China Law Update

New IPO Guidelines

Sheppard Mullin — Thu, 10 May 2012 11:21:37 -0800

The China Securities Regulatory Commission (“CSRC”), China’s securities regulator, recently unveiled new guidelines (“Guidelines”) for China’s initial public offering (“IPO”) system. The guidelines were issued pursuant to feedback that was gathered from the public earlier in April.

The Guidelines present increased efforts by the CSRC to administer China’s securities market and to help restore investor confidence in what remains an uncertain economic climate. The Guidelines aim to better protect the interests of investors through greater transparency and financial integrity.

Pricing. The Guidelines attempt to better ensure that the pricing of newly offered shares more accurately reflect enterprises’ real values. This follows other efforts by the CSRC to control the weak performance of newly offered shares, particularly where such weak performance has been preceded by unusually high offering prices.
Disclosure Requirements. The Guidelines include strengthened information disclosure requirements from issuers and intermediary institutions. This includes a requirement to disclose further information concerning pricing and potential risks where pricing is 25% higher than the price of listed companies in the same industry.
Participation. The Guidelines expand the scope of investors that may take part in the inquiry of new offerings by allowing underwriters to recommend five to ten individual investors to participate in the inquiry process.
Increased Share Levels. The Guidelines include efforts to increase the number of outstanding shares of newly listed companies available in the market, alleviating problems associated with inadequate share levels. This includes the removal of a three month lock-up period after the offering of new shares acquired by institutional investors, and the increase in share levels available to institutional investors.
Responsibilities. The Guidelines further outline the respective responsibilities of issuers, sponsor institutions, accounting firms, law firms and intermediary institutions, as they pertain to the offerings of new shares.

Analysts have commented that the Guideline’s impact on China’s IPO system will be limited, given that the Guidelines present adjustments to, rather than a fundamental reform of, China’s existing IPO framework.

MOFCOM's "Fusion" Approach to Chinese Merger Control

Sheppard Mullin — Thu, 19 Apr 2012 10:14:09 -0800

By Becky Koblitz

We often hear about how China’s merger review “diverges” from other jurisdictions, most recently in reaction to conditional approvals of the Seagate/Samsung and Western Digital/Hitachi mergers. But China's MOFCOM is merely doing its homework. Similar to “fusion” cuisine, MOFCOM practices “fusion” merger control as it blends two aspects: its mandate under the Anti-Monopoly Law (“AML”), and the antitrust theories of other jurisdictions.

Unlike other jurisdictions, which are relatively independent of their respective governments, MOFCOM answers to the State Council. Under the AML, MOFCOM’s mission has a political perspective to advance “healthy development of a socialist market” and it has the authority to formulate and implement regulations “suitable for the socialist market economy.” Therefore, MOFCOM’s mission will vary depending on the State Council’s national economic policy: whether to move more to a capitalistic market-driven economy or remain as a socialist controlled economy.

From a purely theoretical perspective, the AML’s standard of review is in line with other mature jurisdictions; however, as in the case of MOFCOM’s mission, the standard of review has the added political element of considering the “socialist market”. The standard of review is whether it is likely that the transaction will result in eliminating or restricting competition. Similar to the US and EU practice, the factors to consider include: market shares and ability to control the market, degree of market concentration, effects on market access and technological progress, and effects on consumers. But for MOFCOM there is also the additional political factor—the effect of concentration on the political development of the national economy.

MOFCOM wants to be seen as being cooperative with other antitrust authorities and is keeping a high profile in this regard. MOFCOM continues to consult other jurisdictions with regard to the AML. The Chinese antitrust authorities signed Memoranda of Understanding (“MOU”) with both the UK Office of Fair Trading (January and March 2011) and with the US Department of Justice (“DOJ”) and US Federal Trade Commission ( “FTC”) (July 2011) with regard to developing competition policy and enforcement. The MOU with the US agencies was followed up in November with guidelines for cooperation between MOFCOM/DOJ/FTC with respect to merger filings. Under the guidelines, information can be shared relating to the timing of their respective investigations, technical aspects such as market definition, evaluation of competitive effects, theories of competitive harm, economic analysis and remedies.

In light of MOFCOM’s mandate under the AML and MOFCOM’s exposure to other jurisdictions’ experiences, this means that even though the market may be global, MOFCOM will focus on the impact on the Chinese market, allowing it to protect industries such as the automobile, agriculture and computer sectors. As such, MOFCOM has set conditions specific to the Chinese market, for example, by requiring an auto parts supplier to continue to supply other customers in the Chinese market (GM/Delphi merger); by requiring Russian potash producers to continue to sell to Chinese customers (Uralkali/Silvinit merger); and more recently, by not allowing the purchaser to exercise control over the target for a period of time (Seagate/Samsung and Western Digital/Hitachi).

In the Seagate/Samsung merger, MOFCOM required Seagate to establish an independent subsidiary to produce, price and market Samsung products and to build a firewall to prevent information from being exchanged between Seagate and the Samsung subsidiary. Seagate could request a waiver of this requirement after one year, depending on the competitive conditions. In the Western Digital/Hitachi merger, MOFCOM required the parties to maintain Hitachi’s subsidiary as an independent competitor that would market and develop the products and to build a firewall to prevent the exchange of information between the two parties. Western Digital could request a waiver of this requirement after two years, depending on the competitive conditions.

MOFCOM imposed these requirements despite the fact that the US and EU authorities had already cleared the Seagate/Samsung merger without conditions and cleared the Western Digital/Hitachi merger with structural remedies. MOFCOM’s concern was that China had the greatest number of consumers who bought computers and it was these end-users who suffered the most from imbedded price increases of the components, which were the products in the merger transactions. The hold-separate requirements which MOFCOM imposed in the Seagate/Samsung and Western Digital/Hitachi offshore mergers are prohibitions in disguise, since the parties must maintain their independent, pre-merger situation for a given period of time and the probability that the competitive landscape would change to justify the waiver of the requirements is low.

These hold-separate requirements are reminiscent of the “carve-out” conditions used in the airline alliance cases. In airline alliance cases the issue is whether a particular alliance can be granted antitrust immunity so that it can conduct its otherwise allegedly collusive, anticompetitive behavior without the risk of being prosecuted by the DOJ. In the event the reviewing agencies (the Department of Transportation grants antitrust immunity, but the DOJ comments during the application process) decide that not all the markets served by the alliance should fall under the antitrust immunity blanket, these markets are “carved out”, meaning that the carriers who are members of the alliance must retain their status quo as competitors in these markets.

The rationale for the hold-separate and carve-out requirements is the same: the nominal competitive state of the market is preserved. In the hold-separate situations, MOFCOM wanted to maintain the five players in the global HDD market (Seagate, Western Digital, Hitachi, Toshiba and Samsung). In the carve-out situations, the DOT/DOJ wanted to preserve a state in which the carriers conducted their business as competitors. Both the hold-separate and carve-out conditions are subject to review after a time period designated by the agencies and the conditions can be removed.

Thus, although MOFCOM’s most recent "hold-separate" conditions diverge from other jurisdictions’ decisions and as such, appear to contradict this image of international cooperation, they show that in fact MOFCOM has been doing its homework and applying the competitive analysis within its parameters under the Anti-Monopoly Law, a highly political creature.

China's Parliament Adopts Revision to Criminal Procedure Law

Sheppard Mullin — Mon, 09 Apr 2012 09:07:29 -0800

By Jiamu Sun

On March 14, 2012, the fifth session of the National People’s Congress adopted the latest revision to China’s Criminal Procedure Law (“Revised Law”). The Revised Law is the second amendment to the Criminal Procedure Law following its enactment in 1979 and its first amendment in 1996. Altogether, one hundred and eleven revisions have been made, concerning topics including, among others, evidence, compulsory measures, defense, investigation, trial procedure, and execution. The Revised Law will come into force on January 1, 2013. The Supreme Procuratorate of the People’s Republic of China has embarked upon revising corresponding judicial interpretations, including the Criminal Procedure Rules of The People’s Procuratorate and the Basic Norms of Enforcement Work by The People’s Procuratorate.

