ChiNext and the Small and Medium-sized Enterprise Board have given many law firms their first experience of the securities market. But could stiff competition and high professional standards put an end to their dreams of dancing breezily through this market? By Raymond Yang
Securities lawyers have grown in both number and ability with the growth of China’s capital markets. But companies that are planning to list need to understand more of the role securities lawyers play in IPOs and other securities-related business. What should a good securities lawyer bring to the table?
Many people view being a securities lawyer as a licence to print money. The fees such lawyers charge are certainly at the top end of the range of lawyers’ fees. But how transparent are their fee structures, and how much do they really cost? When a company hires legal counsel for a listing, how can they ensure that the legal fees incurred remain reasonable?
Who controls in a troika?
The sponsor, accounting firm and law firm providing intermediary services for the listing of a company are called a “troika”. In China’s capital markets, the sponsor is undoubtedly the leader of this troika, while the financial audit work of the accounting firm is clearly also indispensable. Of the three, could the law firm be the one that is marginalized and in an awkward position?
Lawyers say there are two major reasons why the sponsor has obtained its leading position. According to Zhang Liguo, a partner at Grandfield Law Offices, “on the one hand this is because of the requirements of the China Securities Regulatory Commission”. From 1 February 2004 the CSRC began to implement a sponsor-based system, whereby a company wishing to offer and list its stock publicly must be recommended by a qualified sponsor. “On the other hand it is the result of the inconsistent standard of law firms and lawyers,” adds Zhang.
An investment bank once told Zhang privately that “some law firms have to rely on the help of the investment bank to write the lawyers’ work report”. This clearly falls short of the required standard. In Zhang’s view, in a listing, the sponsor should play a coordinating role, but the core financial and legal work should be done by the accountants and lawyers. What’s more, lawyers of the requisite standard “should certainly be better than the sponsor in terms of professional judgment and their handling of the legal issues”.
So, what legal services can lawyers provide to companies in relation to securities work? According to the Law Firms Engaged in the Business of Securities Law Administrative Measures, jointly issued by CSRC and the Ministry of Justice, the major legal services include handling initial public offerings and listings; the refinancing, merger, acquisition and equity incentives of listed companies; issues of securities and listings overseas; securities investment funds; and derivative products. Securities lawyers may also advise on the pre-IPO restructuring and reorganization (including private placements) of companies, as well as the governance of listed companies and the continued disclosure by them of necessary information.
In no way does the CSRC underestimate the role of lawyers. Gao Xiqing, who served as CSRC’s vice-chairman and who is now general manager of China International Investment, previously worked in a law firm on Wall Street. He has a high opinion of legal practices in the US capital markets, believes that lawyers are usually more intelligent than other professionals, and hopes that they will come to lead the entire team of advisers, according to Bao Huifang, a partner at Beijing Kangda Law Firm. However, Bao points out that “the role that lawyers can play in the listing process ultimately depends upon the lawyers’ own professional level and practice”. Bao says she has worked with some excellent colleagues who have a thorough mastery of the law, are familiar with finance and understand policy matters. In her view they indisputably play the role of commander in chief or chief of staff in the advisory team.
The role played by lawyers is expanding. Unlike US attorneys, Chinese lawyers are not in charge of writing the prospectuses during the listing of companies. However, some Chinese law firms are getting involved. Liu Su, a partner at Haiwen & Partners, says that as underwriters’ counsel, his firm was “substantially involved in the writing and drafting of the prospectus” for the offering of A-shares by the Bank of Ningbo. He says the firm encouraged its lawyers to take part in discussions with the other intermediaries on commercial and financial due diligence, in order to raise the lawyers’ all-round understanding.
Li Zhiqiang, founding partner of Jin Mao Partners, mentions that a growing number of lawyers are also acting as independent directors of listed companies, “playing a positive role in promoting the governance and legal compliance of these companies”.
EQ = experience + quality
Only outstanding securities lawyers can provide legal services that are really up to the mark. But what are the criteria for evaluating whether securities lawyers are up to the mark or not?
The Shenzhen Stock Exchange, in accordance with its Sponsorship of Companies Listed on the SME Board Evaluation Measures (issued in 2008 and revised in 2009), conducts an annual evaluation of the work of sponsors of companies listed on the SME board and the sponsors’ representatives. The exchange divides them into four grades: outstanding, good, basically competent and incompetent. However, for the securities business of law firms there is as yet no public evaluation system.
