An interesting recent article in the Wall Street Journal discusses how various levels of the Chinese government are taking stakes in private companies.
According to the article: “the government stakes are sometimes very small [sometimes a 1% holding] but they tend to give the government board seats, voting power and sway over business decisions. Colloquially, they are known as golden shares.”
The article states:
“For the companies, there is little choice: Selling such a stake to a government entity that seeks one is crucial for staying in business. For the state, the stakes mean more direct involvement in some of China’s most high-profile companies—digital cornerstones of Chinese life and, in some cases, darlings of global investors.
One result of the new normal of subtle influence is that the boundary between the party-state and the private sector is getting increasingly muddled. […] “The burden of proof is on the private companies to show they’re not agents of the state.”
[…]
Golden shares have become a useful tool to keep companies like these in line with party objectives without the need for the state being a major stakeholder. Many of the firms involved count on capital from foreign investors, who worry about getting entangled with the Chinese state at a time of high political tensions.
[…]
As of last year, about 37% of companies listed in Shanghai and Shenzhen had amended their charters to formalize the role of party committees inside the companies, up from 6% in 2018, according to research by Lauren Yu-Hsin Lin at the City University of Hong Kong School of Law and Curtis Milhaupt at Stanford Law School.
[…]
Hybrid-ownership companies, with the government owning between 20% and 80%, now represent about 26% of the total capitalization of mainland-listed companies, according to Thomas Gatley, a China market strategist at research firm Gavekal Dragonomics.
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But companies that sell the government the much smaller stakes called golden shares are finding how even this way, the government is getting a lot of power over their businesses.
The director whom China’s cybersecurity watchdog named to the board of ByteDance’s main subsidiary has veto rights over content on apps including Douyin, the Chinese version of TikTok, according to people close to the subsidiary.
The director also can vote on corporate issues such as the subsidiary’s personnel decisions, compensation packages and investment or divestiture plans, the people said. “In China, it’s just normal business,” one said.”
Here is what the DOJ/SEC issued FCPA Guidance says:
“Foreign officials under the FCPA include officers or employees of a department, agency, or instrumentality of a foreign government. When a foreign government is organized in a fashion similar to the U.S. system, what constitutes a government department or agency is typically clear (e.g., a ministry of energy, national security agency, or transportation authority). However, governments can be organized in very different ways. Many operate through state-owned and state-controlled entities, particularly in such areas as aerospace and defense manufacturing, banking and finance, healthcare and life sciences, energy and extractive industries, telecommunications, and transportation. By including officers or employees of agencies and instrumentalities within the definition of “foreign official,” the FCPA accounts for this variability.
The term “instrumentality” is broad and can include state-owned or state-controlled entities. Whether a particular entity constitutes an “instrumentality” under the FCPA requires a fact specific analysis of an entity’s ownership, control, status, and function. The Eleventh Circuit addressed the definition of “instrumentality” in United States v. Esquenazi, a case involving the state-owned and controlled telecommunications company of Haiti. The Eleventh Circuit concluded that an “instrumentality” under the FCPA is “an entity controlled by the government of a foreign country that performs a function the controlling government treats as its own.” Although the court noted that this test is a fact-bound inquiry, it provided the following non-exhaustive list of factors to determine whether the government “controls” an entity:
- the foreign government’s formal designation of that entity;
- whether the government has a majority interest in the entity;
- the government’s ability to hire and fire the entity’s principals;
- the extent to which the entity’s profits, if any, go directly into the governmental fiscal accounts, and, by the same token, the extent to which the government funds the entity if it fails to break even; and
- the length of time these indicia have existed.
To determine whether the entity performs a function that the government treats as its own, the Eleventh Circuit listed the following non-exhaustive factors:
- whether the entity has a monopoly over the function it exists to carry out;
- whether the government subsidizes the costs associated with the entity providing services;
- whether the entity provides services to the public at large in the foreign country; and
- whether the public and the government of that foreign country generally perceive the entity to be performing a governmental function.
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Companies should consider these factors when evaluating the risk of FCPA violations and designing compliance programs.
While no one factor is dispositive or necessarily more important than another, as a practical matter, an entity is unlikely to qualify as an instrumentality if a government does not own or control a majority of its shares. However, there are circumstances in which an entity would qualify as an instrumentality absent 50% or greater foreign government ownership, which are reflected in a limited number of DOJ or SEC enforcement actions brought in such situations. For example, in addition to being convicted of funneling millions of dollars in bribes to two sitting presidents in two different countries, a French issuer’s three subsidiaries were convicted of paying bribes to employees of a Malaysian telecommunications company that was 43% owned by Malaysia’s Ministry of Finance. There, notwithstanding its minority ownership stake in the company, the Ministry held the status of a “special shareholder,” had veto power over all major expenditures, and controlled important operational decisions. In addition, most senior company officers were political appointees, including the Chairman and Director, the Chairman of the Board of the Tender Committee, and the Executive Director. Thus, despite the Malaysian government having a minority shareholder position, the company was an instrumentality of the Malaysian government as the government had substantial control over the company.”
The enforcement action referenced above in the FCPA Guidance is the 2010 enforcement action against Alcatel-Lucent. (See here).
See here for how the Eleventh Circuit’s 2014 decision in U.S. v. Esquenazi is flawed. (See also here).