As has been reported, major progress has been made with respect to the protection of the rights of criminal suspects and defendants. Notably, the phrase "respecting and protecting human rights" has been incorporated in the Revised Law's first chapter with respect to its aim and basic principles. Some deem the update from the current law’s “convicting” to the Revised Law’s “convicting and respecting and protecting human rights” to represent a shift in values.

The Revised Law provides for the greater protection of suspects in several aspects. First, the Revised Law allows defense lawyers to represent a suspect from the time of a suspect’s first interrogation or under compulsory measures. Lawyers can meet with suspects without the permission of detention center authorities as long as the accused’s crime does not threaten national security, and was not a crime of terrorism or serious corruption. Second, the Revised Law explicitly provides that no person can be forced to testify against him/herself. Third, the Revised Law makes it clear that confessions, witness testimonies and depositions that are obtained illegally, for example through forced confessions, should be excluded during trial. Fourth, in order to encourage witnesses to testify in court, the Revised Law provides financial support and even security protection in circumstances where crimes involve threats to national security or terrorism, or crimes involving mafia organizations or drugs, among others. Fifth, as compared to the current law, the summary procedures provided in the Revised Law are subject to more restricted use. Finally, the Revised Law requires the Supreme People’s Court to interrogate defendants when reviewing death sentences, indicating what appears to be a desire that the death penalty be applied more cautiously.

Deserving special attention is the fact that the Revised Law adds four new separate proceedings to the current law; namely, proceedings for (i) juvenile criminal cases, (ii) cases involving parities’ reconciliation, (iii) cases involving the confiscation of illegally obtained incomes by suspects and defendants who have fled or died, and (iv) cases involving the forced medical treatment of mental patients who are not criminally liable. Three of the aforementioned proceedings are intended to benefit suspects and defendants in special circumstances, whereas the confiscation proceedings aim to increase the punishment for corrupt officers having fled abroad.

The Revised Law has aroused a great deal of discussion and debate. Among others is the Revised Law’s Article 73 and Article 83, which stipulate that for suspects suspected of threatening national security, or committing terrorism or serious corruption, the public security organ may appoint a monitoring dwelling place and may elect not to inform such suspects’ relatives under circumstances where such notification may hinder an investigation. Some have expressed concern over Article 73 and Article 83, contending that such articles unduly enlarge the investigative power of the public security organ and suspects could be more easily abused and tortured. Some have even contended that the articles suggests that so-called “secret arrests” exist under the Revised Law; a claim that has been denied by officials from the Legislative Affairs Commission of National People’s Congress.

Concern has also been expressed about the implementation of the Revised Law itself. In a recently published book on Chinese criminal procedure, one legal scholar concludes that there is an intense system-wide focus on obtaining convictions of criminal defendants. For example, the book reports that prosecutors suffer a decline in their performance ratings where the cases that they have handled do not conclude with a guilty verdict. One of China’s leading law reformers said in a recent interview that “if the men who wield state power believe that it is their role to protect private rights and that protecting private rights is the ultimate purpose of state power, then the concept of law is changed. But, unfortunately, this is an obstacle that we have yet to overcome.”

To be viewed from a deeper perspective, it will take more than revising laws on paper to advance China’s system of criminal justice. Among other things, there is also an urgent need to reform the system that governs how legal rules are implemented.

CIETAC's New Arbitration Rules

Sheppard Mullin — Thu, 29 Mar 2012 09:31:07 -0800

The China International Economic and Trade Arbitration Commission (“CIETAC”) recently adopted revised arbitration rules (“Revised Rules”), to be effective on May 1, 2012. The Revised Rules replace the rules that became effective in 2005 (“2005 Rules”).

Some key features of the Revised Rules:

Interim Measures
The Revised Rules provide that at the request of one party, the arbitral tribunal may order any interim measure it deems necessary or proper in accordance with the applicable law. It remains to be seen to what extent an arbitral tribunal can enforce such interim measures under China’s laws of civil procedure, where parties agree to arbitration in China. The 2005 Rules did not provide for interim measures.

Suspension of Proceedings
The Revised Rules provide that arbitration proceedings may be suspended where parties request a suspension or under circumstances where suspension is necessary. The arbitral tribunal decides whether to suspend or resume arbitration proceedings and, where the arbitral tribunal has not yet been formed, the decision is to be made by the Secretary General of CIETAC. The 2005 Rules did not provide a suspension of proceedings provision.

Summary Procedure
The Revised Rules provide that summary procedure applies to any case where the amount in dispute does not exceed RMB 2,000,000 (or to any case where the amount in dispute exceeds RMB 2,000,000, yet one party applies for arbitration under the summary procedure and it is agreed to by the other party). The 2005 Rules provided a summary procedure threshold of RMB 500,000.

Consolidation of Arbitrations
The Revised Rules provide that at the request of one party and with the agreement of the other parties, or where CIETAC believes that it is necessary and all the parties agree, CIETAC may consolidate two or more arbitrations into a single arbitration. In deciding whether to consolidate arbitrations, CIETAC may take into account any factors that it considers relevant with respect to the different arbitrations, including whether the various claims are made under the same arbitration agreement, whether the different arbitrations are between the same parties, and whether one or more arbitrators have been nominated or appointed in the different arbitrations.

Language
The Revised Rules provide that, in the absence of the parties’ agreement, the language to be used in the arbitration proceedings shall be Chinese or any other language designated by CIETAC. The 2005 Rules provided that where parties fail to agree on the language of the arbitration, the arbitration would be conducted in Chinese.

The ability of CIETAC to designate the language of the arbitration proceedings under the Revised Rules will likely help resolve challenges encountered under the 2005 Rules. Under the 2005 rules, where one or more foreign arbitrators are to be members of the arbitration tribunal, and where parties fail to agree on the language of arbitration (by default making the arbitration language Chinese), the pool of foreign arbitrators would be significantly limited to only those fluent in Chinese.

Place of Arbitration
The Revised Rules supplement the terms regarding circumstances in which parties have not agreed to the place of arbitration. The Revised Rules provide that CIETAC may now determine the place of arbitration, taking into account the circumstances of the case. The 2005 Rules provided that where the parties have not agreed on the place of arbitration, it would be the domicile of CIETAC or its Sub-Commission.

CIETAC has for years been regarded as the preeminent arbitration commission for foreign-related arbitrations in China. The Revised Rules reflect increased consistency with the rules of other major arbitration bodies.

Authored By:

Amin Amirkia
86.10.5706.7517
aamirkia@smrh.com

China's Newly Revised Foreign Investment Guidance Catalogue

Sheppard Mullin — Tue, 20 Mar 2012 09:23:35 -0800

By Yan Zhang

In late 2011, China’s National Development and Reform Commission (“NDRC”) and Ministry of Commence (“MOFCOM”) jointly announced the new Foreign Investment Guidance Catalogue (2011 Amendment) (“New Catalogue”). For years, China’s Foreign Investment Guidance Catalogue (“Catalogue”) has been among the most essential regulations and industrial policies in guiding foreign investment. The New Catalogue became effective on January 30, 2012, replacing its predecessor which became effective in December 2007.

The Catalogue categorizes the specific industries in which foreign investment in China is “encouraged”, “restricted” or “prohibited” (industries not specifically mentioned in the Catalogue are generally considered “permitted”). The Catalogue was first announced in 1995 in order to meet the needs of China’s growing economy and economic reform. The NDRC and MOFCOM have since revised the Catalogue several times, with the New Catalogue being the Catalogue’s fifth revision.

