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Nasdaq’s listing policies do not explicitly prohibit companies from utilizing a contract-based structure, such as a Variable Interest Entity (VIE), for their operations. This type of structure is often employed by companies operating in markets with foreign ownership restrictions, such as China. A VIE allows a company to circumvent these restrictions by obtaining control through a series of legal agreements rather than direct ownership. Companies like Alibaba Group Holding Limited (BABA) and Baidu, Inc. (BIDU) have historically used this structure to navigate regulatory constraints in their home markets.
Overview of VIE Structures
In markets with strict foreign ownership rules, a VIE structure can enable foreign investors to invest in companies operating in restricted industries. The VIE structure involves a set of agreements between the operating company and the VIE entity, which is usually owned by public shareholders. While this allows for operational control without direct ownership, it has posed risks in the past, including potential loss of control over the operating company. This risk can adversely affect public shareholders of the VIE entity if control is lost.
Nasdaq’s Review Process
Nasdaq does not have specific listing rules that ban companies using VIE structures. However, Nasdaq’s Listing Qualifications team carefully reviews the disclosures and documents related to such corporate structures. For example, if a company like JD.com, Inc. (JD) seeks to list on Nasdaq using a VIE structure, the exchange’s review will focus on the details surrounding the VIE agreements and overall corporate structure.
Nasdaq may request additional information or impose supplementary requirements based on its review. The aim is to ensure that all relevant aspects of the VIE structure are transparent and well-documented.
Considerations for Investors
Investors considering companies with VIE structures should carefully review several key factors disclosed by the company, including:
Purpose of the VIE Structure - Understand why the company employs a VIE structure. For instance, companies like Pinduoduo Inc. (PDD) use VIEs to comply with regulatory requirements in their home markets.
Future Plans - Determine whether the company plans to unwind or dissolve the VIE structure if foreign ownership restrictions are relaxed or lifted.
Legal Documents - Assess whether there is a legally enforceable power of attorney or similar document granting the company all rights of the VIEs. This includes control over operations, assets, and employees.
Legal Opinions - Check if the company has obtained legal opinions from local counsel regarding the legality and enforceability of the VIE structure. This includes opinions on the binding nature of VIE contracts and the potential for successors or assignees to be bound by these agreements.
Regulatory Rulings- Investigate any government or regulatory rulings relevant to the VIE structure. This includes understanding whether there are objections or concerns from regulatory authorities.
Approvals and Compliance - Verify if the company has obtained all necessary government and regulatory approvals to operate the VIE business. This ensures that the structure is compliant with local regulations.
Financial Consolidation - Confirm whether the VIE structure allows the company to consolidate the financial results of the VIEs under applicable accounting principles.
Conflicts of Interest - Determine if any VIE shareholders are also company officers, directors, or employees. If so, review how potential conflicts of interest are addressed.
Revenue Repatriation - Assess whether the company is required to, and has the capability to, repatriate revenues generated by or amounts advanced to the VIE businesses.
Conclusion
While Nasdaq permits the listing of companies utilizing VIE structures, it imposes a thorough review process to ensure transparency and compliance. Companies like Tencent Holdings Limited (TCEHY) and NIO Inc. (NIO), which employ VIE structures, must provide detailed disclosures to address potential risks and regulatory concerns. Investors should carefully evaluate these factors to understand the implications of investing in companies with such structures. This thorough scrutiny helps maintain the integrity of the market and provides investors with a clearer understanding of the associated risks and benefits.
