Securities Industry Commentator by Bill Singer Esq

July 30, 2021

Recently, the government of the People's Republic of China provided new guidance to and placed restrictions on China-based companies raising capital offshore, including through associated offshore shell companies. These developments include government-led cybersecurity reviews of certain companies raising capital through offshore entities.

This is relevant to U.S. investors. In a number of sectors in China, companies are not allowed to have foreign ownership and cannot directly list on exchanges outside of China. To raise money on such exchanges, many China-based operating companies are structured as Variable Interest Entities (VIEs).

In such an arrangement, a China-based operating company typically establishes an offshore shell company in another jurisdiction, such as the Cayman Islands, to issue stock to public shareholders. That shell company enters into service and other contracts with the China-based operating company, then issues shares on a foreign exchange, like the New York Stock Exchange. While the shell company has no equity ownership in the China-based operating company, for accounting purposes the shell company is able to consolidate the operating company into its financial statements.

For U.S. investors, this arrangement creates "exposure" to the China-based operating company, though only through a series of service contracts and other contracts. To be clear, though, neither the investors in the shell company's stock, nor the offshore shell company itself, has stock ownership in the China-based operating company. I worry that average investors may not realize that they hold stock in a shell company rather than a China-based operating company. 

In light of the recent developments in China and the overall risks with the China-based VIE structure, I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective. In particular, I have asked staff to ensure that these issuers prominently and clearly disclose:

  • That investors are not buying shares of a China-based operating company but instead are buying shares of a shell company issuer that maintains service agreements with the associated operating company. Thus, the business description of the issuer should clearly distinguish the description of the shell company's management services from the description of the China-based operating company;

  • That the China-based operating company, the shell company issuer, and investors face uncertainty about future actions by the government of China that could significantly affect the operating company's financial performance and the enforceability of the contractual arrangements; and

  • Detailed financial information, including quantitative metrics, so that investors can understand the financial relationship between the VIE and the issuer.

Additionally, for all China-based operating companies seeking to register securities with the SEC, either directly or through a shell company, I have asked staff to ensure that these issuers prominently and clearly disclose:
  • Whether the operating company and the issuer, when applicable, received or were denied permission from Chinese authorities to list on U.S. exchanges; the risks that such approval could be denied or rescinded; and a duty to disclose if approval was rescinded; and

  • That the Holding Foreign Companies Accountable Act, which requires that the Public Company Accounting Oversight Board (PCAOB) be permitted to inspect the issuer's public accounting firm within three years, may result in the delisting of the operating company in the future if the PCAOB is unable to inspect the firm.
In addition to this specific guidance, we will continue to hold all companies to the securities laws' high standards for complete and accurate disclosure.

Further, I also have asked staff to engage in targeted additional reviews of filings for companies with significant China-based operations.

I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies. This work builds on the SEC's Division of Corporation Finance's previous guidance on disclosure considerations for companies based in or with significant operations in China.[1]

I believe such disclosures are crucial to informed investment decision-making and are at the heart of the SEC's mandate to protect investors in U.S. capital markets.

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[1] See CF Disclosure Guidance: Topic No. 10, "Disclosure Considerations for China-Based Issuers" (Nov. 23, 2020), available at, the SEC charged Michael Shustek and Vestin Mortgage LLC with violating the antifraud provisions of the Securities Act, Exchange Act, and Advisers Act. As alleged in part in the SE Release:

[S]ince at least 2012, Shustek fraudulently enriched himself and one of the REITs he controlled, The Parking REIT, at the expense of two publicly traded REITs that he earlier had founded, Vestin Realty Mortgage I (VRTA) and Vestin Realty Mortgage II (VRTB). According to the complaint, Shustek drained $29 million from VRTA and VRTB in order to funnel the money into The Parking REIT and later directed VRTA and VRTB to enter into a series of money-losing transactions in which the same six buildings were repeatedly re-sold, all to benefit himself and The Parking REIT. The complaint also alleges that Shustek deceived the boards of directors of VRTA and VRTB-and violated his fiduciary duties to those companies-in two separate securities transactions to get the companies to pay him almost $10 million. Finally, the complaint alleges that Shustek repeatedly misled investors by causing VRTA and VRTB to make false and misleading statements in their public filings, which hid his self-dealing.
As set forth in the Syllabus to the OHO Panel Decision:

For four years, Respondent Joshua Helmle and the brokerage firm that he owned and operated, Respondent Integrity Brokerage Services, Inc., improperly allowed a person subject to a statutory disqualification to associate with the firm and to act as an unregistered representative. For this misconduct, Helmle is barred from associating with any FINRA member firm in any capacity and the firm is ordered to pay a fine of $44,938. 

