Silicon Valley Legal Bible（10）The history of the demise of Chinese probable equity market

In March 2022, the value of Chinese stocks on the American Stock Exchange began to plummet, and the market values of Tencent, Ali, and Meituan reached 6 trillion, 5.4 trillion, and 2.3 trillion yuan at their peaks, but within a few days, by the close of the market on March 21, 2022, the market values of these three companies had fallen by 51.7%, 67.6%, and 68.3%, respectively. Pinduoduo's share price also fell from a once-record high of $212.6 to close at $39.37/ADS, instantly evaporating 80% of its market value.

After less than half a year, on August 12, 2022, China's five largest state-owned enterprises, including PetroChina, Sinopec, Aluminum Corporation of China, China Life, and Shanghai Petrochemical, issued separate announcements that they had applied for voluntary delisting from the New York Stock Exchange, which caused a great deal of shock on social media. Everyone knows that Chinese stocks are not working! So what exactly is a Chinese stock? Why did Chinese stocks plummet collectively in such a short period of time? Is the future of Chinese stocks in the United States still save? How can Chinese entrepreneurs avoid becoming Chinese stocks?

Today we will talk about the story of "Chinese stocks".

1.What is a "Chinese stock"?

To understand how to build the structure of "non-Chinese stocks", we first need to understand what is a Chinese stock.

Let's first understand the concept of the stock, the concept of the stock refers to a special connotation of the stock, such as financial stocks, real estate stocks, brokerage stocks, Olympic theme stocks, asset reorganization stocks and so on are called the concept of the stock. Conceptual stocks are generally on the stock where the industry business performance growth in advance of speculation.

China concept stocks, on the other hand, is a collective term for all overseas-listed Chinese stocks because foreign investors are optimistic about China's economic growth. Generally speaking, China concept stocks are stocks of Chinese-incorporated companies that are listed abroad, or companies that are incorporated abroad but have their business and relations in the mainland. Since China concept stocks are relative to overseas markets, China stocks may be listed in foreign countries, or they may be listed in both China and foreign countries.

So how do you differentiate between Chinese stocks? First of all, I listed some of the Chinese companies here, we can see, through Google search to Sohu, Tencent, Beili, and Alibaba, four Chinese companies, the stock, in the company name after the word "ADR". In fact, in the U.S. listed Chinese companies, trading is not the company's shares, but ADR, and ADR is an important symbol to distinguish whether it is a Chinese company.

So, what is ADR? ADR's full name is American Depositary Receipts (ADR), which in Chinese is American Depository Receipts (ADR), a kind of transferable securities issued by U.S. commercial banks to assist foreign securities to be traded in the United States. Since the securities not issued in the United States can not be traded on the U.S. stock exchange, so the shares of foreign companies can not be directly listed and traded in the U.S., Chinese companies want to be listed in the U.S., is through the ADR in the U.S. listing. The method of listing can be shown in a chart here, that is, the U.S. financial institutions first buy the shares of Chinese companies ready to be listed in the U.S., and then through this organization to issue a representative of the shares of the depository receipts, that is, ADRs, so the U.S. investors are not really buying the shares, but the depository receipts.

2,"Why are Chinese stocks failing?

How big is the impact of the collective collapse of Chinese stocks? From March to July 2022, less than half a year, nine batches of pre-delisting list, nearly 200 Chinese companies on the list.

Batch 1: on March 8, the U.S. SEC under the Foreign Corporation Accountability Act (HFCAA) announced the first batch of five issuers at risk of delisting provisional list, for the will be Baizi Shenzhou, Yum China, then Ding pharmaceuticals, Shengmei Semiconductor, and Hutchison Pharmaceuticals.

Batch 2: On March 23, the Securities and Exchange Commission (SEC) added Weibo Inc. to its "Pre-Delisting List," making it the sixth company on the list that could be at risk of delisting. Weibo needs to provide evidence to the SEC by April 13 that it is not eligible for delisting. If it fails to do so, it will be placed on a "definitive delisting list".

Batch 3: On March 30, the SEC added Baidu, Futou Holdings, Aqiyi, Kaixin Yuanda Pharmaceuticals, and Nocera, a company engaged in fisheries farming, to its "pre-delisting list. According to the SEC, these five companies need to provide evidence to the SEC by April 20 to prove that they do not have the conditions to be delisted.