Several key aspects of the New Catalogue:

There are 473 articles in total, including 354 articles regarding encouraged industries, 80 articles regarding restricted industries, and 39 articles regarding prohibited industries; as compared to 351 articles, 87 articles and 40 articles in the 2007 Catalogue, respectively. Meanwhile, the New Catalogue has deleted 11 articles requiring joint capital proportion in encouraged and restricted industries, resulting from a more proactive opening principle.
In an attempt to restructure manufacturing, the New Catalogue puts advanced manufacturing among the focus of encouraged industries. Vehicle manufacturing, the polysilicon industry and the coal chemical industry are no longer encouraged industries. According to a spokesman of the NDRC, these changes are based on estimates of the level of China’s domestic vehicle manufacturing and the attempt to avoid unnecessary construction.
Several articles related to emerging industries have been classified as encouraged industries, which can be considered a sign of the government’s determination in cultivating the emerging industries. This includes, among others, the manufacturing of key parts and components of new energy automobiles, and the development and manufacturing of certain next generation Internet system equipment.
Nine of the items classified as encouraged industries are new, largely in order to stimulate the development of the service sector. These include the construction of vehicle charging stations, venture capital enterprises, intellectual property right services, offshore oil pollution cleaning and ecology recovery technology and relevant product development, occupational skills training, foreign invested medical institutions, and financial lease companies.
Items removed from the encouraged industries classification are being considered with respect to the Catalogue of Priority Industries for Foreign Investment in Central and Western China, according to a spokesman of the NDRC, as part of a policy that seeks to balance development among China’s various regions.

In practice, foreign investment projects approved before the January 30, 2012 effective date of the New Catalogue shall comply with the 2007 Catalogue. However, in the event a foreign invested project applies for a capital increase, equity assignment or overseas listing, among others, then it shall comply with the New Catalogue.

China Adopts Revision to Criminal Procedure Law

Sheppard Mullin — Mon, 19 Mar 2012 10:44:36 -0800

By Jiamu Sun

As has been reported, major progress has been made with respect to the protection of human rights, especially those governing forced confessions. Further, the phrase "respecting and protecting human rights" has been incorporated in the Revised Law's first chapter with respect to the Revised Law’s aim and basic principles.

The Revised Law has aroused a great deal of discussion and debate. Among other articles, this includes Article 73, which stipulates that for suspects endangering national security, committing crimes of terrorism or serious bribes, the public security organ may appoint a monitoring dwelling place and may not inform such suspects’ relatives under circumstances where such notification may hinder an investigation. Some have expressed concern over the Revised Law, contending that the article unduly enlarges the investigative power of the public security organ and could suppress a suspect’s legitimate rights. Some have even contended that the article suggests that so-called “secret arrests” exist under the Revised Law; a claim that has been denied by officials from the Legislative Affairs Commission of National People’s Congress.

The Revised Law requires the Supreme People’s Court to question defendants when reviewing death sentences. Further, the Revised Law makes it clear that confessions, witness testimonies and depositions that are obtained illegally should be excluded during trial.

Details Of 2012 Annual Inspection Of Foreign-Invested Enterprises Announced

Sheppard Mullin — Wed, 14 Mar 2012 09:07:07 -0800

The Ministry of Commerce, Ministry of Finance, General Taxation Administration Bureau, State Administration for Industry and Commerce, National Bureau of Statistics and State Administration of Foreign Exchange (“SAFE”) have recently released the “Notice on Implementing the Joint Annual Inspection of Foreign-Invested Enterprises in 2012” (“Notice”). Pursuant to the Notice, the time period for the joint annual inspection of foreign-invested enterprises (“FIEs”) for 2011 is from March 1 to June 30 2012, and all FIEs established and registered in China on and before December 31, 2011 shall be subject to the annual inspection within the specified time.

The annual inspection is designed to ensure that FIEs conduct business in compliance with China’s legal requirements. The annual inspection will be jointly conducted by the following government agencies:

Ministry of Commerce (local office)
Finance Bureau
Administration of Industry and Commerce (“AIC”)
Tax Bureau
Customs
SAFE
Statistics Bureau

The procedures for FIEs to complete the annual inspection includes two steps. First, the completion of the preliminary inspection by logging onto the online annual inspection system at www.lhnj.gov.cn and filling out all the required information. Second, the submission of the required documents after passing the preliminary inspection. As was the case last year, FIEs shall provide annual inspection reports (to be accessed and printed from the online system, executed by the legal representative and sealed with the FIE’s chop), auditor’s reports (or capital verification reports for FIEs established in the second half of Year 2011), audited foreign currency reports, all original company certificates (including business license, tax registration certificate, certificate of approval, customs registration certificate, financial registration certificate, statistical registration certificate, SAFE registration card), etc.

The above inspection procedures and requirements slightly differ from city to city. As such, it is important that FIEs contact their local authorities to confirm detailed procedures.

The branch offices of FIEs established in China are also required to complete the annual inspection, however such branch offices cannot proceed with such annual inspections until their head company completes their annual inspection. Typically, a copy of the verified business license of a head company passing its annual inspection is required for the branch office for its annual inspection. As such, it is important that branch offices ensure that the annual inspection of their head company is completed as early as possible such that the branch can meet the annual inspection deadline.

The representative offices of foreign enterprises (“ROs”) are also required to complete the annual inspection. The procedures for the annual inspection of ROs are simplified as compared with the procedures and documents required for FIEs, as they only involve AIC and tax inspections. The required documents for a RO’s annual inspection are more complicated, however, requiring a certificate of good standing and bank reference letter for its head company, with both documents requiring notarization and legalization.

Any questions regarding this blog can be directed to Xinlan Liu at xliu@sheppardmullin.com in Beijing.

Six Ministries and Commissions to Join Force to Administer the Renminbi Settlement of Export Trade

Sheppard Mullin — Fri, 09 Mar 2012 10:51:35 -0800

On February 23, 2012, the People’s Bank of China, Ministry of Finance, MOFCOM, State Administration of Taxation, General Administration of Customs and China Banking Regulatory Commission jointly issued the Notice on the Administration of Company Settling Export Trade in Renminbi (YinFa [2012] No. 23). According to this notice, company will be subject to “key supervision and administration” if in the last two years it (1) has committed tax evasion or export refund fraud, or issued or accepted fake VAT invoice; (2) has been subject to the investigations of tax bureau and public security bureau for tax evasion, export refund fraud, issuance or accepting fake VAT invoice; (3) has committed serious Customs violation e.g. smuggling; (4) has committed serious violations of financial regulations; (5) has committed serious violation of state foreign trade laws and regulations (6) has committed serious violation of other laws.

The name list of these companies under key supervision and administration will be submitted by the local government and local counterparts of these ministries and commissions to the ministries and commissions at the state level for review and confirmation and this name list is required to be updated annually by the local government. The information of these companies will be shared between these ministries and commissions as well as their local counterparts through the “Renminbi Cross Border Payment and Remittance Information Management System” established by the People’s Bank of China. The application documents of these companies for Renminbi payment for export trade will be subject to a more stringent review process and any Renminbi obtained by these companies for their export trade cannot be deposited in their oversea bank accounts.

Any questions regarding this article can be directed to Sharon Xu at sxu@sheppardmullin.com in Beijing.

Regulatory Challenges for the "Big Four"

Sheppard Mullin — Wed, 07 Mar 2012 10:06:16 -0800

The “Big Four”, which dominate the Chinese market, are facing regulatory changes that could mean that only accountants with Chinese qualifications can be partners in their China-based audit practices.

At the time of China’s accession to the World Trade Organization in 2001, the Big Four successfully lobbied to have an exception to China’s requirement that only Chinese certified accountants could own Chinese accounting firms. As a result, the Big Four were allowed to maintain their foreign ownership in their existing joint ventures. However, the exception only applied to the Big Four’s existing joint ventures, which have 20 year terms. As a result, the joint venture agreements signed by KPMG, Deloitte & Touche, and Ernst & Young will expire later this year, with PricewaterhouseCoopers’ to expire in 2017.

China’s Ministry of Finance has indicated that, upon the expiration of the terms of the Big Four’s respective joint ventures, they will be required to convert into the same mode of practice as local firms (i.e. limited liability partnerships). This would require that all partners are Chinese certified accountants, which would present a major challenge given that such exams are in Mandarin and notoriously difficult.

Many of the Big Four partners in China are foreigners, including many from Hong Kong. Few of such foreign partners are certified in China. Further, it has been reported that although the number of Chinese partners in the Big Four has increased significantly in recent years, China’s accounting industry remains relatively young and there may not yet be enough highly experienced and locally qualified accountants to take the helms at the Big Four’s China based operations.