But despite the lack of formal evaluation criteria, it appears that certain standards are becoming accepted within the profession.
Zhang believes that there are at least three criteria to evaluate whether securities lawyers are outstanding. First, their intelligence quotient (IQ) should be high. Lawyers must have good legal skills, but also a thorough understanding of the listed company system and the related legal services. Secondly, their emotional quotient (EQ) should be high. The demands of securities work on the lawyers’ EQ are greater than those of other types of legal work. On the one hand, securities lawyers need to liaise effectively with companies. In due diligence work lawyers must be able not only to identify problems but also to solve them, and be able to persuade companies to improve and meet the required standards in a way that is acceptable to them.
On the other hand, securities lawyers should communicate and co-operate well with other intermediaries. Frontline lawyers especially need to respond flexibly to the problems that may arise at any time. Thirdly, they need to offer dedication and personal service. In this respect, he says, securities lawyers resemble Chinese rather than Western medical practitioners. The recommendations made by lawyers should not only be lawful, but also consistent with the actual situation and future development needs of companies. One cannot “cut the foot to fit the shoe” for the short-term interests of a listing.
Liu Gang, a partner at Commerce & Finance Law Offices, draws an analogy, saying “a lawyer is like a chef”, to emphasize the importance of experience. A combination of practical experience and outstanding performance are the holy grail a law firm can use to attract new clients. However, the size of a firm is not the decisive factor which determines its strength and the experience of its lawyers. “Big firms also have relatively inexperienced lawyers and small ones also have experienced lawyers of a high level,” says Zhang Tao, a partner at Jun He Law Offices.
A key difference between law firms can lie in the channels and methods by which they obtain information. Clients often want to find lawyers in Beijing because “Beijing lawyers may have the edge over lawyers in other places in the extent to which they grasp policies and regulations in a timely manner and the efficiency with which they communicate with the relevant government departments,” adds Zhang Tao.
Under the approval system for the issuing of stock and the listing of companies, smooth communication with the regulatory authorities as well as the maintenance of good relations with them is one of the key factors by which a securities lawyer can attract clients.
Lawyers also stress the importance of the regulatory documents of the CSRC and the rules of the stock exchanges. Engaging in securities business without being familiar with these would be a case of “blind men sizing up an elephant”. However, Guo Kejun, a partner at Zhong Lun Law Firm, thinks that it is not enough for lawyers to be familiar with the rules. “Good securities lawyers should be able to help companies find ways to satisfy the rules, rather than find ways to circumvent them,” says Guo.
At the end of 2002, the CSRC and the Ministry of Justice cancelled the licensing system that issued certificates of qualification to law firms and lawyers engaged in legal business connected with securities. With the licences gone, in theory, all Chinese law firms and lawyers could engage in such business. Many people questioned the rationale behind this decision, afraid that disorderly competition in the market for legal services might ensue and service levels decline.
Now, nearly 10 years later, these worries seem exaggerated. Although the list of law firms taking part in legal services connected with securities is constantly getting longer, Guo thinks that the majority of business remains in the hands of a minority of top law firms.
Nothing, however, is immutable. The rapid development of ChiNext and the SME board has given law firms outside Beijing and Shanghai their first real experience of the securities market and the opportunity to demonstrate their prowess. The list of securities law firms and deals in the last issue of China Business Law Journal (see The difficulties of staying afloat) included firms from Guangdong, Zhejiang, Hunan and even Inner Mongolia. Tang Jinlong, senior partner of Zhong Yin Law Firm, says the CSRC and the All-China Lawyers Association are now planning training for securities lawyers, “hoping to further expand the ranks of lawyers practising securities business”. At the same time, the Administrative Measures and the Securities Law Business Practices of Law Firms Provisions issued by the CSRC and the Ministry of Justice “have set an invisible threshold for access to the market for securities legal services”, effectively guaranteeing the quality of such services.
Beijing and Shanghai law firms which occupy a vanguard position in the profession know well that “when you are sailing against the current, either you forge ahead or you fall behind”. While demanding a lot from their individual lawyers, they are also strengthening their internal management systems. Xu Jianjun, a partner at Deheng Law Offices, says his firm has adopted a double-insurance system of “authentication of qualifications plus internal audit”. Only lawyers who have passed the internal audit and comply with the required standards are allowed to engage in securities business. Guo is even prouder to proclaim that partners in Zhong Lun’s securities team are involved in nitty-gritty frontline work from the start. “The lawyer who signs the legal opinion is the real contractor of the project and the one who is responsible for it,” he says.
