New Oriental Education & Technology Group Inc's booth at a parenting and education exhibition in Beijing.

Wikipedia says that Variable interest entity (VIE) is a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity (the investee) in which the investor holds a controlling interest that is not based on the majority of voting rights. It is closely related to the concept of a special purpose entity. The importance of identifying a VIE is that a company needs to consolidate such entities if it is the primary beneficiary of the VIE.

A VIE is an entity meeting one of the following three criteria as elaborated in formerly FIN 46 (Revised):

1. The equity-at-risk is not sufficient to support the entity's activities (e.g.: the entity is thinly capitalized, the group of equity holders possess no substantive voting rights, etc.); 2. As a group, the equity-at-risk holders cannot control the entity; or 3. The economics do not coincide with the voting interests (commonly known as the "anti-abuse rule").

A recent scandal surrounding China's education firm New Oriental Education and Technology Group centers on the company's VIE structure. On July 11 EDU announced it had restructured its VIE ownership. The VIE had been owned by 11 shareholders, including an entity controlled by Mr. Michael Yu, the founder, Chairman and Chief Executive Officer of the company. Some of those shareholders are no longer active in the company. It is now held by an entity owned by Chairman Michael Yu (Yu Minhong). The SEC investigation was launched on July 13 over its possible accounting irregularities following the company's announcement.

In July 18, Muddy Waters Research issued a report on New Oriental Education, calling it “lying to shareholders about its store growth and financial performance”. Stock price of New Oriental, the largest provider of private education services in China, plummeted 30% to $9.50 per share in the afternoon alone.

Since the firm said on July 17 it was being investigated, around US$1.6 billion has been wiped off New Oriental shares.

Related reading: New Oriental Education sued by US investors

US investors will sue New Oriental and some of its senior executives for alleged violations of federal securities laws, according to an announcement on a US law firm's website.

The investors, who purchased American Depository Shares from the firm between July 21, 2009 and July 17, 2012 (known as the "class action period"), sued New Oriental Education Group Inc in the United States District Court for the Central District of California, China Securities Journal reported Wednesday.

The prosecution alleges that during the class action period, New Oriental Group made false or misleading statements and failed to disclose the facts of its business, operations and prospects.

After short seller Muddy Waters LLC, a small China-based research firm that focuses on uncovering fraudulent China stocks announced that financial statements in New Oriental Group units were fraudulent, the group sank to a five-year low.

Glancy Binkow & Goldberg LLP investigated accusations of New Oriental's variable interest entities and found that some of the details were consistent with the report released by Muddy Waters.

In response to Muddy Waters' questions about the ownership of some of New Oriental's schools and the consolidation of their financial statements with the parent company, Yu said that those labeled as "New Oriental" are all regular chains of New Oriental Education & Technology Group, while 19 franchisee schools are authorized by New Oriental's sub-brand and 2 are New Oriental Stars.

The 21 schools only have the authority to use the brands Pop Kids Education and New Oriental Stars, and not "New Oriental".

On July 20, New Oriental Education issued two reports, announcing that five senior executives would buy back stocks on the open market over the next three months. Meanwhile, the board of directors will establish an ad hoc committee to investigate the accusations from Muddy Waters.

New Oriental Education is a leading private education company in China, providing language training courses in English, German, Japanese and other foreign languages. Founded in 1993, it has had over 13 million student enrollments and a network of 55 schools.