The potential changes come at a sensitive time for the audit industry, in light of the highly publicized accounting irregularities of some Chinese companies listed in the U.S. and other markets. Further, some commentators have noted that any reduction in the capacity of the Big Four in China (or the control of the Big Four’s China practices by their global headquarters) could result in increased concern by foreign regulators and investors about the integrity of auditing and the financial markets.

It has been reported that the Big Four are currently in discussions with Chinese regulators. The position of China’s regulators is consistent with international practice. That is, in most countries the Big Four are owned by local partners, and such partners are required to be locally qualified.

Authored By:

Amin Amirkia
86.10.5706.7517
aamirkia@smrh.com

China Corruption & White Collar Crimes Watch: China Strengthens Supervision Over Civil Servants

Sheppard Mullin — Wed, 07 Mar 2012 10:02:15 -0800

In a June 2011 report issued by the People’s Bank of China (and as prepared by the China Academy of Social Sciences) the PRC government found 18,000 Party and government officials fled the country since 1990 with over US$120 billion in government funds missing. The leadership has had significant challenges in stamping out corruption at multiple levels. Foreign companies should be aware of these efforts in dealings with officials and management of state-owned enterprises.

On February 28, 2012, the Ministry of Supervision reported that 36,000 government officials were punished for violating laws and regulations in 2011. The MOS found that 8,500 individuals were found guilty of embezzlement and bribery. The government also sought to crackdown on illegal forced demolition and misappropriation of land (11 cases involving 57 officials) and issues concerning food and drug safety (13 cases involving 269 officials). The ministry has also focused on dealing with commercial bribery cases involving state-owned enterprises, and matters involving the misuse of government property and vehicles.

Hand in hand with the government’s own investigations, the Party also has its own disciplinary system to check corrupt officials. In this regard, the Central Commission for Discipline Inspection (CCDI) of the Communist Party of China issued its annual report on February 19, 2012, found that the Party punished 142,893 officials, and with 5,334 officials referred for criminal prosecution. The CCDI report also proposed special campaigns to root out corruption in key areas, such as the construction sector, government-funded events and the use of public vehicles. The Party also called for greater transparency in public affairs, better protection of witnesses in corruption cases, and to use social media platforms for fighting corruption.

In addition to the MOS and CCDI reports, on February 22, 2012, regulations jointly issued by the Organization Department of the CPC Central Committee and the Ministry of Human Resources and Social Security jointly issued regulations that are intended to control nepotism and corruption in the civil service. The new regulations provide that civil servants and their spouses/relatives are barred from holding positions that have a director-subordinate relationship or from holding two separate positions that report to the same director. Civil servants are also asked to avoid situations such as recruitment, promotion or demotion of staff, taxation and approval for overseas travel that involve their relatives. If two civil servants marry or form a familial relationship, their posts are required to be adjusted. A failure to comply with the regulations may result in penalties including the removal from office. These anti-nepotism rules may check the ambitions of the mom and pop teams that seek to control the village coffers, but unlikely to impact the appointment of Party princelings to posts at major State-owned enterprises.

The quarterly China Corruption & White Collar Crimes Watch is an on-the-ground review of updates in the law or policies concerning China’s anti-bribery activities, and is prepared by the Beijing office of Sheppard Mullin. Any questions regarding these issues or this blog can be directed to Becky Koblitz at BKoblitz@sheppardmullin.com or James Zimmerman at JZimmerman@Sheppardmullin.com in Beijing.

China Adopts Procurement Policies for SMEs

Sheppard Mullin — Tue, 06 Mar 2012 09:44:56 -0800

On January 6, 2012, the Ministry of Finance (MOF) and the Ministry of Industry and Information Technology (MIIT) issued a joint statement outlining a number of preferential procurement policies for small- and medium-sized enterprises (SMEs) to boost their development. Government agencies usually prefer larger companies and well-known brands during the procurement process, and SMEs have had a difficult time successfully bidding on tenders.

The MOF/MIIT Notice provides that government agencies are required to set aside at least 30% of their total budgets for SMEs, of which at least 60% should be dedicated to small- and micro-sized enterprises. Small- and micro-sized businesses will also be entitled to an extra price preference between 6% and 10% when they submit a tender for government procurement projects. The MOF/MIIT Notice also encourages SMEs to form consortiums and allows large enterprises to subcontract purchases from SMEs.

The PRC defines small, medium or "micro-sized" companies as follows: industrial companies with fewer than 1,000 employees and an annual income of less than RMB400 million (US$63.32 million) qualify as SMEs, and companies with fewer than 20 employees and less than RMB3 million (US$477,000) in income are considered to be "micro-sized." China's government procurement was RMB842.2 billion in 2010.

These measures are a positive step in reducing the monopolistic practices of the State-owned sector. It is no mystery that SOEs are favored vendors for government procurement, and especially those SOEs that have historical ties to the government agencies that are also customers. These rules should help to level the playing field between the SMEs and the SOEs, and bring some degree of competition to the procurement sector (although foreign companies still do not have effective access). Going forward, SMEs will likely pose a commercial threat to the monopolistic SOEs. China's SMEs exceed 43 million companies and are reported to account for 58.5% of China’s GDP and responsible for half of China’s tax revenues.

For more information concerning this blog and other China-related topics, contact James Zimmerman in the Beijing office at jzimmerman@sheppardmullin.com.

Banking Authority Issues Guideline To Encourage Green Credit

Sheppard Mullin — Mon, 05 Mar 2012 09:48:17 -0800

On February 24, 2012, the China Banking Regulatory Commission (“CBRC”) introduced a new Green Credit Guideline (“Guideline”) in order to encourage commercial lenders to facilitate loans to “green” enterprises. The CBRC, China’s top banking regulator, ordered commercial lenders to cut loans to industries with high-energy consumption and high levels of pollution or excessive capacity, and to strengthen financial support for environmentally friendly industries and projects.

The CBRC encouraged banks and financial institutions to evaluate, classify and rate the environmental and social risks in their clients’ businesses and to take such results as a key reference in their ratings and access to credit. It has been reported that the CBRC will, as a next step, establish key indexes in order to make the Guideline more specific.

The Chinese government has made efforts to employ green lending practices in recent years. In 2007, the CBRC, the People’s Bank of China and the State Environmental Protection Administration (“SEPA”) (now the Ministry of Environmental Protection), introduced the Green Credit Policy requiring SEPA to provide a list of heavy polluters to the CBRC and the People’s Bank of China. The companies on the list that failed to pass environmental assessments or to implement environmental protection regulations became disqualified from receiving loans from banks and financial institutions.

The Guideline emphasizes the role and ability of banks and financial institutions to promote an environmentally sustainable economy. Specifically, given the influence of commercial lenders on businesses through credit controls, the Guideline is expected to generate greater environmental awareness among businesses. Further, the Guideline underscores the economic risks inherent in activities that are detrimental to the environment, as environmental risks can be closely tied to the credit risks of a bank or financial institution, and can lead to operational losses.

Authored By:

Amin Amirkia
86.10.5706.7517
aamirkia@smrh.com

China Anti-Monopoly Law: What might we see in 2012?

Sheppard Mullin — Tue, 28 Feb 2012 11:12:55 -0800

On February 16, 2012 the Beijing office of Sheppard Mullin had a reception to celebrate the opening of new office space in China World Trade Center in the central business district. Firm Chairman Guy Halgren welcomed our 120-plus guests. Prior to the reception, Sheppard Mullin hosted a roundtable discussion on the Anti-Monopoly Law of China (“AML”). We had 18 participants, including in-house counsel for major corporations, as well as the German Chamber of Commerce. Our guest speaker, Mr. Zhang Yuqing, former director general counsel of the Chinese Ministry of Commerce (“MOFCOM”), who headed the inter-agency group which developed the AML, spoke on two topics which will probably be “hot” this year: a new regulation which will fine companies which didn’t report their transactions and went ahead with the transactions, and another regulation that deals with national security review. Gary Halling, head of Sheppard Mullin’s antitrust practice, spoke about recent enforcement trends in the U.S, specifically with respect to cartels. Michael Zhang of Sheppard Mullin’s Shanghai office also attended and gave his views on investment structures. The subsequent discussion among the participants was lively.