In contrast, once clients have signed a retainer agreement, some partners in law firms can be more like absentee leaders, paying little attention to the project. According to Wayne Chen, a partner at Llinks Law Offices, companies are gradually realizing this and accordingly when choosing legal counsel, they require that “principal lawyers be substantially involved”.
Rewarding the diligent, punishing the lazy
The “Green-Land case”, in which Yunnan Green-Land Biological Technology Company is suspected of having inflated its assets, income and profits during the listing process, has attracted a great deal of attention from the regulatory authorities. The company’s chairman is currently under criminal investigation.
Some lawyers acknowledge that sponsors, accountants and law firms cannot dodge their responsibility where suspected fraud, the disclosure of false information and other issues arise in the listing process. Huang Wei, director of the legal department of the CSRC, has said that internal control systems are not implemented strictly in some law firms, that lawyers are not sufficiently diligent, and that standards of legal advice can be low.
In October last year the CSRC and the Ministry of Justice jointly issued the Securities Law Business Practices of Law Firms Provisions (Trial Implementation) (the Practice Provisions) (see China Business Law Journal volume 2 issue 2, page 17). The Practice Provisions require law firms to establish and strengthen internal mechanisms to control quality and risk. They set out specific requirements for quality control with regard to three areas: inspection rules, legal opinions and working papers. A CSRC official has said: “They not only provide business norms and guidance for lawyers engaged in securities business, but also provide a basis for the investigation and punishment of cases where lawyers fail to fulfil their duties diligently.” It is reported that since 2007 the CSRC has imposed sanctions on 23 lawyers from nine law firms, and standards are only likely to become stricter.
Lawyers see the Practice Provisions as a positive development which will help to raise the level of legal services related to securities. Guo thinks that the provisions can “reward the diligent and punish the lazy, thus ensuring the survival of the fittest”.
All law firms have, to some extent, changed their internal work procedures and auditing systems in accord with the Practice Provisions. For example, Yao Yuan, a partner at DHH Law Firm, says that after the promulgation of the Practice Provisions, the firm adjusted its existing internal practice rules in response.
However, nothing is perfect. “Some of the rules in the Practice Provisions are somewhat overdone, stricter even than similar rules abroad, and they are difficult to implement in practice,” says Liu Gang of Commerce & Finance Law Offices. Most other lawyers appear to hold the same view.
Kong Xiaoyan, a partner at Tian Yuan Law Firm, points out that since the Practice Provisions were promulgated, the regulatory authorities have placed increased emphasis on the independent verification capabilities of law firms in due diligence, and lawyers must seek more documentary proof from third parties. “For overseas litigation involving a company, it was acceptable in the past for Chinese lawyers just to cite the legal opinion of the foreign lawyers. But now, regulators hope that Chinese lawyers will, from the perspective of common sense, form their own judgments and publish their own opinions,” she says by way of example. In practice, when feedback from lawyers is required on specific items, the regulators may propose even higher verification requirements. “Regulators may ask lawyers about financial, environmental protection and technological issues. Sometimes they may even ask about macro-level issues like the impact on companies of industry risks, political risks and financial crises,” says Shi Zhenkai, another partner in the same firm. “These things are clearly beyond the special expertise and range of knowledge of lawyers.”
Article 11 of the Practice Provisions provides that where a matter needs to be investigated and there is no written evidence or only written evidence that is insufficient as proof, the lawyer should go to the relevant departments to conduct an investigation using on-the-spot checks and face-to-face interviews. Some lawyers are uncomfortable with this requirement.
Article 35(2) of PRC Lawyers’ Law, which came into effect on 1 June 2008, states: “If lawyers investigate and collect evidence by themselves, they may investigate relevant units or individuals regarding the circumstances related to the legal affairs they have taken on by presenting their lawyer’s certificate of practice and the certificate of their law firm.” However, in practice this provision has not been able to become a magic weapon in the hands of lawyers.