Bill Singer's Comment: Often, I have a lot to criticize when it comes to FINRA's docket but not this time. Frankly, as compelling a case as we should expect from a Wall Street regulator, and the charges are presented in meticulous fashion -- in the end, you finish reading the OHO Decision convinced that FINRA made its case and assessed the appropriate sanctions. 

At the core of FINRA's case was Enforcement's contention that from February 2016 through April 2020, Joshua Helmle and Integrity Brokerage Services, Inc. improperly allowed Marc Jaffe to associate with the firm despite his being statutorily disqualified based upon the finding that his non-disclosure of tax liens on his Form U4 was "willful." Also, Enforcement charged that Helmle and IBS improperly  allowed Jaffe to engage in activities that required registration. After Helmle tried to register Jaffee with IBS, he was informed by FINRA that Jaffee was statutorily disqualified and any desired association required FINRA's written permission pursuant to the filing of an MC-400 Application. 

In 2016, FINRA's Department of Member Regulation recommended the denial of IBS's MC-400 seeking Jaffe's association; and in 2017, FINRA's National Adjudicatory Council found that IBS had improperly allowed to Jaffee to associate with it despite not having obtained approval via the MC-400 route -- and the NAC denied the application. FINRA's Complaint alleges that notwithstanding the aforementioned history, through at least April 22, 2020, Helmle and IBS allowed Jaffe's association with the firm. Reduced to basics, FINRA argues that Helmle and IBS should have known and did know that Jaffe was SD'd, and even if the Respondents want to argue that they didn't think that Jaffe was SD'd and couldn't work for them, that FINRA, in fact, told them as much. 

Spread over some 66 pages, the OHO Decision is a delight to read and as persuasive a regulatory document as one would desire. In expressing disdain for the Respondents' conduct, the OHO Panel offers in part this explanation [Ed: footnotes omitted]:

This is an egregious case. FINRA told Helmle and IBS multiple times over the course of four years that Jaffe could not be associated with the Firm. The first time was in December 2015, when the staff explained that Jaffe was subject to a statutory disqualification and that he had to cease activities related to his association with the Firm. The second time was in November 2016, when Member Regulation informed Helmle it was recommending the MC-400 Application be denied because the Firm was improperly allowing Jaffe to associate with it. The third time was in May 2017, when the NAC denied the Application in part because Jaffe was improperly associating with the Firm without the required approval. The fourth time was at the end of 2018, when the cycle examination concluded that the Firm was not in compliance because Jaffe was associating with the Firm. 

Nevertheless, Helmle and the Firm disregarded those clear regulatory directives relating to membership and registration when they permitted Jaffe to continue communicating with clients about securities and their accounts. It is an aggravating factor that Respondents engaged in the misconduct notwithstanding warnings from FINRA because FINRA is entitled to require complete and precise compliance with its directives relating to membership and registration. Moreover, the misconduct continued even after the filing of the Complaint and after the change in ownership, further demonstrating continuing disregard for the applicable regulatory requirements.

Jaffe's improper communications with customers were frequent and routine. He was the Firm's securities business in Indianapolis. Wood and the rest of the branch office staff assisted him, but, as everyone involved knew, the business would not have existed without Jaffe. Accordingly, we find the nature and extent of the disqualified person's activities and responsibilities were extensive. 

Furthermore, the misconduct continued before the MC-400 Application was filed, during the time the Application was pending, and after the Application was denied. Neither Helmle nor the Firm treated the MC-400 Application as a meaningful checkpoint. 

