Jiayuan.com is by all accounts an entirely above-board Chinese company. Its purportedly Chinas largest online dating platform, and it raised $78 million in a Nasdaq listing ticker symbol: DATE in May. It boasts a famous brand name, a smart founder and a plausible business model. Yet even for this company, where there is not a whiff of any misdeed, the prospectus still included some red flags beyond the standard developing-country disclaimers about uncertain rule of law and the like.
Consider what seems to have been some questionable lawyering surrounding Jiayuan.com’s corporate structure and brand. Because foreign investment is technically forbidden in the Internet services sector, Jiayuan.com created a ‘variable-interest entity,’ or VIE─a common feature of many Chinese listings.
Under this structure, the operating part of the company and the overseas listed part technically are two completely separate entities. The Chinese-owned part signs a series of contracts with the listed entity to transfer revenues in a way that allows the books of the two companies to be consolidated under U.S. accounting rules. It’s a risky structure since the foreign shareholders don’t actually own the Chinese company.
But Jiayuan.com also disclosed several important risks beyond its VIE structure. A big one involved the company’s compliance with regulations for offshore companies. A rule issued in 2006 requires Chinese residents to register with the State Administration of Foreign Exchange (SAFE) before setting up offshore companies. Jiayuan’s prospectus said its founders failed to do this when they created the offshore entities used in the VIE structure.
When the company attempted to rectify this problem prior to the IPO, SAFE wouldn’t let it. This very nearly cost the company its business license, until some last-minute wrangling shifted control of the Beijing-based portions of the VIE structure to a separate Jiayuan entity based in Shanghai, which was not being challenged on its SAFE registrations. But this wasn’t a definitive solution. Jiayuan says it has now completed the required registrations, but the question remains: Why was the IPO brought to market before this potentially fatal problem was resolved?
In its pitch to investors, Jiayuan also noted that its brand name and logo, Shiji Jiayuan, is the most well-known and trusted online dating brand in China. If only the company owned it. The prospectus disclosed that the company had not obtained a trademark registration for the brand when they started using it in 2003.
When executives got around to applying in 2007, they discovered someone had already registered the brand in 2005. (The identity of this registrant is not disclosed, but it could well be a ‘trademark troll’ who hoped to sell Jiayuan its own brand identity back.) The company is fighting that 2005 trademark, but China’s legal system still is new to this kind of case and the outcome is uncertain. One must question whether this and other, smaller, trademark problems should have been cleaned up long before the IPO.
Remember, other than these fully disclosed risks, Jiayuan appears to be exactly what it says it is─a profitable operator of a big dating site. Nor are such potential problems unusual. SEC filings of U.S.-listed Chinese companies are filled with similar oddities.
So this case study raises the question of the role of Western market professionals in all this. Up to now, the only legal requirement for underwriters, lawyers and accountants has been to disclose the relevant risks. But should uncertainties of sufficient magnitude stop an offering completely?
They probably should. Right now, auditors are required to assess whether a company is likely to continue as a going concern, but they tend to focus only on financial strength rather than sustainability. The approach of the lawyers and underwriters is to ‘adequately’ disclose the risks and let investors hope for the best.
But the basic purpose of an audit is to give investors firm insight about the financial position, and thus the viability, of a company. It’s time to include a holistic assessment of the actual severity of the risks disclosed in the prospectus. In Jiayuan.com’s case, such an assessment might have noted the serious legal threats to the company’s continued existence despite its profitability.
The Public Company Accounting Oversight Board (PCAOB) is contemplating a rule that would facilitate this kind of assessment by giving auditors greater scope to look at the risks facing a company as a whole. Such a rule would be important regulatory progress from the perspective of policing Chinese listings. The question people are asking right now is ‘Are they frauds?’ The question should be, ‘Are they fit to list at all?’
Very good example showing cultures tend to be separated from each other due to institutional reasons and deep down the ICE reasons. While a honest firm in China may not even fit to be listed in US