Chinese Law Professor has an excellent post, entitled, “Who Owns The Chinese Internet,” seeking to answer that very question. The post is in reference to this article [in Chinese] by Jing Linbo and Wang Xuefeng from the Chinese Academy of Social Sciences, asserting “(a) that foreigners (“foreign capital”) in the article’s terminology) have come to control the Chinese Internet, and (b) that this is a bad thing.”
Chinese Law Professor analyses whether or not foreigners do control China’s Internet and he concludes they do not. In fact, he persuasively argues that many of the Variable Interest Entities (VIEs) to which the Linbo/Xuefeng article cites, are actually controlled by Chinese, not foreigners:
- Take Baidu (the Cayman Islands company listed on the NYSE), for example. 52% of the voting power is owned by Robin Li, either directly or through a BVI company he owns and controls. Another 16% is owned by his wife. Except for a Scottish partnership that holds 2.49%, the rest of the voting power appears to be widely held. In other words, foreign capital is helping out Robin Li, but exercises no control. Robin Li, to the best of my knowledge a patriotic citizen of China, controls the offshore company and the money.
- Sina.com presents a third model. The president and CEO, Charles Chao, is of PRC origin. (I don’t know if he is still a citizen.) He appears to be the largest single shareholder, controlling over 8.66% of voting rights. Only one other shareholder holds more than 5% of the voting rights. In other words, the shareholding is largely dispersed and there is no controlling shareholder. Since Jing and Wang admit in their 2009 article that Sina.com has no controlling shareholder, how then can they claim at the same time (as they do) that the company is “controlled by international capital”? They state that ownership of more than 50% of the shares constitutes absolute control, but this means that some unified will – a single person or a unified group – has to control all those shares. In grammatical terms, the subject of the verb “to own” has to be an entity capable of thinking and expressing a will. “International capital” is not a person with a unified will. The authors appear to believe that in a 10,000,000-share company, if 5,000,001 foreigners each own one share, that is “foreign control” just as much as if one foreigner holds 5,000,001 shares. It is not. One can always identify a group of random and unconnected shareholders in any company whose holdings add up to more than 50%; that does that mean that they control the company. When a company has no controlling shareholder, who does control it? The answer is: management. And in the case of Sina.com, management appears to be predominantly in the hands of Chinese nationals.
- Dangdang presents another model of control. In this case, the Chinese entrepreneurs – Li Guoqing and Peggy Yu – don’t have absolute, majority control. They do, however, control more than 45% of the company’s voting power and occupy the top management and board positions. This doesn’t look very much like control by foreign capital.
To which I say so what? To me the big question is not who owns China’s Internet? I know the answer to that and if you define it by who actually controls the content or who actually has final say over the overwhelming bulk of Internet companies, it is the Chinese. I mean, come on. Chinese law effectively precludes foreign involvement and though there are foreign companies involved in China’s Internet through VIEs and other patchwork solutions, those companies are always going to be at least somewhat beholden to their Chinese “partners.”
The better question is who is perceived in China, by Chinese, to “own” China’s Internet?
if the perception in China becomes that foreigners control China’s Internet, that perception will lead to repercussions for those entities that are perceived to be foreign and perceived to control China’s Internet. Or as the China Accounting Blog put it in its post, “Communist Party School on VIEs:”
We have already seen regulatory challenges to VIEs, leading to Yahoo losing its interest in Alipay, and alleged theft of a VIE. Now we can add political risk. I think it is time to again ask the question whether VIEs are a going concern. I started this series suggesting that the VIE could be compared to the fable of the Emperor’s new suit – not really doing what people are told they do. My recommendations to clean up this sector remain valid.
The China Real Time Report blog of the Wall Street Journal has picked up this story. There is also a good analysis of it at China Finance Blog. An interesting read on the legal theories at play here was posted by Professor Clarke at the Chinese Law Prof Blog. I like his conclusion: “I think we all agree that these structures are OK until they are not OK.” Are we there yet?
China Finance blog is more blunt. In its post, “China IT Just Got Even Riskier,’ it starts out noting that the Linbo/Xuefeng article has deemed China’s Internet to already be controlled by foreigners and that this does not bode well:
The piece doesn’t just brand the obviously foreign companies as being controlled by foreign capital, but includes almost every Chinese internet company in this group. As such the risk of increased scrutiny of VIE structures (explained at lengths in the article), and any dealings between foreign and domestic players in the sensitive IT market has gone up significantly.
China Finance Blog then goes on to note that no matter how accurate the article is or is not regarding foreign control of China’s Internet, the “bigger picture” is what is going to matter:
Although I think the report misses the mark on some issues, the details are unlikely to matter too much, the bigger picture will sell it.
One of my disagreements with the article lies for instance in that the Alipay case to some extent demonstrates the power that VIE structures can give the Chinese government over the IT-companies, rather than highlight the dangers of foreign investment.
That this issue is being discussed in this detail, at this level, at this point in time, should give everyone reason to take this quite seriously, indeed.
The last time I wrote on VIEs, Paul Gillis of the China Accounting Blog left the following comment:
What about all the lawyers who have given clean opinions to the use of these structures for the past decade?
What about all those lawyers? Don’t cry for them. Any lawyer worth his or her salt that was involved in a VIE structure wrote a lengthy CYA letter making crystal clear that VIEs were risky, that the whole purpose of VIEs is to usurp/circumvent Chinese law, that Chinese law is itself risky, and that nobody really knows what will happen to VIEs or for how long they will be allowed to exist.
China Hearsay spoke to this as well, in its post, “Gray Areas in China Law: A Vote For Legal Realism:”
I think what this comes down to is that Dan Harris and I are looking at this [VIE structures] as practitioners. If a client wants to do a deal in a restricted area by setting up a structure that has never been shut down by the government in 25 years, I still can’t tell that client that this is a “gray area.” I just can’t do it as a lawyer, for basic liability reasons.
What I can say is that it is technically illegal, and then explain the history of enforcement (or lack thereof). If the client then wants to proceed, then (in some cases), I will stay on board and help facilitate the transaction (in some cases, I will beg off).
I think I might add something along the following lines: VIES. They were risky yesterday and they are even riskier today. They are okay right now and will be okay until they are deemed not okay. I have no idea when or if that will ever happen, nor does anyone else, but hey, you are big boys and it’s your money, so you make the call.
What do you think?