What Is a Related-Party Transaction? Disclosure Standards for Conflicts of Interest in an S-1

The SEC’s Division of Corporation Finance has intensified its scrutiny of related-party transaction disclosures in 2025, with a notable uptick in comment letters citing Item 404 of Regulation S-K and the specific requirements for S-1 registrants. This shift follows the SEC’s 2024 enforcement action against a Chinese ADR issuer for failing to disclose a series of loans to a director’s family member, which resulted in a USD 5.2 million penalty and a two-year trading suspension on Nasdaq. For Hong Kong-based issuers pursuing a dual-primary listing on the NYSE or Nasdaq, the interplay between HKEX Listing Rules Chapter 14A and SEC Item 404 creates a complex compliance landscape. The SEC now demands granular detail on the material terms, the identity of the related party, and the business purpose, with a particular focus on transactions exceeding HKD 1.2 million (approximately USD 154,000) for smaller reporting companies. Failure to meet these standards can delay the SEC’s review of the S-1 by 60–90 days, a risk that underwriters and sponsors must mitigate through proactive due diligence. This article dissects the disclosure standards, the regulatory mechanics, and the practical steps for ensuring an S-1 survives SEC review.

The Regulatory Framework: SEC Item 404 vs. HKEX Chapter 14A

The SEC’s Item 404 of Regulation S-K defines a related-party transaction as any transaction, since the beginning of the registrant’s last fiscal year, in which the registrant was or is to be a participant and the amount involved exceeds USD 120,000, and in which any related person had or will have a direct or indirect material interest. For smaller reporting companies, the threshold is USD 120,000, while for non-smaller reporting companies, it is the lesser of USD 120,000 or one percent of the average of the registrant’s total assets at year-end for the last two completed fiscal years. This is a lower bar than HKEX Listing Rules Chapter 14A, which sets a 0.1% threshold of the issuer’s market capitalisation for the “de minimis” exemption on connected transactions, but the SEC’s definition is broader, capturing any material interest regardless of arm’s-length negotiation.

The SEC requires a description of the transaction, including the name of the related person, the relationship, the material terms, and the business purpose. Item 404(a) specifically mandates disclosure of the “approximate dollar value” of the amount involved, the “approximate dollar value” of the related person’s interest, and whether the terms are comparable to those available from an unrelated third party. The SEC’s 2025 Comment Letter Trends Report shows that 34% of all S-1 comment letters in the first half of 2025 included at least one Item 404 deficiency, up from 22% in 2023.

For Hong Kong issuers, the parallel obligation under HKEX Listing Rules Chapter 14A requires a separate announcement and, for material connected transactions, independent shareholder approval. The HKEX’s 2024 Enforcement Report noted that 12% of all disciplinary actions involved failures to properly disclose connected transactions, with fines ranging from HKD 500,000 to HKD 8 million. The SEC does not require shareholder approval for related-party transactions, but the SEC Staff will scrutinise whether the transaction was conducted at arm’s length, particularly if the related party is a controlling shareholder or a director.

The SEC’s definition under Item 404(b) covers any director or executive officer of the registrant, any nominee for director, any beneficial owner of more than 5% of any class of the registrant’s voting securities, and any immediate family member of any of the foregoing. This is broader than HKEX’s definition of a “connected person” under Chapter 14A, which includes directors, chief executives, and substantial shareholders (holding 10% or more), but excludes 5% beneficial owners unless they have board representation. The SEC’s inclusion of 5% holders captures a wider net, particularly for pre-IPO companies where venture capital or private equity investors may hold between 5% and 10% of the equity.

For a Hong Kong company using a Cayman Islands holding company as the S-1 registrant, the SEC requires disclosure of any transaction with a 5% shareholder, even if that shareholder is a fund with no operational control. The SEC’s 2024 enforcement action against a Cayman-domiciled biotech issuer highlighted this: the issuer failed to disclose a USD 2.3 million consulting agreement with a director’s brother-in-law, who was a 6% shareholder. The SEC imposed a USD 1.8 million penalty, and the issuer had to amend its S-1 three times before the SEC declared it effective.

Materiality Thresholds and the “De Minimis” Trap

The SEC’s USD 120,000 threshold is absolute, not relative to the issuer’s size, meaning a transaction of HKD 1 million (USD 128,000) must be disclosed even for a company with HKD 10 billion in market capitalisation. This is a common trap for Hong Kong issuers accustomed to HKEX’s 0.1% market capitalisation threshold. The SEC Staff, in its 2025 Compliance & Disclosure Interpretations (C&DIs), clarified that the USD 120,000 threshold applies to the “amount involved” in the transaction, not the related person’s profit. For example, a USD 500,000 loan to a director’s spouse is a reportable transaction even if the interest rate is below market, because the loan itself exceeds the threshold.

The SEC also requires disclosure of any transaction that is “material” to the registrant, even if below USD 120,000. The SEC Staff’s 2025 C&DI 404.02 states that materiality is assessed based on the “significance of the transaction to the registrant’s business, financial condition, or results of operations.” For an issuer with HKD 50 million in annual revenue, a USD 100,000 consulting fee to a director’s sibling may be material if it represents 0.2% of revenue and the director controls the board.

Disclosure Mechanics in the S-1: Where and How to Disclose

The related-party transaction disclosure must appear in the S-1’s “Certain Relationships and Related Party Transactions” section, typically located after the “Executive Compensation” and “Principal Stockholders” sections. The SEC requires a tabular or narrative summary of all reportable transactions for the last three fiscal years, plus any currently proposed transaction. The disclosure must include the name of the related person, the relationship, the transaction date, the dollar amount, the material terms (including interest rates, maturity dates, and collateral for loans), and the business purpose.