Sheppard Mullin hosts such roundtable discussions periodically, where we invite government officials and representatives of companies to exchange ideas and ask questions in an informal, off-the-record setting. If you are interested in participating in future roundtable discussions please contact Becky Koblitz, email address: bkoblitz@sheppardmullin.com. Below are the opening remarks of Becky Koblitz, Special Counsel, Beijing office of Sheppard Mullin Richter & Hampton LLP.

Antitrust Roundtable, February 16, 2012
China Anti-Monopoly Law: What might we see in 2012?

Let us begin with a look at the past three years of antitrust enforcement in China and recent trends in the US. Today, we are lucky to have with us Zhang Yuqing, former general counsel for MOFTEC/MOFCOM, who led an inter-agency working group to develop the Anti-Monopoly Law and Gary Halling, head of Sheppard Mullin’s antitrust practice. I will open with a brief summary of some highlights of antitrust enforcement in China and the US so that we have a backdrop or framework for our discussion.

China Anti-Monopoly Law: it’s still evolving

Unlike other jurisdictions where antitrust enforcement is centralized, in China three agencies enforce the Chinese Anti-Monopoly Law (“AML”). The Ministry of Commerce (“MOFCOM”) handles mergers, while cases related to anticompetitive conduct are split between the National Development and Reform Commission (“NDRC”) and the State Administration for Industry and Commerce (“SAIC”). The NDRC handles price-related violations and SAIC the non-price related violations. The AML has been in effect since August 2008 and continues to evolve as these three agencies adopt additional regulations in order to provide more guidance on and clarification of such aspects as terminology, procedures, and enforcement.

In the first three years the major focus has been merger filings. Merger notifications continue to be time consuming (some taking up to 6 months or more), and involve elaborate formalities and investigations which sometimes were not necessary. Last year 160 investigations were completed (in comparison to 25 in 2008, 80 in 2009 and 117 in 2010). Of those 160, four were cleared with conditions (in comparison to 1 in 2008, 4 in 2009, 1 in 2010), bringing us to a total of 10 conditional clearances, all involving foreign companies. There has been only one rejection (Coca Cola/Huiyuan, March 2009). This was only the second decision published by MOFCOM and there was little in-depth discussion of what was analyzed to reach the conclusion. The general reaction was that this was a political decision. Over the years MOFCOM’s analysis has become more sophisticated. For your convenience I have prepared a list of the transactions which were conditionally approved and the one trans action which was rejected. Of the four conditional clearances in 2011, three are noteworthy:

Penelope/Savio (October 31): MOFCOM required the controlling shareholder of Penelope to divest its interest in another company which was one of two major players in the global market for yarn cleaners (the other was a subsidiary of Savio). This case is the first time MOFCOM considered how control could be exercised through portfolio interests by examining voting patterns.
GE/Shenhua (November 10): MOFCOM imposed conditions related to the joint venture’s relationships with its licensees. This case involved a joint venture. The AML does not expressly state that joint ventures are subject to merger control, therefore this conditional approval is constructively an affirmation by MOFCOM that joint ventures are subject to the AML merger control provisions. Another interesting aspect of this case is that it involved a state owned enterprise (“SOE”).
Seagate/Samsung (December 12): MOFCOM imposed conditions related to the relationship between the two parties and production capacities. Similar to the Sanyo/Panasonic case, this case highlights MOFCOM’s divergence from the US and EU authorities which issued unconditional clearances.

Although 97% of the filings were approved, the system still needs to be streamlined, and MOFCOM is aware of this. In the recent press conference in December 2012, Shang Ming, director of the Anti-Monopoly Bureau of MOFCOM mentioned that efforts would be made to streamline the system.

Two topics which will probably gain more attention this year relate to the treatment of mergers which were not reported and national security reviews.

As of February 1st a new regulation has been in effect that penalizes companies that fail to make a required merger filing (i.e., they had met the thresholds). Based on information provided by a whistle-blower (member of the public or an entity or “other channels”) MOFCOM will open a file and start a preliminary investigation. The subject parties will be notified and required to submit within 30 days information regarding the transaction. MOFCOM will determine whether to continue the investigation. In the event it continues, the parties must suspend implementation of the transaction. The second in-depth investigation can last up to 180 days. MOFCOM can fine the parties (RMB 500,000/USD 80,000) or order other sanctions such as the unwinding of the transaction. We have made an unofficial translation of the regulations for your convenience.

The AML has a provision that requires an additional review when foreign firms acquire control of domestic firms and the transaction involves national security. In 2011, final rules to implement the national security review were issued in which “national security” sectors were identified and broken down into two categories: one related to the military and the other related to defense, agriculture, energy, transportation, technology and equipment manufacture. The purpose of the review is to see whether the transaction poses a threat to national security by looking at its potential impact on such areas as production of domestic products and services required for national defense, national economic stability, order within society, and China’s ability to research and develop key technologies involving national security. This terminology is still very vague. If the transaction meets the threshold for merger review and the domestic firm that is being acquired is in possible category of national security, then two reviews will be required. Timing may be an issue. It is not clear, but companies can probably submit reviews for National Security Review and AML merger notification at the same time.

This requirement has the potential to be used politically. The US has a similar national security review process under The Committee on Foreign Investment in the United States (“CFIUS”). The US definition of “national security” is not as broad as China’s. Up until now six cases involving national security have been filed. Of these three have been approved and three are still being reviewed by the committee designated to conduct the national security review. There have not been any public announcements regarding cases requiring national security reviews since there is no obligation under the rules to publish decisions.

Anti-competitive conduct

Although merger control is the area with the most activity and attention, it is not too early to consider the other component of antitrust, namely enforcement of AML provisions governing anticompetitive conduct. In early 2011 the NDRC and SAIC adopted rules setting forth how the two agencies would enforce the AML with respect to anticompetitive conduct ( the terminology used in the AML is monopoly agreements and abuse of dominance, in the US we refer to contracts/combinations/or conspiracies to restrain trade). There are surprisingly few cases in China.

In 2011 SAIC had its first cartel case under the AML, fining a concrete association and 5 of its members for market allocation (RMB 200,000/$30,000). The NDRC had three cases brought under the AML (it has brought many other cases under pre-AML price law). A paper association was fined for price-fixing and output restriction (RMB 500,000/USD80,000). Two pharmaceutical companies were fined for market allocation and price-fixing (RMB 7 million/USD 1.1). The fine was--for Chinese standards--huge. Two SOE’s (China Telecom and China Unicom) were investigated for restricting broadband access, but subsequently the two parties applied for a suspension of the investigation in exchange for their promise to improve internet interconnection quality, adjust pricing system and improve broadband network in China. The investigation is still pending.

International cooperation

We can expect more activity in the future based on the Chinese authorities’ fast learning curve and willingness to apply what has been effective elsewhere. Up until recently, the EU has had more influence over the Chinese practice: the AML is modeled after the EU treaty and the Chinese authorities continue to consult the EU. However, this is changing. The Chinese antitrust authorities have started to enter into cooperation agreements with other antitrust authorities with regard to antitrust enforcement. There is no cooperation agreement between the EU and Chinese authorities. In January and March, the UK Office of Fair Trading signed Memoranda of Understanding (“MOU’s”) with the NDRC and SAIC, respectively, in which they commit to cooperate and exchange best practices on competition and consumer policy as well as enforcement. In July, a MOU was signed between the US Department of Justice (“DOJ”) and US Federal Trade Commission (“FTC”) and the three Chinese enforcement agencies, under which they agree to cooperate in developing competition policy and enforcement. This was followed up in November with guidelines for cooperation between MOFCOM/DOJ/FTC with respect to merger filings. Under the guidelines, information related to the following issues could be shared: timing of their respective investigations, technical aspects such as market definition, evaluation of competitive effects, theories of competitive harm, economic analysis and remedies. Although enforcement in the anticompetitive conduct area is sparse in comparison to the US, the Chinese will be learning more about investigative methods as a result of the increased cooperation.

