Chinese Dotcoms Face Legal Woes

The recent legal problems encountered by Chinese firms listed on the Nasdaq will not have a serious impact on investors' confidence in the Internet industry, but the nation's dotcoms should see the situation as a warning about improving management and legal structures, legal and industry experts have pointed out.

"The lawsuit that Chinadotcom faces in the United States has nothing to do with the performance of `China concept' stocks on the Nasdaq and the legal problems that confront Chinese dotcoms will not discourage foreign investors, as the Internet market in China still offers lots of opportunities," said Charles Li, a famous legal expert in Beijing.

A few major Chinese portals including Chinadotcom, and have been at the center of legal disputes in the United States over the past couple months.

On July 5, US law firm Bernstein Liebhard & Lifshitz, LLP started a class action lawsuit against the Hong Kong-based Chinadotcom and its major underwriters, including Lehman Brothers and Merrill Lynch, on behalf of all the company's common shareholders.

One week earlier, another US law firm Schiffrin Barroway, LLP had initiated a similar action.

In the actions, Chinadotcom and its underwriters were accused of providing a "materially false and misleading" prospectus, because it failed to disclose the fact that its underwriters had solicited and received excessive and undisclosed commissions from certain investors and also required some investors to purchase additional Chinadotcom shares in the after market at pre-determined prices.

In June, two other Chinese Web portals, Netease and Sina, were also beset with potential legal troubles. announced on June 12 that it had expanded internal investigations into incorrect financial reporting last year involving about US$3 million of misreported revenues. Some analysts have predicted the company will face class action lawsuits like Chinadotcom if the matter is not resolved soon. faced its own legal problems when former Chief Executive Officer Wang Zhidong refused to relinquish control of the firm's Internet Content Provider (ICP) license after claiming Sina's decision on his resignation on June 4 was "illegitimate".

According to Li, the practices of Chinadotcom and its underwriters are quite common on the Wall Street and have nothing to do with Chinadotcom's identity as a Chinese Internet business.

However, some legal experts have warned that if the legal problems of Sina and Netease are not handled properly, it will leave a bad impression of China's Web businesses.

"Both the ICP license and revenue problems of Sina and Netease are very typical of Web firms in this country," said one local industry analyst. "If they are not resolved, potential investors in the sector will be discouraged."

According to some insiders, Web businesses often try to increase revenues through cross-transactions to make their financial performance look better on paper.

The introduction of foreign capital through channels that circumvent the government's regulations on the Internet industry is also a popular practice.

Though not illegal, both of these practices could lead to lawsuits.

In spite of the ongoing and potential legal problems, legal experts believe that the lessons of Chinadotcom and possible disputes with Sina and Netease will eventually exert a positive influence on China's Internet industry.

"These incidents prompt Chinese businesses to abide by laws if they want to incorporate into the world economy," said Yan Ming, another legal expert.

Li claimed lessons still have to be learned. "Chinese Internet companies have been facing many lawsuits in the past year and it shows that an awareness of legal operations has yet to take root in the minds of management," he said.

"The lessons of Chinadotcom will prompt Sina and Netease to solve their problems as soon as possible and avoid the situation facing the Hong Kong-based firm," Li added.

Observers also believe that the interest of foreign investors in the Chinese Internet market will remain high, although they will be more cautious in talks with Chinese businesses.

"China is still an attractive market for international Web businesses because it is still underdeveloped and because there will be more opportunities after China's entry into the World Trade Organization," said Lu Benfu, an analyst with the Chinese Academy of Social Sciences.

The significant rises in the prices of Chinadotcom, Sina and Netease shares last Friday on the Nasdaq seems to confirm the charms of the "China concept" stocks.

The stocks of Chinadotcom, Sina and Netease closed at US$4, US$1.9 and US$1.47 respectively, rising more than one third, 10 percent, and one fifth, after China won its bid to host the 2008 Olympic Games.

(Business Weekly via China Daily 2001/07/16)

In This Series

More Dotcom CEOs Byte the Dust

Dotcoms Enamoured with Second Board

Wise Business Modes Needed for Dot.coms

Chinadotcom Revenues Meet Estimates, Cuts Jobs



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