Chinese law firms are vowing to take a close look at their past conduct and procedures after the country’s securities regulator hit some of them with tough penalties for performing inadequate due diligence on initial public offerings. But many lawyers privately question just how much more they can do in China’s uncertain legal and regulatory landscape.
Last month, the China Securities Regulatory Commission ordered Beijing firms Dacheng Law Offices and JunZeJun Law Offices to pay $246,000 and $295,000, respectively, for their roles in proposed Shenzhen Stock Exchange IPOs determined to be based on fraudulent financial disclosures. The CSRC said it had suspended review of all listings applications submitted by Jingtian & Gongcheng pending an investigation of its work on the canceled IPO of a solar panel maker suspected of similar misconduct.
Zhang Hongjiu, a partner at Beijing-based Jingtian & Gongcheng, said the firm regrets mistakes it made and will make sure they don’t happen again. “We didn’t do a good job in terms of risk control and we are currently reviewing it internally,” he said. “We hope the CSRC will issue their decision of punishment soon.”
The firms have been swept up in what appears to be a major crackdown on IPO abuses by CSRC chairman Xiao Gang, who took office in March. New IPOs in the major exchanges of Shanghai and Shenzhen have already been frozen for over a year, and banks and accounting firms have been punished along with law firms. In August, Chinese investment bank Everbright Securities Co. Ltd. was fined $71.3 million, while Ping An Securities had its underwriting license suspended and was fined $8.4 million a month later.
Other law firms that so far have not been targeted by the CSRC nonetheless said the regulator’s recent actions have been a wakeup call.
“This is a lesson for all of us to learn,” said David Tang, a senior partner at Shanghai’s Allbright Law Offices. “We have to be more prudent handling businesses. Partners should be more thorough and cautious when they take in cases.”
Liu Hongchuan, a partner at Beijing’s Broad & Bright, said the problem is that Chinese law firms usually have only weak oversight of partners’ activities.
“Some partners, motivated by money, will give legally questionable opinions just to satisfy the client,” he said. “They’re willing to take a risk because they will get paid if the deal works out, but the whole firm will take responsibility if things go badly.”
Both Tang and Liu said their firms are reviewing their internal processes.
But a capital markets partner at another Beijing firm disagreed that greed is a major factor in faulty legal opinions, noting that domestic Chinese IPOs are usually handled by firms for flat fees he considers low, ranging from $164,000 to $328,000.
“Given our fees, it’s really not worth taking the risk,” the partner said. Instead, he blames the pressure placed on lawyers to move forward by their clients and the underwriters.
Some outside observers also noted that Chinese firms have not historically faced much external discipline, either from the government or unhappy clients.
“Malpractice is obviously one of the key risk management issues for lawyers and law firms operating in the normal course in jurisdictions outside China,” said one Beijing partner with a British Magic Circle firm, “but the cultural and legal basis of malpractice liability is relatively weak in China. It’s still a developing area for many Chinese law firms.”
Sida Liu, an assistant professor of sociology and law at University of Wisconsin–Madison, said the CSRC crackdown could help fill a void in terms of discipline.
“I think government scrutiny, in China and abroad, would make some positive influence on the practice of Chinese law firms,” Liu said. “After all, government sanctions are likely to generate at least temporary obstacles of business and potential loss of clients.”
The Beijing Magic Circle partner agreed. “The silver lining of this is that it will give the Ministry of Justice more ammunition to continue improving the overall standard of lawyering in China,” he said. The investigations “might improve the quality of due diligence and legal work in the future. From that point of view, it’s good for the further maturity of the industry.”
But a number of Chinese lawyers who spoke to The Asian Lawyer said they are angry about the CSRC’s actions. They said the law firms are being unfairly blamed for a flawed system they’ve tried their best to navigate. These lawyers said the Chinese government itself is more to blame for faulty IPOs, because it has failed to encourage the kind of transparency throughout the economy that’s necessary for effective due diligence. Punished firms, they said, are also being given no guidance on how to do things differently in the future.
“They said we didn’t exercise adequate due diligence, but what is adequate due diligence for lawyers?” asked a partner at one of the firms targeted by the CSRC. “What do the auditors do then? What are the things we should check? We used to just make sure the candidate is legally eligible for an offering. But is it our problem that they wrote 50 or 500 instead of five on their balance sheet? We weren’t’t involved in every transaction, how could we know?”
A partner at a Beijing firm that has not been the subject of a CSRC investigation agreed. “How can you give a flawless legal opinion given the way things work in China?” he said. “You can’t just assume everything can be checked out. They can’t. The CSRC sets a goal that cannot be reached. Some companies have been cooking the books for years. How can you expect lawyers to fix that?”
The partner whose firm was targeted said that just trying to verify registrations and other supposedly publicly available regulatory filings can be hit-or-miss in China. Sometimes the government simply refuses to cooperate. “Lawyers rarely have any say about what can be investigated,” he said, “but when it comes to responsibility, we are the ones taking the heat.”
One Shanghai-based partner with a U.S. firm said he sympathizes with his Chinese counterparts and regards the CSRC investigations as a joke.
“These alleged wrongdoings are completely normal practices if you are in the capital markets business in China,” he said. The partner also noted that the CSRC has had some major corruption scandals in its past and continues to be dogged by allegations that companies can buy IPO approval.
“They are nowhere near the position to point fingers at professional law firms,” said the Shanghai partner.
The Beijing partner said all Chinese firms will undoubtedly be reviewing their practices and risk management. But he doubts things will change on a larger scale if the system itself remains the same.
“I think the most important thing is for the regulators to clarify in detail exactly how far lawyers should go in terms of due diligence,” said the partner. “Let’s say one company received $1 but they create a fake contract saying they received $100. How do we find out? Do we go check the validity of every contract? Do lawyers now also do auditors’ jobs? If so, how is that reflected on fees?”
One problem Chinese firms face in all this is they don’t have anyone to effectively advocate for them as a group, the Beijing partner said said. Bar groups like the All China Lawyers Association, which are state-sponsored, have remained silent about the crackdown.
“It’s a sad moment for Chinese legal industry,” he said. “The lawyers association, which is supposed to have our back, didn’t say anything after something this big happened.”