Cartel enforcement

The Chinese are also no doubt looking at recent trends in the US and other jurisdictions. The US experience is a good starting point to figure out what is likely to happen in China. Cartel enforcement is a trend in the US, involving such products as computer components, automotive electronic components, air cargo and passenger surcharges. The US investigations have targeted or charged many Asian executives. For your information we have prepared a table entitled “The $100 Million Club” which lists foreign companies and how much they were fined. Recently in the New York Times there was an article about a price-fixing case involving Japanese auto suppliers (the three companies were fined $78, $470 and $78 million and the executives received prison sentences or fined). “Since November, the Justice Department has obtained $748 million in fines from Japanese auto suppliers for price-fixing and bid-rigging, more than its antitrust division received in the entire previous fiscal year.“ The article quotes the acting assistant attorney general in charge of the antitrust division: ”Criminal antitrust enforcement remains a top priority and the antitrust division will continue to work with the F.B.I. and our law enforcement counterparts to root out this kind of pernicious cartel conduct that results in higher prices to American consumers and businesses.” The article then ends, “The plea agreements, which are subject to court approval, require the defendants to help the government in its investigation of the auto parts industry.”

What does this tell the Chinese?

This type of enforcement is a great potential source of revenue. More important, however, is the how a leniency program can be an effective enforcement tool. The US program provides for no prosecution of the company and cooperating executives if they are the “first in”. Such a program is a successful detection method and destabilizes cartels by creating anxiety and the race to the prosecutors. Presently the NDRC and SAIC have leniency provisions in their implementing regulations, but the general public opinion is that the provisions lack specificity as to the extent of the advantages of self-reporting. Perhaps we will see additional regulations regarding leniency measures.

Wrap up

Merger enforcement will continue to be a major focus and source for consumption of time and resources for foreign companies. We may see more activity in the cartel enforcement area as the Chinese enforcement agencies interact with those of other jurisdictions.

Deadline Approaches For Users Of Beijing-Based Microblogs To Register With Their State-Issued IDs

Sheppard Mullin — Fri, 24 Feb 2012 10:05:33 -0800

China’s major Beijing-based microblogging service providers will institute real name identification systems by March 16, 2012. This will require users to register with the service providers by such date with their state-issued IDs. Users who do not register by March 16, 2012 will still be able to login to their accounts, but will only be permitted to browse postings on the sites and not transmit messages.

Chinese officials first proposed real name identification for microblogs late last year, leaving it up to different cities to craft their own policies. On December 16, the Beijing Municipal Public Security Bureau, the Beijing Communications Administration and the Beijing Internet Information Office and the Beijing Municipal Information Office jointly issued "Beijing Microblog Development and Management Regulations," (the “Rules”), which became effective on the same date.

In addition to requiring users of microblogging services to register their real names with microblogging service providers, the 16-point Rules:

- Require that before applying for a telecommunications business operating license or going through the filing procedure for a non-business Internet information service, a microblogging service that a website launches is to submit an application to the department in charge of the Internet information content and go through an examination and approval process.

- Require microblogging service providers to ensure the identities of their users within three months (i.e. by March 16).

- Prohibit the unlawful use of microblogs to make, duplicate, issue, or propagate information that contains content falling into eleven prohibited categories, including information that leaks state secrets or damages national unity, information that incites ethnic hatred, information that undermines social stability, and other information otherwise prohibited by law or regulation.

The Rules are applicable to Beijing-based microblogging service providers and their users. Three of China’s biggest microblogging services (namely, Sina, Sohu and Netease) are based in Beijing, whereas Tencent (a major web portal company with microblogging services) is based in Shenzhen. It has been reported that after Beijing's initiative, several other cities, including Shanghai, Guangzhou and Shenzhen, have moved to adopt similar measures.

It is estimated that China currently has more than 300 million registered microbloggers, and a total Internet user population exceeding 500 million.

Authored By:

Amin Amirkia
86.10.5706.7517
aamirkia@smrh.com

Loosening Current Restrictions, While Implementing New Ones--Notice on Further Improving the Administrative Measures for Foreign-Funded Investment Companies Issued

Sheppard Mullin — Tue, 07 Feb 2012 11:40:41 -0800

The Ministry of Commerce and the State Administration of Foreign Exchange jointly released the Notice on Further Improving the Administrative Measures for Foreign-Funded Investment Companies (“the Notice”) on Dec 8, 2011. While amending some of the current regulations on foreign-invested investment companies, the Notice also sets some new restrictions.

1. Foreign-invested investment companies must be designated as “investment company”.

The Notice imposes a heightened requirement on the verification and management of the statistical information required in the review and approval of foreign-invested investment companies. Once a foreign-invested investment company is approved, it must be clearly designated as an "investment company" in the Basic Information Form of the Foreign-Invested Enterprises. Other types of foreign-invested companies shall not be designated as "investment company", "investment holding" or other similar designations.

2. Domestic loans shall not be used for domestic reinvestment purposes.

Article 2 of the Notice prohibits that domestic loans obtained by foreign-invested investment companies be used for domestic reinvestment purposes. However, concepts such as “domestic loans” and “domestic reinvestment” still need to be further defined and clarified.

3. Certain restrictions on investments by foreign-invested investment companies are loosened.

According to Article 1 of the Notice on Operation Guidelines for Issues Concerning Capital Verification Inquiry Into Foreign-Funded Investment Companies' Reinvestment issued by the State Administration of Foreign Exchange on March 29, 2011, a foreign-invested investment company can only use its lawfully earned domestic income to reinvest in China after such income has been capitalized as its registered capital. However, Article 3 of the newly released Notice provides two options for foreign-invested investment company to invest in China with its lawfully earned domestic income (including RMB profits, recovery of investment and income derived from liquidation, equity transfer and capital reduction, etc.): (1) use such income directly for domestic investment upon the approval of the local foreign exchange bureau where the company is located; or (2) capitalize such income as registered capital (either by contribution or increase of capital) and then make domestic investment. Therefore, more options become available for foreign-invested investment companies to invest with their lawfully earned domestic incomes.

While the Notice sets new restrictions for foreign-funded investment companies, it also in some ways loosens certain existing restrictions. Its effects on foreign-invested investment companies are not clear and remain to be seen.

Going Private: U.S. Listed Chinese Companies

Sheppard Mullin — Wed, 18 Jan 2012 09:54:25 -0800

Many U.S. listed Chinese companies have their eye on going private, with a growing number of such transactions having recently closed. This is the combined result of the current weakness of the U.S. capital markets, significant losses in the value of many U.S. listed Chinese companies, and pessimistic market forecasts that have resulted in trading at values below what controlling shareholders, management or private equity firms may think certain companies are worth.

Why Companies May Go Private

To save costs. There are considerable costs associated with being listed on a U.S. exchange, including ongoing regulatory compliance and defending against shareholder lawsuits and other litigation. Further, in the case of leveraged buyouts, acquirers and targets may realize tax and accounting benefits of a more leveraged capital structure, as compared to a public company.
Strategic business reasons and the ability to manage the company. Private companies are not required to publicly disclose competitive information, are provided more flexible corporate governance, and can focus on business objectives rather than investor relations issues and the short-term pressures of appeasing shareholders. Moreover, a going private transaction can allow for the restructuring of a company’s businesses in ways that would adversely affect its stock prices in the short run if it remained a public company.
The ability to realize value. Going private may allow shareholders to realize a better price for their shares then they would otherwise realize from continuing to hold the shares or selling them on an exchange. Further, companies may go public because analysts consider a company’s share valuations to be low when compared to what the company could generate from other equity markets such as Hong Kong or Mainland China.

Challenges
Going private presents companies with challenges as well, including the inability to utilize the public markets to obtain immediate financing, a diminished public profile, and less transparency. Further, the going private process can be arduous and many such transactions are challenged in court.

Structures
A going private transaction may take various forms. Factors that influence the choice of structure include the need for outside financing, the composition of shareholders, and the likelihood of a competing bid for the company. Going private transactions are commonly structured as buyouts (either mergers or tender offers), and in some cases as reverse stock splits.