Bao of Kangda admits that it is rarely effective for lawyers to visit financial institutions and government departments, armed with their certificate of practice and the certificate of their law firm, ready to carry out an investigation. “Sometimes they have no choice but to rely on co-ordination between an enterprise and the departments concerned. Only in this way can counsel conduct on-the-spot checks and face-to-face interviews relatively smoothly.” Sometimes they cannot gain admission at all or have the door shut on them, so that they have to prove by means of photographs that they have fulfilled their obligations to conduct an investigation. Bao also points out that the Practice Provisions are more just a framework and a laying down of principles. And some provisions lack clarity. For example, how is one to reconcile the Practice Provisions with CSRC rules about the format and content of legal opinions? Are the matters requiring verification in the Practice Provisions all to be included in the legal opinion issued by lawyers?
Li Min, a partner of JunZeJun Law Offices, thinks that the Practice Provisions have laid down the boundaries for the content and scope of lawyers’ due diligence work, which helps to protect them. However, they “failed to consider some of the practical problems which occur in real life and there has been an unrealistic extension of the matters that need to be verified”. She explains that the Chinese legal system lacks uniformity of law enforcement in different places, standardization of property registration, a unified national credit information system and standards for the signature of agreements (various forms of signature by proxy exist). All these things have a direct adverse effect on lawyers’ investigatory work.
Wang Bing, another JunZeJun partner, cites the example of investigating companies involved in litigation. Because there is no unified national platform for seeking information on litigation, it is difficult to obtain complete information on a company’s and its controller’s involvement in litigation. “If you have not found that the object of investigation is involved in litigation after you have exhausted all reasonable means of investigation, you can only presume that it is not involved in litigation,” says Wang. He adds: “Of course, we will disclose our entire investigation process to the CSRC truthfully and in detail.”
Fortunately, most lawyers have a good eye for discovering and solving problems. Liu of Haiwen points out that with regard to lawyers’ due diligence work, apart from stressing the “prudence principle”, article 8 of the Practice Provisions also sets out the “importance principle”. This shows that the regulatory authorities “do not require lawyers conducting due diligence to attend to each and every detail of matters regardless of their importance”. Wang of JunZeJun agrees, saying: “the importance principle has long been the rule followed by lawyers in practice. When conducting due diligence, they strike a balance between importance, relevance and prudence.” Bao also stresses that to judge from the cases in which the CSRC has imposed penalties on lawyers, the regulators pay close attention to whether lawyers fulfil their obligation to conduct due diligence. They do not require lawyers to be absolutely correct in their judgment of all questions, because “there has always been debate and discussion in jurisprudence”. And with regard to visits and interviews, Li of JunZeJun points out that under the Practice Provisions, “even if the transcript of an interview was not confirmed by being signed by the interviewee it can be used as the basis of a lawyer’s legal opinion.”
It seems that the Practice Provisions are not leg irons to shackle the dancers, but dancing shoes for their feet. If securities lawyers are to achieve their dream of dancing breezily they need to properly break the shoes in, rather than “cutting their feet to fit the shoes”.
The power to set prices?
The development of ChiNext has contributed to growth of the legal services market in the field of securities. From the biggest names in Beijing and Shanghai law firms down to previously little-known local law firms, all and sundry are taking part.
Everybody is curious and some have speculated that every law firm must have made pots of money in the capital markets gold rush. Others have come up with the notion of “lawyers’ power to set prices” and a “thieves’ ranking” for law firms, showing the ratio between the firms’ fees and the amount of funds raised by their client companies on the market. What is the truth of the matter?
Grandfield Law Offices ranks number five both in market share and price-setting power. Zhang Liguo says that the firm’s fees have always been at the upper middle level. “The quality of our lawyers’ work is recognized by clients. They feel that the relatively high fees are value for money,” he says. However, this does not mean that the firm enjoys great price-setting power, in his view.
A Chinese news agency recently ranked Beijing Kangda Law Firm bottom among law firms in terms of price-setting power on the basis that it received RMB330,000 (US$50,000) in legal fees for its work on the listing of Zhengzhou Coal Mine Machinery. In this regard Bao of the firm says she doesn’t know whether to laugh or cry. “This was not the total sum of all our fees,” she says. “It was merely a bonus paid after the listing and IPO in recognition by the client of the hard work performed by the firm’s lawyers.”
Most lawyers disagree with the notion that they have the power to set prices because, unlike underwriters’ commission, which is charged according to a fixed percentage of funds raised, the amount of lawyers’ fees is not proportional to the funds raised when a company lists.
