Helping Chinese Companies Access U.S. Capital Markets

Monday, December 6, 2010 - 01:00

Editor: Tell us about your professional backgrounds .

Auguste: I joined Kramer Levin as a partner in 2005. I had been doing a significant number of PIPE and SPAC transactions when those were in vogue. I am currently spending a fair amount of time working on transactions involving Chinese companies coming to the U.S. I help them become reporting companies and raise capital in the U.S. We represent the companies themselves or the underwriters. This has definitely been a growth area.

Lerner: I am a corporate partner at Kramer Levin and came to Kramer as a lateral partner in late 2006. My practice has focused on corporate, securities and M&A matters since 1982. It includes small-cap and mid-market capital formation, public and private financing, '34 Act SEC Reporting and small-cap and mid-market M&A transactions. I became more involved in our China practice more recently as that practice has grown. Chris has been instrumental in growing this practice and our success reflects his efforts.

Editor: When and how did Kramer Levin begin its China practice?

Auguste: Two or three years ago, we handled an IP infringement matter for a Chinese company with respect to patents in the U.S. Our IP lawyers who handled the matter included an associate who was Chinese. It became clear that, given our expertise not only in IP but in securities work, we could assist Chinese companies in U.S. corporate and securities matters.

As a result of that initial involvement, we began seeking out and advising Chinese companies interested in raising capital in the U.S. In fact, our Chinese associate I mentioned returned to Shanghai and assists in that effort. We introduce these Chinese companies to underwriters and bring them to the U.S. through an IPO, a reverse merger or other strategies. Our practice has grown remarkably in the last six to eight months.

What we are seeing is that lawyers in other firms who were doing PIPEs and SPACs are now advising Chinese companies interested in coming to the U.S. In fact, they are the same players both in terms of the investors as well as the lawyers from other firms. If I speak on a panel about Chinese deals, I see the same people that I have been speaking with on panel discussions in the last five to eight years, except now we are discussing China transactions instead of SPACs or PIPEs. The bottom line is that we are still assisting companies raising money in the U.S. and looking for the most efficient way to do that.

Editor: You mentioned that the Chinese company may use a reverse merger. How does that work?

Auguste: In that scenario, the Chinese company, or BVI or Cayman Islands company, reverse merges into a U.S. shell company, a company that has been public and has limited or no assets and may have cash and a ready base of shareholders. Upon the completion of the reverse merger there are usually major changes that the company undergoes because now it's going to be majority owned by a Chinese entity. There is typically a change in directors, CEO and CFO as well as an effort to raise capital. Typically, either a PIPE transaction bringing money into the company contemporaneously with the reverse merger occurs or a public secondary offering to raise funds is held. The result is that the company becomes a public company in the U.S.

Editor: Does the SEC look askance at these reverse mergers as a means of bypassing the normal initial registration process?

Auguste: No, because the SEC has an opportunity to review the company's first registration statement or its '34 Act filings. The SEC asks questions about how assets were transferred and what risks are involved etc., so that the disclosure ends up being very close to that required in an initial public offering of a U.S. company.

Editor: How does marketing securities for a Chinese company differ from working with a domestic issuer?

Auguste: The due diligence involved tends to be quite complicated. Let me give you a quick example in terms of a company that is going public. Typically, if we are representing a Chinese company, there is also local Chinese counsel, and the underwriter will, in addition to U.S. counsel, have local Chinese counsel.

Because many of the organizational documents are in Mandarin Chinese, local counsel assists us in doing due diligence on that aspect of the company. That enables us to make disclosures in our registration statements and describe the risks that apply to the company and its business. Therefore, local counsel plays a critical role. We have worked with a number of them that are quite good and provide very detailed information.

Editor: What changes have taken place since you started your China practice?

Auguste: Looking at these transactions from an investment banker and underwriter perspective, there is now enhanced concern about the auditors of these companies. They advise the Chinese to use larger U.S.-based auditors that have offices in China, because it is essential to be comfortable that the underlying audits of these companies are accurate and done as they would be for U.S. companies.