Special Committees
In order to mitigate litigation risks for the breach of fiduciary duties, boards need to ensure the fairness of a transaction to the company’s shareholders, particularly where transactions involve controlling shareholders. As such, it is common for a board to appoint a special committee of independent directors.

Listing in Mainland China or Hong Kong
Some companies plan subsequent listings in Hong Kong or Mainland China, where they speculate the valuation for their companies may be higher. For companies that were delisted or suspended from U.S. exchanges, the stigma associated with such could pose a challenge with respect to a subsequent listing, as stock exchanges and regulators require issuers to disclose their history.

Conclusion
Some basic questions that the directors and senior management of all U.S. listed Chinese companies should be asking themselves when considering going private, include: what is the most appropriate going private structure? What is a price that is demonstrably fair? Is the special committee of the board sufficiently independent? How should detailed records be maintained of board and special committee meetings, transaction negotiations and other proceedings? How can the risk of litigation be minimized?

Sheppard Mullin received the "Taking Private 2011 Deal of the Year" award by China Business Law Journal, in recognition for its representation of Tongjitang Chinese Medicines Company Limited in connection with the company's going private transaction. To read more about the Tongjitang transaction, please click here. If you have any questions, please contact the Sheppard Mullin attorney with whom you regularly work, or one listed below.

Authored By:

Don S. Williams
86.21.2321.6018
dwilliams@sheppardmullin.com

Eric Wang
86.21.2321.6013
ewang@sheppardmullin.com

Amin Amirkia
86.21.2321.6014
aamirkia@sheppardmullin.com

SEC Toughens Listing Requirements for Reverse Merger Companies

Sheppard Mullin — Fri, 06 Jan 2012 09:02:34 -0800

On November 9, 2011 the U.S. Securities and Exchange Commission ("SEC") approved additional listing requirements proposed by the New York Stock Exchange ("NYSE"), NYSE Amex ("Amex") and the NASDAQ Stock Market ("NASDAQ") for companies going public through reverse mergers. The additional requirements are a response to the highly publicized cases of reverse merger abuses in recent months, in many cases involving the alleged accounting fraud of U.S.-listed Chinese companies.

Under the new requirements, a company will not be eligible for listing until it:

completes a one-year “seasoning period” by trading in the U.S. over-the-counter market or on another regulated U.S. or foreign exchange;
timely files all periodic reports required to be filed with the SEC, including at least one annual report containing audited financial statements for one full fiscal year; and
maintains a minimum closing stock price for a sustained period, and for at least 30 of the most recent 60 trading days, prior to the filing of its listing application and the exchange’s decision to list.

Furthermore, the NYSE and Amex rules reserve the discretion to impose more stringent listing requirements in the case of particular reverse merger companies based on factors including:

an inactive trading market in the company’s securities;
the existence of a low number of publicly held shares that are not subject to transfer restrictions;
if the company has not had a Securities Act registration statement subject to the SEC’s comprehensive review; and
if the company has disclosed that it has material weaknesses in its internal controls and has not yet implemented an appropriate corrective action plan.

There are two exceptions under which a reverse merger company will not be subject to the additional listing requirements. First, where the company is applying to list its securities with a firm commitment underwritten public offering where the proceeds to the company will be at least US$40 million and the offering occurs subsequent to or concurrently with the reverse merger. Second, if the company satisfies the one-year "seasoning period" and has filed at least four annual reports containing audited financial statements, then it may apply for listing under the respective exchanges' other initial listing standards.

Reverse mergers allow private companies, including those located overseas, to access U.S. investors and markets by merging with an existing public shell company. In some cases, regulators and auditors have greater difficulty obtaining reliable information from reverse merger companies, particularly in cases where the reverse merger company is based overseas. Recently, the SEC launched an initiative to determine whether certain companies with foreign operations were accurately reporting their financial results, suspended or halted the trading of more than 35 companies based overseas, and issued an investor bulletin warning investors about reverse merger companies. As a response to these concerns, NYSE and NASDAQ each proposed additional and more stringent listing requirements for reverse merger companies seeking to list on their exchanges.

Authored By:

Amin Amirkia
86.21.2321.6014
aamirkia@smrh.com

SAIC Issued Administrative Measures for Corporate Debt-for-Equity Swap Registration

Sheppard Mullin — Thu, 15 Dec 2011 15:23:54 -0800

Responsive to issues faced with difficulty in obtaining financing by businesses (particularly small- to medium-size enterprises) due to the global financial crisis, State Administration of Industry and Commence officially released Administrative Measures for Corporate Debt-for-Equity Swap Registration (the “Measures”) recently, which formalizes regulation of debt-for-equity swap on the national level. The Measures will be put into implementation on January 1, 2012.

A debt-for-equity swap within the meaning of the Measures refers to the conversion of a creditor’s rights in the indebtedness owed to it by a limited liability company or joint-stock company established in China into equity by way of increasing the registered capital of such entity. The Measures apply to the following types of debts:

Indebtedness arising from a contract between a creditor and a company in the course of business, provided that the creditor has performed all its contractual obligations giving rise to the indebtedness and the swap will not violate any prohibitive provision of any laws, administrative regulations, measures of the State Council or the articles of association of the company;
Debts pursuant to an effective judgment of a People’s Court; and
Debts included in a reorganization plan as approved, or a settlement agreement accepted and confirmed, by a People’s Court in connection with a bankruptcy reorganization or settlement of the debtor.

A company seeking to implement debt-to-equity swap shall apply to the company registration authority for change of registered capital and paid-up capital. In accordance with the Measures, the amount converted into equity from debt-for-equity swap when adding to other non-cash capital contribution shall not in the aggregate exceed 70% of the company’s registered capital, and shall not exceed the appraised value of the converted debts.

The Measures also requires that debts to be swapped for equity shall be appraised by legally established asset appraisal institutions, and equity swapped from debts shall be verified by legally established capital verification institutions for which capital verification certificates shall be issued.

The implementation of the Measures will alleviate the debt burdens of businesses after the financial meltdown and broaden financing channels available to them. At the same time, the Measures will effectively manage and mitigate potential risks facing businesses in the course of the debt-for-equity swap by requiring warranties by relevant parties, appraisal and capital verification, and public disclosure of information, as well as imposing administrative penalties in accordance with relevant laws.

Authored by:

Josie Shi
86.21.2321.6000
jshi@sheppardmullin.com

and

Willow Wei
86.21.2321.6000
wwei@sheppardmullin.com

China Implements a Security Review System for Certain Mergers and Acquisitions of Domestic Enterprises by Foreign Investors

Sheppard Mullin — Wed, 26 Oct 2011 10:06:31 -0800

The Chinese State Council has officially implemented a Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “Review System”) based on a set of interim rules (the “Rules”) issued earlier this year.

Mergers and acquisitions by foreign acquirers (“M&A”) will be reviewed under the Review System based on factors such as the target’s industry, the type of M&A, and the right to de facto control. Foreign acquirers must submit an application to China’s Ministry of Commerce (“MOFCOM”) for review prior to certain mergers or acquisitions of a domestic enterprise.

Scope and Substance of Review

M&A involving certain industries must be reviewed for national security reasons (the “Restricted Industries”). The Restricted Industries include national defense, transportation services, key technology, and significant agricultural products, energy and natural resources, infrastructure, and heavy equipment manufacturing. For M&A of national defense-related enterprises, foreign acquirers must apply for a security review regardless of whether such acquirers will assume control after the M&A. For all other M&A in the Restricted Industries, security review is required only if foreign acquirers will take over control.

Pursuant to the Review System, assessment will be based on the impact of a transaction on a) national defense, b) economic stability, c) basic social order, and 4) capability for research and development of key national defense technology. In addition to the review criteria explicitly stated, MOFCOM will be looking beyond the form of a transaction, and it will assess whether substantively, the transaction falls into the scope of the Review System and impacts the above aspects. Further, the Rules specifically state that a foreign acquirer cannot circumvent the Review System by using mechanisms such as variable interest entities, loans, and shareholding on behalf of others.

The Review System has already targeted a large scope of transactions, but it may only widen as the question of which areas of the Restricted Industries will be considered “significant” is expected to be clarified in practice. The Rules indicated that Chinese authorities are no longer turning a blind eye to circumvention mechanisms such as the VIE, and that they will be under additional scrutiny.

