The CSRC has fined three Chinese law firms in recent months over shoddy legal work on IPOs. The IPOs in question were all on China’s stock exchanges, and accordingly come under the regulatory authority of the CSRC. It is about time that the CSRC has taken action to raise the standards of legal practice on listed companies. The first crackdown on the accounting profession took place in 1997 and it was brutal. A quarter of Chinese CPAs faced discipline or eviction from the profession in the 1997 rectification. The legal profession is overdue for recti-fication.
The CSRC’s jurisdiction does not extend to overseas listed Chinese companies. Overseas listed Chinese companies of any meaningful size tend to use well-known international law firms. But these international law firms are not allowed to opine on matters of Chinese law, so local firms are used for this purpose.
Some local firms are well known for their willingness to issue clean opinions on variable interest entity (VIE) structures even in the face of considerable doubt as to whether the agreements that underpin these structures are enforceable. Many Chinese lawyers do not believe these agreements are enforceable, but those lawyers are not engaged to issue opinions on VIEs. The SEC has been tough on companies using the VIE structure, but is not in a position to challenge Chinese lawyers on matters of Chinese law. The CSRC does have that power, but it lacks jurisdiction over these companies. That is one of the things that the Singapore Solution can fix.
The other important development is the report that two of China’s top law firms – Jun He Law Offices and Zhong Lun Law Firm – are discussing a potential mer-ger. The firms, together with King & Wood Mallesons are generally considered to be among China’s top three firms. Consolidation of China’s legal sector would be a positive development for investors. Larger firms are more likely to put in place quality control measures, and to hold their partners to higher standards since there is more for the partners to lose.
In other major markets certain groups of law firms are considered elite. These firms tend to be the firms selected for major IPOs and other key assignments. In the UK this group is known as the Magic Circle; in the US the firms are often called “white shoe” law firms, named for the suede shoes once popular among Ivy League graduates. Australia has its Big Six, Canada the Seven Sisters, Japan the Big Four, and Singapore the Big Five. No such group of Chinese firms has emerged to date, but consolidations, such as the potential Jun He/Zhong Lun tie up, will create firms that will make up that group. Readers might suggest a clever moniker for this group in the comments, and maybe it will stick.
Once an elite group of Chinese law firms emerges, investors need to demand opinions from these firms, rather than some Chinese equivalent to Dewey, Cheatum and Howe. But that might create problems for companies with shaky legal structures.