Batch 4: On April 13, the U.S. Securities and Exchange Commission (SEC) added 12 Chinese companies to the "pre-delisting" list, which is the fourth batch of Chinese companies to be included in the list since March. The list includes Microvast, China Automotive Systems, Dah Sing Energy, Conrad Bio, Financial One, Green Map Biotechnology, Legend Bio, Sohu, Melco, Melco Burson-Marsteller, Logiq and Noah Holdings.

Batch 5: On April 21, the U.S. Securities and Exchange Commission (SEC) put 17 Chinese companies on the "pre-delisting" list, including Zhihu, Ideal Motors and Shell, and five Chinese companies, including Futura Holdings, Nocera, Aqiyi, Baidu and Kaixin Yuanda Pharmaceuticals, moved from the "pre-delisting" list to the "pre-delisting" list. Nocera, LoveQiYi, Baidu and Kaixin Yuanda Pharmaceuticals are five mid-cap companies that have moved from the "Pre-Delisting List" to the "Definitive Delisting List. The deadline for these 17 companies to submit their comments is May 3, local time.

Batch 6: On May 4, the U.S. Securities and Exchange Commission (SEC) placed 88 companies on the Holding Foreign Companies Accountable Act (HFCAA) tentative list. Jingdong, Beili Beili, Pinduoduo, Tencent Music Group, Kexing Bio, Huazhou Group, Azure, China Southern Airlines, China Eastern Airlines, and a number of other well-known companies were included.

Batch 7: On May 9, the U.S. Securities and Exchange Commission (SEC) expanded the list of "pre-delisted" Chinese stocks. This time, the 11 companies included in the "pre-delisted" list are: Xinxiang, Antelope Enterprises, Ai Click, Lujinshi Holdings, Kuko Music, Lanting Jisi, Dingtong Grocery, Kingsoft Cloud, DDT, Qitoujiao, and 51Talk, which brings the list of "pre-delisted" Chinese stocks to 139 companies.

Batch 8: May 20, the U.S. Securities and Exchange Commission (SEC) updated the eighth batch of "pre-delisting" list, this list added eight new Chinese companies. The list of the eight Chinese stocks, including Temple Bank, the magic line, Ruishi education, medical international, Eurofins, Blue Flood, China's natural resources, Greenhotel. Together with Plastec Technologies, Ltd., which was added to the list on May 13, a total of 148 companies have been put on the "pre-delisting" list, of which 40 have been put on the "definite delisting list".

Batch 9: On July 30, Alibaba was placed on the "Pre-Delisting" list by the U.S. Securities and Exchange Commission (SEC). In addition to Alibaba, other companies on the list include Mushroom Street, Bocci Pets and Cheetah Mobile.

Why did the Chinese stocks fall collectively in such a short period of time? In fact, the core of this event lies in the game between China and the United States on the issue of audit transcripts of listed companies.

According to the Foreign Corporation Accountability Act enacted by the United States in 2020, the US Securities and Exchange Commission can remove foreign companies from the US stock exchange if they do not comply with US auditing standards for three consecutive years. Back on May 4, the SEC announced that it had placed more than 80 Chinese companies on a pre-delisting list and ordered that they must submit evidence of meeting the conditions for being listed companies, also known as audit drafts, by May 25th. Chinese companies that were unable to provide audit drafts were to face delisting from the U.S. stock exchanges.

The following month, on August 12, 2022, China's five largest state-owned enterprises (SOEs), including PetroChina, Sinopec, Alcoa, China Life, and Shanghai Petrochemical, each announced that they were applying for voluntary delisting from the NYSE.

We don't get it. Don't we need the audit trail? Just give it to him! The key is not to get it! Why? Because it's impossible to read the audit reports of Chinese companies!
What? Yeah, right. Remember the fall of Ruixing Coffee? The first person to come to buy coffee order number 001, in the next person to come to buy coffee order number 006, jumping orders to fill the number, financial fraud, rocket listing. These play all the Chinese stock companies are doing, just Rising did a little too much.