Lawyers say neither clients nor lawyers can set prices. Fees are ultimately determined by consultation between them. And in practice, all law firms have adopted the methods of calculating fees which are set by convention within the profession. Xu Ying, a partner at Jia Yuan Law Firm, points out that the basic formula for calculating lawyers’ fees is “cost plus reasonable profit”.
Wang of JunZeJun further analyses the specific make-up of lawyers’ fees. In his view, under normal circumstances four factors need to be considered when calculating the fees: the standard amount of work required for lawyers to complete a project; the degree of legal complexity of the project; the project’s inherent risk and the operational risk at the time lawyers undertake it; and finally the potential added value derived from the project.
Wang also mentions that there may be clients who pay an extra bonus because they are satisfied with the legal services provided by the lawyer.
However, “the time of mega-profits is long over and the present time can only be regarded as an era of hard work,” Xu Meng, a partner at V&T Law Firm, says wryly. He says that legal fees from the securities business have been flat for the last 10 years, while a law firm’s costs for office space and personnel have increased considerably.
However, not all law firms will accept any business that comes their way, with no questions asked. Zhang Tao of Jun He Law Offices says that when talking with clients who plan to list, the firm will first determine whether the company satisfies the basic listing requirements. If it does not, on the firm will consider whether the company can reach the listing conditions after a period of reasonable adjustment. Secondly, the mindset of the company’s boss and management team will be considered. That mindset should be focused and pragmatic.
Grandfield Law Offices helps prospective clients to analyse whether it is really necessary for them to list. Zhang Liguo says he often asks the following questions of entrepreneurs who come for advice about listing: Has the company’s business reached a plateau? Do you intend to make the company bigger and stronger? Are there major capital needs if you do?
There is a clear legal basis for lawyers to refuse a client’s instructions. Article 17 of the Administrative Measures states: “If a lawyer discovers that the materials provided to him by the client contain false or misleading statements or material omissions, or that the client has committed a major violation of the law, he shall require the client to correct and supplement such materials. If the client refuses to correct or supplement the materials, the lawyer may refuse to continue to accept the instructions.” The same article also stresses that the lawyer “should perform his or her obligation of reporting to the relevant authorities”. It seems that apart from giving lawyers the courage to say no to clients, the regulatory authorities have also placed even more legal and moral obligations on their shoulders.
Where are the next pieces of cake?
Apart from ChiNext, the new third board and the international board, where are the next pieces of cake for legal business linked to the capital markets?
Stock index futures and margin trading is probably one of the pieces. Lu Yan of SG & Co PRC Lawyers mentions that the China Financial Futures Exchange launched 300 Shanghai and Shenzhen stock index futures in April 2010, filling a gap in the country’s financial markets and changing the one-sided operation mechanism of the market.
Mergers, acquisitions and restructuring of listed companies may become hot. A report recently released by the Shenzhen Stock Exchange indicated that of the top 20 companies listed on the main board of the exchange in terms of net profit in 2010, more than half had implemented various forms of merger and acquisition or restructuring, such as listing in their entirety, industry consolidation and overseas acquisition. The stock-swap merger by absorption of Hebei Taihang Cement by Beijing’s BBMG Corporation and the acquisition of Shenzhen Development Bank by Ping An Insurance were two typical cases of the merger or acquisition of listed companies in 2010.
Haiwen & Partners has helped several overseas investors to make strategic investments in listed companies. Liu Su, a partner at the firm, believes non-public offerings will become a common means of refinancing for listed companies. “It is also becoming a trend for red chip companies to acquire A-share listed companies,” he adds. Liu Gang of Commerce & Finance Law Offices says that “if in five years’ time, foreign exchange controls on the renminbi have been fully liberalized, there will be even more such transactions”.
Guantao Law Firm was counsel for the underwriters when Sinopec issued RMB23 billion of A-share convertible bonds. The amount of the bonds was staggering, but the trend to issue RMB bonds overseas seems to be even more attractive. In 2010, Haiwen & Partners helped a number of clients to issue bonds denominated and subscribed to in RMB.
Zhang Ming, a deputy director of the Information Centre of the State-owned Assets Supervision and Administration Commission of the State Council, believes that central-level enterprises will be listed in their entirety after gradually restructuring its unlisted businesses. Liu of Haiwen has also noted this trend and expects that related policies may be promulgated and implemented in the near future.