Jaffe's ineligibility arises from a securities violation. Jaffe agreed to a finding that he did not disclose material information on a required regulatory report.

at Pages 61 - 62 of the OHO Panel Decision
In a Complaint filed in the United States District Court for the Northern District of Illinois, the SEC alleged that Lupo Securities LLC violated Rule 14e-4 under the Securities Exchange Act. As alleged in part in the SEC Release:

[A]s part of a 2016 partial tender offer for the common stock of Lockheed Martin Corp., Lupo, then an SEC-registered broker-dealer, tendered more Lockheed shares than it owned on a net basis, in violation of the short tender rule. Because partial tender offers are for less than all of the outstanding shares of a security, if the partial tender offer is oversubscribed, the offeror accepts shares pro rata. Here, Lockheed's partial tender offer was oversubscribed, and the complaint alleges that, by tendering excess Lockheed shares, Lupo received more shares of Leidos Holdings, Inc. - the company acquiring a Lockheed business unit through the tender offer - than it was entitled to, at the expense of other participants who would have received more Leidos shares but for the violation. The complaint alleges that, as a result of this conduct, Lupo received approximately 610,000 more Leidos shares than it would have received had it complied with the short tender rule.
In a Complaint filed in the United States District Court for the Southern District of New York, the SEC charged Trevor R. Milton with violating the anti-fraud provisions of the Securities Act and the Securities Exchange Act.  As alleged in part in the SEC Release:

[M]ilton founded Nikola in 2015 with the primary goal of manufacturing trucks that run on alternative fuels with low or zero emissions, and building an alternative fuel station infrastructure to support those vehicles.  Milton allegedly helped Nikola raise more than $1 billion in private offerings and go public through a business combination conducted by a special purpose acquisition company (SPAC).  According to the SEC's complaint, during that time and after Nikola was publicly traded, Milton acted as Nikola's primary spokesperson appearing regularly on national media and communicating directly with investors through social media.  Milton allegedly encouraged investors to follow him on social media to get "accurate information" about the company "faster than anywhere else."  Instead, however, Milton allegedly used his extensive media platform to repeatedly mislead investors about, among other things, Nikola's technological advancements, products, in-house production capabilities, and commercial achievements.  The complaint further alleges that Milton ultimately reaped tens of millions of dollars in personal benefits as a result of his misconduct.

International Wholesale Currency Dealer Pleads Guilty to Unlawfully Operating in the United States (DOJ Release)
GPOMCT Grupo Empresarial S.A. de C.V., an international, Mexico-based wholesale currency dealer and currency exchange business, pled guilty in the United States District Court for the Southern District of California to operating an unlicensed money transmitting business. As alleged in part in the DOJ Release:

[G]POMCT imported shipments of currency from Mexico into the United States for the purposes of selling Mexican pesos to a currency exchange located in San Ysidro, California, identified only as "MSB 1" in the plea agreement. Between September 2019 and September 2020, GPOMCT imported approximately 195 shipments of currency-each worth between $90,000 and $100,000 in U.S. dollars-and delivered them to MSB 1 in San Ysidro. GPOMCT used the services of an armored car company to collect currency from MSB 1 as payment and deliver it to a third-party intermediary in Miami, Florida.

By offering a variety of services as a wholesale currency dealer, GPOMCT admitted that it operated as an unlicensed money transmitting business in the United States and agreed to criminally forfeit $1.1 million as property involved in its unlawful operations. By failing to register as a money transmitting business, GPOMCT did not file currency and transactional reports with the Department of the Treasury, as required by the Bank Secrecy Act, nor did it subject itself to inspection by the Department of Treasury for compliance with these financial laws and regulations.
Given the sexual politics on Wall Street, a lot of men in positions of authority "get the girl to do it" when it comes to something that seems a tad dicey from a compliance or regulatory perspective. Later on, when whatever the girl did blows up and the regulators come a knockin', well the old boys' playbook tends to call the same audible. The girl was never told to do that. The girl acted on her own. No one knew. She went rogue. Of course, FINRA is too eager to buy into that crap, and the industry's women and minorities pay a disproportionate price for their relatively low-level infractions. Consider a recent FINRA regulatory settlement with another of the industry's female employees.
You ever read something and you think that you understand what happened but when you go back and re-read the same document, you realize that you assumed a lot of stuff that wasn't in there and, geez, the more I read this thing, the less confidence that I have with what I'm being told happened because I don't think that what they meant is what they said, but if that's the case, then I don't think that they said what they meant, but if they did, I'm not quite sure that it makes sense but for the fact that I still think that I intuit what went on here even if I can't actually explain it. And thus we begin the tale of a recent public customer's FINRA Arbitration.

( Blog)
BofA/Merrill Lynch alleged that it discharged an analyst for using his corporate credit card at a so-called adult entertainment venue. They also sold steak there, in case you were wondering. The thing about FINRA's regulator case is that it sure as hell didn't have much proof. What it did have was four FINRA lawyers going after some poor shlub who must have wished the floor would open up and swallow him.