Alibaba is case study in US-China legal gulf

Alibaba is case study in US-China legal gulf

Monday, Jun 23, 2014

Reuters

NEW YORK- Alibaba’s coming US initial public offering will probably value the Chinese e-commerce firm at more than $100 billion. But will shareholders actually own the business? That’s the timely concern raised by a US congressional commission. Lack of clarity in PRC law is mainly to blame.

The US-China Economic and Security Review Commission, which monitors bilateral relations on behalf of Congress, on June 18 published a paper highlighting the legal risks of so-called variable interest entities. Many Chinese companies use these contracts to give offshore investors control over – and economic benefits from – mainland businesses they cannot own directly.

Investors have swallowed the risks of VIEs in plenty of other cases, like the recent US IPO of microblogging site Weibo. Foreign shareholders assume the Chinese authorities would be reluctant to undermine the growing number of companies with overseas listings that rely on the structures.

Alibaba says businesses held through VIEs account for only about 17 per cent of its assets. The rest goes through wholly and majority foreign-owned enterprises. Besides, the company discusses its VIE arrangements at length in its IPO documents and quotes a Chinese law firm’s opinion that everything is legal.

Still, the US commission’s paper calls VIEs “an intricate ruse” and says they are “potentially illegal in China.” Even Alibaba concedes that efforts to enforce contractual rights on the mainland could be challenging. Though the company is big and entrenched enough to matter to the economy, the danger for prospective Alibaba investors is that its prominence in the sensitive internet sector would put it in the crosshairs should Beijing decide to crack down on VIEs.

The commission raises another legal issue that doesn’t get as much attention. Once Alibaba lists on a US exchange, it will be subject to new aspects of the sprawling Foreign Corrupt Practices Act. If, for example, the company mischaracterized corrupt payments in its accounts, American authorities could take action.

Of course, China has its own anti-graft laws, and there’s no suggestion Alibaba has done anything wrong. Yet the US report is a reminder that there are risks both in the uncertainty of Chinese legal arrangements and in the certainty that US law has extraterritorial reach. Investors shouldn’t forget that Alibaba is a case study in the gulf between the two legal systems.

CONTEXT NEWS

– The US-China Economic and Security Review Commission on June 18 published a paper, “The Risks of China’s Internet Companies on US Stock Exchanges.”

– The paper highlights “major risks” faced by US shareholders from so-called variable interest entities through which Chinese internet firms often structure foreign ownership of businesses that are not open to overseas investors.

– The commission’s paper also notes that US-listed Chinese companies fall under aspects of the Foreign Corrupt Practices Act, raising potential issues in relation to any mischaracterized financial records, among other things.

– Alibaba filed with the Securities and Exchange Commission on May 6 for a US initial public offering and lodged revised documentation on June 16.