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23 June 2014 By Richard Beales

Alibaba’s coming U.S. 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 U.S. congressional commission. Lack of clarity in PRC law is mainly to blame.

The U.S.-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 U.S. 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 percent 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 U.S. 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 U.S. 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 U.S. report is a reminder that there are risks both in the uncertainty of Chinese legal arrangements and in the certainty that U.S. law has extraterritorial reach. Investors shouldn’t forget that Alibaba is a case study in the gulf between the two legal systems.



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