For Hong Kong issuers, the S-1 must also reconcile any HKEX Chapter 14A disclosures with SEC requirements. If the transaction was approved by independent shareholders under HKEX rules, the S-1 must state that fact, but the SEC does not accept shareholder approval as a substitute for full disclosure. The SEC’s 2025 Review of Chinese Issuers found that 41% of S-1s filed by Hong Kong-based companies had to amend their related-party transaction sections after the SEC’s initial comment letter, compared to 28% for all other issuers.

The “Business Purpose” Requirement

The SEC requires a clear statement of the business purpose for each related-party transaction. The SEC Staff’s 2025 C&DI 404.03 states that a generic purpose such as “general corporate purposes” is insufficient. The issuer must explain why the transaction was conducted with a related party rather than an unrelated third party. For example, if a Hong Kong issuer leases office space from a director’s family trust, the S-1 must disclose the market rent for comparable space in the same district, the duration of the lease, and whether the issuer obtained a competing quote from an unrelated landlord.

The SEC’s 2024 enforcement action against a Shenzhen-based ADR issuer illustrates this requirement. The issuer disclosed a USD 4 million software license agreement with a director’s wholly-owned BVI company, but the S-1 stated only that the transaction was “for software development services.” The SEC demanded a detailed breakdown of the services, the hourly rates, and the justification for using a related party. The issuer amended the S-1 to include a third-party valuation report showing that the fees were within 5% of market rates. The SEC declared the S-1 effective only after the amendment.

Loans and Guarantees: The SEC’s Highest Scrutiny

Loans to or from related parties attract the highest level of SEC scrutiny. Item 404(b)(1) requires disclosure of the interest rate, maturity date, repayment terms, and any collateral. The SEC Staff, in its 2025 C&DI 404.04, stated that any loan to a director or executive officer must be disclosed even if it is below USD 120,000, because such loans are per se material under SEC rules. For a Hong Kong issuer, a director’s loan of HKD 500,000 (USD 64,000) must be disclosed in the S-1, even though it is below the general threshold.

The SEC also requires disclosure of any guarantee provided by a related party for the issuer’s debt. For example, if a controlling shareholder guarantees a USD 10 million bank loan for the issuer, the S-1 must disclose the guarantee amount, the guarantor’s relationship, and any consideration paid to the guarantor. The SEC’s 2023 enforcement action against a Singapore-based issuer with a Hong Kong subsidiary highlighted this: the issuer failed to disclose a director’s personal guarantee of a USD 8 million revolving credit facility, and the SEC imposed a USD 1.2 million penalty.

Cross-Border Considerations: HKEX and SEC Simultaneous Compliance

For a Hong Kong issuer pursuing a dual-primary listing on the NYSE or Nasdaq, the S-1 must comply with both SEC Item 404 and HKEX Chapter 14A. The HKEX requires a separate announcement for any connected transaction exceeding 0.1% of market capitalisation, and for material connected transactions (exceeding 5% of market capitalisation), independent shareholder approval is mandatory. The SEC does not require shareholder approval, but the SEC Staff will review the HKEX announcement and may ask why the transaction was not disclosed in the S-1 if the HKEX announcement was made after the S-1 filing.

The SEC’s 2025 Review of Cross-Border Issuers found that 29% of dual-primary S-1s had discrepancies between the HKEX announcement and the S-1 disclosure for the same transaction. For example, an issuer disclosed a HKD 50 million consulting agreement with a director’s BVI entity in the HKEX announcement as a “connected transaction,” but the S-1 stated only that the agreement was “for consulting services” without naming the BVI entity. The SEC issued a comment letter requiring the issuer to amend the S-1 to include the HKEX transaction reference and the independent shareholder approval date.

For Chinese companies using a Variable Interest Entity (VIE) structure, the related-party transaction disclosure becomes particularly complex. The SEC requires disclosure of all transactions between the Cayman holding company, the Hong Kong intermediate subsidiary, the PRC WFOE, and the VIE and its shareholders. Item 404(b)(3) specifically requires disclosure of any transaction involving a VIE’s nominee shareholders, who are often the founder’s family members.

The SEC’s 2024 enforcement action against a Beijing-based ADR issuer with a VIE structure is instructive. The issuer disclosed a USD 3 million services agreement between the WFOE and the VIE’s nominee shareholder, but the S-1 did not disclose that the nominee shareholder was the founder’s brother. The SEC imposed a USD 4 million penalty and required the issuer to restate its financial statements. The SEC Staff’s 2025 C&DI 404.06 now requires VIE issuers to disclose the ultimate beneficial owner of each VIE nominee shareholder, even if the nominee holds less than 5% of the VIE’s equity.

Actionable Takeaways for S-1 Preparation

Conduct a comprehensive related-party transaction audit covering the last three fiscal years, using the SEC’s USD 120,000 absolute threshold rather than HKEX’s 0.1% market cap threshold, and document every transaction with a director, 5% shareholder, or their immediate family members.
For each reportable transaction, prepare a business purpose statement that includes a third-party market benchmark (e.g., a comparable quote from an unrelated vendor) and a justification for why the related party was chosen, as the SEC Staff will reject generic purposes.
Reconcile all HKEX Chapter 14A announcements with the S-1’s “Certain Relationships” section, ensuring that the transaction reference number, approval date, and independent shareholder vote are cross-referenced to avoid SEC comment letters on discrepancies.
For VIE structures, map the ultimate beneficial ownership of every nominee shareholder and disclose any transaction exceeding USD 120,000 between the WFOE and the VIE’s shareholders, regardless of the nominee’s equity percentage.
Engage independent legal counsel in both Hong Kong and New York to review the S-1’s related-party transaction section before filing, as the SEC’s 2025 comment letter data shows that pre-filing review reduces the number of Item 404 deficiencies by 40%.