in response to the increasing exposure of U.S. investors to these unique corporate structures, which have raised significant concerns regarding transparency and regulatory oversight. The investigation is slated to begin as part of the OIAD's agenda for fiscal year 2026, commencing on October 1, 2025.

The report, published on June 25, 2025, highlights the challenges faced by U.S. investors investing in Chinese companies that employ the VIE structure due to Chinese regulations prohibiting foreign ownership in certain sectors. According to the SEC, many operating companies in these sectors create offshore shell companies to facilitate foreign investment. These shell companies issue shares on foreign exchanges, such as the New York Stock Exchange, allowing investors to gain exposure to the Chinese firms indirectly through service contracts rather than direct equity ownership.

"The emergence and proliferation of these U.S.-listed companies implicate a range of investor protection issues, including concerns over the reliability of their financial reporting, the quality of their disclosures, the enforceability of their contractual arrangements, and the extent of intervention or control by the People’s Republic of China government over these companies," stated the report.

The SEC's scrutiny of VIEs is not unprecedented. During Gary Gensler's tenure as SEC Chairman, the commission issued warnings regarding the risks associated with investing in Chinese firms. In December 2021, the SEC’s Division of Corporation Finance (CorpFin) released a sample comment letter urging China-based companies listed in the U.S. to provide clearer disclosures about the risks involved with the VIE structure. This was followed by another letter in July 2023, which sought enhanced disclosures about the implications of Chinese government regulation on these companies.

Beyond the investigation into VIEs, the OIAD has outlined additional objectives for fiscal year 2026. These include enhancing the accessibility of disclosures for retail investors, exploring the inclusion of alternative investments in retirement accounts, and evaluating the impact of Self-Regulatory Organization (SRO) rule proposals on investors. Furthermore, the OIAD is forming a Crypto Task Force to gather insights on various issues related to cryptocurrency, including its classification as a security.

The SEC's efforts to address the complexities of investing in China-based VIEs reflect a growing recognition of the need for robust investor protections in an increasingly interconnected global market. As U.S. investors continue to navigate the intricacies of foreign investments, the SEC aims to ensure transparency and compliance with federal securities laws.

This development comes amid heightened scrutiny of foreign investments and the regulatory landscape surrounding them. With the increasing prevalence of VIE structures, the SEC's proactive measures may serve to safeguard U.S. investors while navigating the complexities of international finance. Investors are encouraged to stay informed about the potential risks associated with these investments and the SEC's ongoing investigations as they unfold.