By Gregory J. Millman 

Major foreign companies and several Chinese Internet companies with U.S. stock-exchange listings are using a corporate structure in China in a way that may be rendered illegal under a proposed law.

The Wall Street Journal, working with Dow Jones Risk & Compliance, identified companies that appear to be at risk from the proposed law. These include Chinese operations of Amazon.com Inc., Pearson PLC and CBS Corp. They also include three major U.S.-listed Chinese Internet companies: Sina Corp., Autohome Inc. and Weibo Corp., which are threatened because foreign investors control them. Most Chinese Internet companies listed abroad, such as Alibaba Group Holding Ltd. and Baidu Inc., also use the structure but don't seem to be at risk because they are ultimately controlled by Chinese nationals.

All these companies use a structure called a variable interest entity, or VIE, to do business in sectors of the economy where foreign investment is restricted by the Chinese government. But under the law, proposed by the Ministry of Commerce of the People's Republic of China, known as MOFCOM, in January, they may not be able to continue those operations or may have to sell controlling stakes in the operations to Chinese nationals, attorneys say.

VIE structures are especially common among U.S. technology companies. "You can't walk down the street in Palo Alto without tripping over a VIE situation, because if you are in the Internet space and looking at China you are looking at VIE," said Tom Shoesmith, head of the China practice at law firm Pillsbury Winthrop Shaw Pittman LLP.

Typically, a company based outside of China sets up what is called a Wholly Foreign-Owned Enterprise in China. The WFOE in turn signs contracts with a Chinese-owned operating company, the VIE, which invests in the restricted sector. The contracts give the WFOE effective control of the operating company but not ownership.

China has heretofore had a number of laws regulating foreign investment. The newly proposed law would draw a simpler distinction between sectors where foreign investors will get the same treatment as Chinese investors, and a "negative" list of restricted and prohibited sectors, where only companies controlled by Chinese nationals could operate, even if structured as VIEs.

Without regulatory relief, "the foreign-controlled VIE entity would have to either sell its controlling stakes in the VIE entity to Chinese nationals [so that the stakes would be controlled by Chinese nationals] or liquidate the VIE entity under applicable Chinese law," said Winston Zhao, a partner in the law firm of McDermott Will & Emery LLP.

The Wall Street Journal and Dow Jones Risk & Compliance identified companies using the VIE structure by searching public sources and securities filings and conducting interviews. Dow Jones Risk & Compliance is owned by News Corp's Dow Jones & Co., which publishes The Wall Street Journal.

Amazon.com paid $75 million in 2004 to acquire Joyo.com, which was structured as a VIE, later changing its name to Amazon.com China Ltd. In its Securities and Exchange Commission filings on the deal, Amazon mentioned the possibility of regulatory risk to the VIE structure. The company didn't respond to requests for comment.

In 2011, Pearson bought VIE-structured Global Education & Technology Group Ltd., a provider of test-preparation services in China, in a $294 million deal. Global Education used a VIE structure, according to its SEC filings. A Pearson spokesman said, "Like all businesses with a substantial presence in China, we are following the development of the new regulations closely. These regulations are still under review."

Expedia Inc. controls 82% of eLong Inc., a Nasdaq-listed provider of travel services in China that reported about $167 million in revenue in 2013, the most recent annual report available, where it also described its VIE structure. Expedia declined to comment.

CBS Corp.'s CNET Networks Inc. uses the VIE structure for its operations in China, according to the last annual report issued by CNET Networks before its $1.8 billion acquisition by CBS Corp. in 2008, as well as a spokeswoman for CBS who confirmed the structure is still in place but declined to comment further.

Among the Chinese companies, Sina and Weibo didn't respond to requests for comment. A spokesman for Autohome confirmed that Australia's Telstra Corp. owns a controlling share in the company but declined to comment on the implications of the proposed law.

To be sure, the legality of using the VIE structure has long been ambiguous, attorneys who spoke with Risk & Compliance Journal agreed. "The VIE structure has never been legal per se," said Zhang Ning, a counsel in the Beijing office of the law firm O'Melveny & Meyers. The proposed legislation would remove the ambiguity by legalizing some VIE operations that are controlled by Chinese nationals, but for others, "this law would make them pretty clearly illegal," Pillsbury's Mr. Shoesmith said.

In a joint statement on the new law, the U.S. Chamber of Commerce, the American Chamber of Commerce in China and the American Chamber of Commerce in Shanghai called for a 25-year grace period or the grandfathering of existing VIEs.

Attorneys caution that the draft law was published for comment just this year, is subject to change, and will probably not become law in any form for at least two years. It also proposes to liberalize investment, and such liberalization could open up some of the sectors where foreign investors currently face restrictions, reducing or eliminating the threat to them. "It's a little bit too early to say they are in great danger," said Mr. Zhao of McDermott Will & Emery. However, he noted that there have been other challenges to the VIE structure in China.

In 1999, Chinese regulators announced that a similar structure, called China-China-Foreign, used by China Unicom Ltd. to bring foreign investment into China's mobile-telecommunication sector was illegal. "A huge amount of money was lost in that process by foreign investors," Mr. Zhao said.

That precedent hasn't deterred foreign investment in restricted businesses, although the VIE structure is "exactly the same creature" with one exception, according to Prof. Nicholas C. Howson of the University of Michigan law school. A pivotal part of the so-called China-China-Foreign, or CCF, structure was a joint venture domiciled in China. The equivalent in the VIE is a wholly owned foreign corporation, "which probably protects the VIE structures less," Prof. Howson said.

According to Mr. Zhang, "It is time [for companies] to consider restructuring the VIE."

On the one hand, Chinese regulators may decide to open to foreign investment some sectors that are currently restricted, in which case entities operating in those sectors through a VIE structure could eliminate the contractual complexity by restructuring. On the other hand, if their sector remains on the negative list, they might have the opportunity to apply for a grandfathered status, or to bring in Chinese investment in order to bring control into line with the provisions of the law.

"It's not a cause for panic," he said.

Write to Gregory Millman at gregory.millman@wsj.com

Access Investor Kit for Telstra Corp. Ltd.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=AU000000TLS2

Access Investor Kit for Pearson Plc

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=GB0006776081

Access Investor Kit for SINA Corp.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=KYG814771047

Access Investor Kit for Amazon.com, Inc.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US0231351067

Access Investor Kit for Baidu, Inc.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US0567521085

Access Investor Kit for CBS Corp.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US1248571036

Access Investor Kit for CBS Corp.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US1248572026

Access Investor Kit for eLong, Inc.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US2901382059

Access Investor Kit for Expedia, Inc.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US30212P3038

Access Investor Kit for Pearson Plc

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US7050151056

Access Investor Kit for Telstra Corp. Ltd.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=US87969N2045

Subscribe to WSJ: http://online.wsj.com?mod=djnwires

Telstra (ASX:TLS)
Historical Stock Chart
From Feb 2024 to Mar 2024 Click Here for more Telstra Charts.
Telstra (ASX:TLS)
Historical Stock Chart
From Mar 2023 to Mar 2024 Click Here for more Telstra Charts.