Opinion: Roadblocks to corporate due diligence
November 15, 2013 | BY
clpstaff &clp articles &Company records were once easy to access in China, but a series of high-profile scandals in 2012 have caused a clampdown. John Kuzmik and Xu Changrong look at how the SAIC has to strike a balance between privacy and legitimate public access to corporate records
Everyone has heard stories about the difficulties of performing transactional due diligence in the face of unscrupulous individuals and companies in China bent on hiding information relevant to the transaction. To hear the tales, one might conclude that every transaction party in China keeps two sets of books, hides real ownership interests and obfuscates liabilities. To be sure, the process of due diligence can be a challenging one even in an advanced commercial jurisdiction and in China there are many cultural, legal and systemic barriers to transparency. Still, the horrific reports of transactional fraud in China may be obscuring an evolving issue that since 2012 has had an impact on nearly every corporate transaction in China.
Since that time, corporate records that are maintained by the State Administration for Industry and Commerce (SAIC) have been closed to the public. Consequently, without a court order, even lawyers are unable to view, let alone copy, a Chinese company's basic information.
Previously, the SAIC archives had been open to Chinese lawyers (and often, in some locations, to anyone willing to ask). Even then, the quality of records maintained by the SAIC have been a subject of concern; many of the SAIC`s records are incomplete or out of date because of lapses in enforcement which have unwittingly or not provided wrongdoers with opportunities to commit fraudulent activities. Nevertheless, access to SAIC records has long provided a refreshingly transparent glimpse into Chinese companies.
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The clampdown
The fact that access to corporate records provided easy fodder to the overly curious is perhaps the root cause of the new, strict information clampdown. Some draw a straight line to the national embarrassment caused by short-sellers like Muddy Waters, which outed fraudulent and financial problems at Orient Paper and Sino-forest, both overseas-listed Chinese companies. Others point to well-researched news articles in Reuters and the New York Times which embarrassed some of China’s most powerful families.
According to sources within the SAIC, whatever its root cause the change does not arise from new rules, regulations or laws. Rather the SAIC and its local bureaus are now taking a strict view of the Measures for Consulting Enterprise Registration Files (企业登记档案查询办法) (published by SAIC in 1996 and amended in 2003) to protect commercial secrets and privacy. Specifically, Articles 5 and 6 of the Measures only give lawyers holding court orders access to hard copies of enterprise registration files. However, even such an interpretation does not explain why public access is denied to certain company information critical to the whole notion of a public corporate franchise. Under Article 6 of the Measures, a company’s articles of association, shareholders’ ID certificates, and other critical information are explicitly open to “each organisation and individualâ€.
At least for now, without court orders, there is no legitimate way to access corporate records in China. Unfortunately, this does not mean that access denied drives away either those who need the information or those with a determined curiosity. In effect, the SAIC has ensured that access to legitimate information is now available only to those willing to use connections or bribes to get it. No matter how you look at it, the unintended consequences of the SAIC’s reinterpretation of the Measures lead to the potential of greater social harm.
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Undisclosed
Needless to say, SAIC records even when available do not always tell the whole story. Those determined to deceive can always beat the system. One critical issue to be addressed by the SAIC is that of beneficial ownership. Many companies in China, both private ones and those ostensibly state-owned, have undisclosed beneficial owners or controlling parties created under contract or informal arrangements which are not required to be registered with the SAIC or any other government agency. In these cases, even public access to full corporate records maintained by the SAIC will not give context to contractual or informal ownership and control structures. Business transactions aside, rule-based transparency of ownership and control would go a long way to combat certain fraudulent activities and financial crimes.
The SAIC is said to be looking at ways to improve the Measures. Finding a balance between privacy and legitimate public access to corporate records has got to be the first step. Here, the SAIC can draw upon both its own experience and the vast number of corporate registries around the world that maintain open, transparent records. We would also expect the revision process to address both the quality of corporate records maintained by the SAIC, and specifically new rules to deal with the increasingly pernicious problems arising from undisclosed beneficial ownership. Until the revision process is completed in a positive way, transaction parties and their lawyers in China will have few legitimate options to gather even basic data about corporate counterparties.
John Kuzmik, Independent, Hong Kong and Xu Changrong, Zhong Lun Law Firm, Beijing
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