On Monday, I wrote about an apparent new policy at several offices of the Administration of Industry and Commerce (AIC), which among other things is China’s corporate registry. Legal and financial due diligence relies heavily, sometimes solely, on documents filed with AIC by local companies. I was responding to a China Finance blog post by Fredrik Oqvist, who was in turn relying on an IFLR article written by Lucy McNulty. I noted at the time that I wasn’t able to confirm the rule changes and actually hoped that this was not a widespread phenomenon.
Unfortunately, it looks like this is not an isolated thing, as the media has confirmed. In addition to some other news out there, Dinny McMahon has two articles (this one is open to everyone; this one is behind the paywall) on the subject in the Wall Street Journal.
My previous post on this topic explained why this rule change is potentially important, but I do have a few other comments. First, and sorry to keep harping on this point of terminology, but it’s important to understand the difference between the AIC and SAIC.
This is from one of the WSJ articles:
A Chinese government agency that compiles extensive Chinese corporate records has begun to withhold information that includes financial reports, shareholder changes and assets transfers, according to lawyers, investors and research companies. The State Administration of Industry and Commerce declined to say whether it had moved to limit what it once made public, but the Beijing-branch of the agency said some lawyers in the past had abused the availability of data by selling it.
As I said on Monday, the SAIC is the State-level agency, which has a very broad portfolio. The local AIC offices are the ones that are involved here. Not only do the local AICs act as company regulators and inspectors, but the AICs are also the offices where these documents are deposited and various approvals are issued. All the action happens at street level, at the AICs, not the SAIC.
Now it’s quite possible that this rule change has been instituted from on high (i.e. the SAIC), but apparently it has not filtered down to all the local AICs yet. I’m not surprised that the SAIC refused to talk to the WSJ about it, yet the Beijing AIC did comment on the issue. In the past, document access policies varied from office to office, and it sounds like that might still be the case, at least for a while.
Regardless, when discussing these records, they really should be referred to as “AIC files” without that extra “S” in the front, which would suggest some sort of national records systems, which it isn’t.
Second, it does appear that the push for restricting access has something to do with information “abuse,” which might mean research firms and short sellers. These folks really embarrassed some large and powerful U.S.-listed Chinese companies and, more important, dragged down the prices of pretty much all the other Chinese companies. This made China look bad and even made parts of the government, including the China Securities and Regulatory Commission, look ineffective, even though the CSRC had no specific jurisdiction over those enterprises.
Third, according to the WSJ, the AIC access restrictions dovetail with changes to other means of data collection:
[A] number of firms that investigate Chinese companies on behalf of investors say a broader police crackdown on consumer information has hindered their ability to gather important data.
[ . . . ]
Until recently China has been a sieve of private data with information on vehicle registration, household residency, phone records and even bank account details available to those who knew who to call. Research companies say that such information has become all but impossible to access since April 20, when the Public Security Bureau launched a nationwide campaign against investigations companies.
To be fair, there’s a big difference between AIC files and some of this other information. Until the rule change, AIC documents were generally available to licensed attorneys; there was no question that this information was obtained legally. In contrast, a lot of the data collected by investigation firms, many of which are run by ex-cops, is not publicly available. Some of these guys pay money to ex-colleagues for information that is supposed to be secret. I’ve had foreign clients that rely on this data, and unfortunately they intentionally look the other way on the issue of whether the information was legally obtained by the investigator (this has always bothered me). The PSB crackdown on this sort of thing is long overdue, and referring to this as an “abuse” sounds fair to me.
Fourth, the WSJ notes that the information you could access in an AIC file pre-rule change was actually much more extensive than one could get for closely-held companies in many countries. This is true, but sort of misleading if you don’t bother to read through the entire piece.
AIC files are a grab bag of stuff. Some document filings are mandatory, others optional, and many enterprises don’t always follow the rules (there are no penalties for failure to file most documents). Moreover, as the late Dr. House was fond of saying, everyone lies. So while a company’s AIC file might turn out to contain that one bit of crucial information you need to pull the trigger on a deal, it might also be a huge pile of garbage.
There are reasons why developed countries do not require private countries to file so many documents with company registries or go through annual inspections. For one thing, many countries have sophisticated credit reporting systems, making it easy to check on the solvency of that potential business partner. Additionally, many nations’ local or central governments collect and make available information on consumer complaints.
And of course there’s litigation. As the WSJ points out:
In Western countries, if something goes wrong with a deal or an investment or a joint venture, the parties involved can turn to a fair and transparent legal system that can force the handing over of internal documents. In China, courts are seldom sympathetic to foreigners and their decisions are heavily influenced by local political and economic considerations. Investors here long ago learnt that it is necessary to do extensive due diligence in advance of any deal to avoid being stuck with a nasty surprise in the future.
That is certainly true for Common Law countries. Not only does this mean that you may not need to perform such thorough due diligence at the outset, but also that if something goes wrong, you do not have to rely on the very small number of documents already in your hands to litigate. Just as an example, I’ve been involved in numerous trade disputes where the plaintiff’s evidence consisted of nothing more than a few emails. Without discovery, those AIC documents can be very important!
By the way, I strongly disagree with the WSJ’s characterization of the Chinese legal system as being “seldom sympathetic to foreigners.” Yes, local protectionism occurs here, but foreigners get a pretty fair shake in Chinese courts much of the time, and at least the vast majority of the commercial disputes I’ve seen personally have not been influenced by “local political and economic considerations.” Some folks like to extrapolate from famous cases where politics and/or local protectionism was evident, but it’s not fair to smear the entire system of commercial litigation with that broad brush.
Fifth, while this new rule change may be designed to shut the door on research firms and short sellers, it may end up doing a lot more. As I mentioned on Monday, AIC files are useful for M&As, licensing, supply agreements, and many other kinds of commercial deals. Some parties will be hurt more than others. If I’m doing an M&A or Joint Venture, for example, I know that I can ask the other party for consent to access their AIC file; if they refuse, the deal is off. For other kinds of deals, though, such as a small supply agreement, it might be problematic to obtain consent. This is just one more thing that will have to be negotiated and could end up being an irritant between the parties to a deal.
And needless to say, if that other party you need information on is an adversary (e.g. a competitor, or IP infringer), you’re out of luck.
Last but not least, the big picture. After what happened with the short sellers, the government has decided that less information is better. As someone who never has enough information to advise my clients appropriately, I’m biased. But I honestly believe that more information is the answer. If short sellers or researchers throw unsubstantiated charges out there, these are best dealt by interested parties with access to relevant information that can be used to either verify or rebut those claims.