You heard right, Sino-US relations soaring 20 years, Chinese companies in the United States to Cayman Viking VIE structure, through the depository voucher ADR way of listing are listed with water listing. Before the U.S.-China relations are good, the international community is optimistic about the Chinese stock companies, that this kind of listing with water even if they come to the U.S. stock exchange, but drive the "rich" Chinese investment in the U.S. For the United States in general, the benefits outweigh the drawbacks. So turn a blind eye, the equivalent of the city of the U.S. Securities and Exchange Commission to the Chinese stock to leave a gap. In 2020, the United States passed the Foreign Corporate Accountability Act, which provides that the company must disclose the audit report to the U.S. Securities and Exchange Commission, within three years of non-compliance with the provisions of the U.S. must be delisted from the U.S. That is to say, the U.S. Securities and Exchange Commission now does not want to give the Chinese stocks to leave a gap to let these false listing of the company must comply with the requirements of the real listings. So a large number of Chinese companies face the risk of delisting.

3. How can you not count mid-cap stocks?

Just when everyone knew that the Chinese stocks were cool, everyone's eyes were focused on the founder of Zoom - Yuan Zheng. The same black eyes, black hair, yellow skin, and the first generation of Chinese new immigrants, Yuan Zheng's company has not been recognized as a Chinese stock, and since its listing in 2019, it has never been found to be in trouble by the U.S. Securities and Exchange Commission because of its "Chinese genes", and this time the Chinese stock market is cold, but it is not at all.

Through Google search Zoom Stock, we can see that there is no "ADR" after Zoom's company name, which means that Zoom is traded in the United States through the issuance of shares rather than ADR depositary receipts. Therefore, Zoom is not a mid-cap company.

So why isn't Zoom considered a Chinese stock? How can Chinese entrepreneurs avoid being recognized as a "mid-cap"?

Eric S. Yuan, a native of Tai'an, Shandong Province, graduated from Shandong University of Science and Technology, received his master's degree from China University of Mining and Technology, and then went on to get his MBA from Stanford in the U.S. This is the proper path for a Chinese techie to study in the United States.

Let's take a look at Zoom's office map. As you can see, Zoom has offices all over the world, including Shanghai, Suzhou, Hangzhou and Hefei.

And of Zoom's 690 non-U.S. employees, more than 500 are from China.

So we are wondering, Yuan Zheng, a native Chinese, is in Cao and his heart is in Han, although he wears foreign clothes, my heart is still Chinese. Why would his company not be recognized as a Chinese stock?

The reason lies in the way Zoom's global structure is built.Zoom has four subsidiaries in China, of which three subsidiaries in Hangzhou, Suzhou and Hefei are 100% owned directly by the U.S. parent company, while the Shanghai subsidiary, Softvision (Shanghai) Software Co. ) Limited is 100% owned by a Hong Kong company called Zoom Video Communications (Hong Kong) Limited. All four subsidiaries are wholly foreign-owned enterprises, and the legal representative of the three subsidiaries in Hangzhou, Suzhou and Hefei is Yuan Zheng, the founder of Zoom.

In fact, Hong Kong, Shanghai, Suzhou, Hangzhou and Hefei are not the main focus of this structure. Although these companies are subsidiaries of Zoom USA, it is not a big problem even if they are not subsidiaries because their only purpose of existence is to transfer R&D and technology work to areas with relatively cheap labor to gain a cost advantage in order to achieve labor market arbitrage. In fact the only thing necessary in this structure is Zoom's U.S. body. Even the absence of Hong Kong, Shanghai, Suzhou, Hangzhou and Hefei branches does not affect Zoom's non-Chinese stock positioning. Just as Google recruited a bunch of overseas engineers in India is the same reason, whether Google set up a local subsidiary, or set up a separate parallel company, or not set up any company through a local human resources company to do third-party labor dispatch, the effect is not much difference.

Some people say that this Hong Kong is how, this Hong Kong is between Hong Kong and the inland tax incentives, and the SEC side of things have nothing to do, we do not start talking about it today.

So Zoom structure is a purely American company, with a blonde American company established by the United States does not have any difference, as for the following in the end in how many places to establish R & D centers to recruit talent, that is the tentacles, the real core, the mind is still in the United States. That is to say, the majority of Chinese entrepreneurs in the United States want to make up for lying in the stock gun, as long as the structure of Zoom honestly according to build again on the line.

So in contrast, these have collapsed in the general stocks, with what kind of structure? That is the VIE structure that has been popular for more than 20 years, but now has fallen from the altar. In the next installment, we will take a detailed look at the development of the VIE structure.

The Silicon Valley Legal Bible with Forty-Two Chapters, a customized legal encyclopedia for founders. I'm Xiaoxiao Liu, a U.S. attorney.