Reconsidering the VIE structure

Chinese online media company Sina pioneered the trend back in 2000, when it used the VIE structure to list on the New York Stock Exchange. Education company New Oriental Group is one of many Chinese companies since then to have also used the structure to list on international capital markets.

New Oriental announced it was under investigation by the US Securities and Exchange Commission (SEC) in a press release on July 17. While the company believes that the investigation concerns the consolidation of one its subsidiaries into the company's financial statements, it has not stopped bloggers such as Stan Abrams at China Hearsay and Paul Gillis of China Accounting Blog from speculating that this could be the end of VIEs.

The structure

Foreign investors can use VIEs as a workaround structure to access restricted or prohibited industries under the country's Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录). The basic structure includes at least one domestic company, owned and controlled by PRC owners, an offshore holding company and a wholly foreign-owned enterprise (WFOE).

The holding company owns the WFOE through a series of intermediary holdings. The domestic company and the WFOE enter into a series of structured agreements, including an exclusive equity option, equity pledge, voting proxy and technical licence and service agreements. These agreements allow the domestic company to be indirectly controlled by the holding company and its financial results are consolidated into the WFOE's financial statements, as if it were one of the company's subsidiaries.

Investigation

Beijing-based Brad Shu, a partner at Jade & Fountain PRC Lawyers said: “The SEC might not be questioning the VIE structure, but they are concerned about whether franchises may be consolidated into the company's financial statements.”