Types of Mergers and Acquisitions

Within the Restricted Industries, the Review System will focus on certain types of M&A (the “Restricted Transactions”). The Restricted Transactions include foreign acquirers 1) turning a domestic enterprise into a foreign-invested enterprise (“FIE”), 2) purchasing shares of an FIE from Chinese shareholders, 3) purchasing a domestic enterprise’s assets and continuing its operations through an FIE, or 4) purchasing all the assets of a domestic enterprise directly, then establishing an FIE to run the enterprise’s operations.

The fourth situation above adds to the three types of M&A that is under scrutiny from China’s antitrust laws. Because of the antitrust implications, foreign acquirers should be diligent in applying for a security review when they acquire all the assets of a domestic company. Further, foreign direct investment will also be subject to the Review System.

Control Rights

The Review System also examines M&A where a foreign acquirer gains de facto control (“Control”). These include situations where after an M&A, 1) the foreign acquirers, its affiliates, or a group of foreign acquirers, hold over 50% of the shares in a domestic company; 2) the voting rights of the foreign acquirers give them de facto control even if they hold less than 50% of the shares of a domestic company; or 3) foreign acquirers have veto rights in major corporate decisions such as those relating to the operations of the business, financing, personnel changes, or technology transfers.

The Review Process

MOFCOM will be responsible for leading an interdepartmental conference where applications under the Review System will be processed. Applications should be submitted towards the beginning of the M&A process so that they can proceed simultaneously. Further, if an M&A is not within scope of the Review System, then related industry associations and enterprises affected by the M&A have the option of requesting review, and the Review System may be triggered at MOFCOM’s discretion.

The security review involves two steps. First is a general review, and second is a special review. During the general review, if the conference can unanimously agree that the M&A will not impact national security, then the conference will issue a written report stating such a decision within 2 months of the application submission. If the M&A fails the general review, it will proceed to special review, which will further analyze the transaction and come to a decision approximately 4 months after the application submission. During this time, applicants may continue negotiating the terms of the M&A or even call off the deal. However, the closing of a transaction may take place only after the Review System has been successfully completed.

The Rules state that applicants may informally discuss their transactions with MOFCOM prior to the formal application so that applicants may streamline the review process by getting a preliminary sense of the transaction aspects that may concern MOFCOM the most. Foreign acquirers should take into account this time-consuming process prior to engaging in M&A within the Restricted Industries.

Authored By:

Cheng Xu
86.21.2321.6022
cxu@smrh.com

Doing Business at ART HK: Better, Bigger, Faster, Stronger

Sheppard Mullin — Fri, 26 Aug 2011 09:21:29 -0800

On the verge of becoming an international institution, the recent Hong Kong International Art Fair, known as "ART HK," represents an exciting development in the state of the art world in China. This growth has critical, yet profoundly inspiring, implications upon the international art community. Since its humble beginnings in 2008, ART HK has shown rapid growth with over 260 galleries from over 38 countries participating in the recent fair. Momentum of ART HK's success and prominence was recently propelled by an announcement that MCH Swiss Exhibition, owners of Art Basel, the world's biggest contemporary art fair, have just signed an agreement with Asian Art Fairs, the owners of ART HK, to purchase a majority stake in ART HK, which went into effect on July 1, 2011. This tactical move, combined with rising auction revenue, favorable tax considerations, a newfound interest in art as an asset class, and interest based on national identity, cements China’s role in the global art market.

It was recently reported in Artprice.com, a French-based data service, that China ranks number one in fine art auction revenue, surpassing the U.S. Moreover, the contemporary Chinese auction market has grown from just below $1 million in 2002 to $167.4 million in 2010. Prominent auction houses, Sotheby’s and Christie’s Hong Kong have seen sales turnover increase by 300% between 2009 and 2010. The total auction sales value (all categories) for both auction houses in Hong Kong rose by 122 percent, from US$658 million in 2009, to US$1.46 billion in 2010. Even mainland Chinese state-owned auction houses, such as Poly and Guardian, have seen their Chinese sales seasons grow from $397 million in 2009 to $2.2 billion in 2010. This year is also set to become a record year in light of the sale of the Ullen Collection at Sotheby’s Hong Kong in April 2011.

The art world focus in Hong Kong, as opposed to mainland China, may have something to do with the tax advantages it provides. While imported art is taxed by mainland China at a steep 34 percent, Hong Kong offers collectors the advantage of more relaxed sales tax and export policies. Organizers of ART HK are aggressively promoting the incredible tax advantages, since there are no tariffs on the import or export of art as it relates to the initial sale at ART HK.

A newfound interest in art as an asset class has also prompted growth in the Chinese art market. The affluent in China have begun to invest in art as an asset, traditionally viewed as a Western luxury. Observers note that the proliferation of art in China is the steady result of a rise in investment-oriented purchases of art, bolstered by China’s growing wealth, and not merely spontaneous overnight purchases. In response to this, at least three Chinese financial institutions have set up hedge funds investing in Chinese art. Notably there have been a succession of Chinese clients who have been spending millions of yuan recently at New York auctions.

National identity and pride is showing itself to be another significant factor behind the surge of Chinese interest in the art world. Such national pride is evident by a report released by Artprice.com on March 19, 2011 showing that 2010 is the first year that four Chinese artists (Fu Baishi, Qi Baishi, Xu Beihong, and Zhang Daqian) have ranked in the top ten of global art auction earners.

In China, the impact of art fair culture through ART HK is no different than in other emerging markets. Art Basel is itself is a pioneer for developing new markets. In fact, in 2002, the decision to open Art Basel Miami Beach in the U.S. was partly to explore the emerging Latin American market. A roaring success – Art Basel Miami provides a new platform for emerging dealers, contemporary artists, new collectors and the art world cognoscenti.

Popularity of the Chinese market for the international art community during ART HK has clearly prompted auction houses to be active. For example, Christie’s has a partnership with ART HK to hold its spring auctions in the same venue and at the same time as ART HK with sales of art, antiques, wines, watches and jewels. Other auction houses, particularly smaller Asian ones, are similarly following suit with auction sales planned at hotels around town during ART HK.

On May 23, 2011, ART HK and ArtTactic even announced in two art market reports (China Contemporary Art Market Report 2011 and US & Europe Contemporary Art Market Report 2011) that confidence in the Chinese contemporary art market greatly exceeds confidence in its US and European counterparts. In fact, the reports claim that 75% of art industry experts indicate that the Chinese market will continue to grow over the next six months, compared to only 36% of art experts indicating growth in the US and European contemporary art markets.

Hong Kong offers a range of comforts for those doing business in the Hong Kong art market. In addition to the tremendous tax advantages in the importation or exportation of art in Hong Kong, doing business in Hong Kong is made easier by the fact that English is commonly spoken and that Hong Kong adheres to international standards of business law, with a great degree of transparency in transactions. Moreover, in contrast to Shanghai or Beijing, the logistics of obtaining shipments in and out of Hong Kong do not typically involve lengthy turnaround times.

When exporting artwork from Hong Kong, buyers must ensure to complete and submit an export declaration in Hong Kong, as well as an import declaration in the destination country, where import duties and taxes are typically chargeable in the destination country. Where the buyer is shipping the artwork to the same country that the seller originally exported it to Hong Kong from, it may be possible for the buyer to avoid payment of import customs duty in the destination country under a "returned goods relief" procedure, as long as the seller can provide the buyer with the relevant proof of original export.

There are many factors contributing to the strength of China's position in the international art market, including its beneficial tax considerations, remarkable auction revenue, a newfound interest in art within China as either an investment or because of national identity and a global interest in contemporary Chinese artists. With offices in Shanghai and Beijing, these are issues encountered frequently here at Sheppard Mullin. Overall the future of the Chinese art world looks optimistic, and it is clear that the impact of the art fair culture, especially vis-à-vis ART HK, has a crucial role to play in this continued growth.

This article was originally posted on Sheppard Mullin's Art Law Gallery blog, which can be found at www.artlawgallery.com.