There has also been a change in the law firms involved. Initially a lot of smaller law firms were doing these deals. Chinese companies and the underwriters are looking for law firms with more experience in securities law because they want to make sure that this process works correctly and can pass muster with the SEC.

Editor: The SEC has emphasized the importance of internal controls. How has this affected Chinese companies seeking to list securities on a U.S. exchange?

Lerner: In the SEC review process, more questions are being asked about internal controls. The SEC wants to make sure that these companies meet public company standards with respect to internal controls. The SEC can be expected to become even more focused on SOX-type internal controls issues as more and more China companies trade on the U.S. exchanges.

Editor: Is it important that Chinese companies understand the disclosure regime imposed by the SEC?

Lerner: The concern is always that, while companies may be doing well operationally, their control and compliance infrastructure may not be mature enough to handle the maze of regulations that the SEC rules create, where virtually everything you do involving your securities, senior management, finances or acquisition activities, among other things, can trigger a public disclosure requirement. So, understanding the need to make timely, almost immediate disclosures is critical for these companies once they are public.

When companies are going through the IPO process or the reverse merger process, the lawyers and the accountants and the bankers are very engaged with the company, making sure everything is being properly handled on a day-to-day basis. Once the company is public and everyone goes back to normal operations, it's still incumbent on the company to bring to the attention of its professional advisers day-to-day events that might require SEC disclosure, might need to be reflected in financial statements or might require an 8-K filing.

Therefore, the company has to have a sufficient understanding of those obligations. This is critically important for many of the companies that recently have come to the U.S. markets. Many of them, once public, are accessing the U.S. capital markets by using the SEC's Form S-3 registration statements, a streamlined way to register shares for sale. But the failure to make timely 8-K filings with respect to significant corporate events can cause the issuer to lose S-3 eligibility. Thus the little tripwires that could cause the Chinese company to miss an important disclosure on an 8-K filing could have dire consequences for their fundraising efforts and obligations to their investors.

Editor: To what extent do you monitor Chinese companies that you assist in going public?

Lerner: We're not in a position as outside counsel to "monitor," so I would question the use of that word. We certainly advise our clients and make them aware of the disclosure requirements. We from time to time send bulletins and checklists to remind them of their responsibilities as public companies and the need to bring to our attention or their accountants corporate events that may seem to the client to be day-to-day mundane activities but that actually may require SEC filings or other disclosures. I think this is an evolving area for many of these companies, but it has also shown improvement over the years.

Auguste: It's no different than what we do for U.S. companies that are being formed and going public; it's just that we have to engage in more hand-holding of our Chinese counterparts.

Editor: The valuation of the RMB is often a concern in the U.S. Has this been a make-or-break issue in deals you have handled?

Auguste: Not at all. We may include in the risk factors the effect of changes in the exchange rate, however, it has not yet been a factor that has caused a Chinese company not to go forward with a transaction.

Editor: Do you work mainly with AMEX and NASDAQ rather than the NYSE, or with each?

Auguste: We work with all of the exchanges to get the companies listed in the U.S. The Chinese deals I'm working on now are all on NASDAQ. None of them are on AMEX.

Editor: What else would you like to add?

Auguste: I would think that at the end of the day, what makes transactions involving Chinese companies so interesting and challenging is that they are multifaceted in the sense of the many jurisdictions that may be involved. As U.S. counsel we obviously have a handle on the U.S. laws, but we also have to work with local counsel in China and other jurisdictions. It's very different from working on strictly U.S. deals and seemingly not as subject to changing market conditions. This summer I was working on deals involving two U.S. companies doing secondary offerings, and they were put off because of the volatility in the marketplace. Chinese transactions continue even though our capital markets haven't completely recovered. Clearly, there is a strong desire by investors to invest in Chinese companies.

Please email the interviewees at cauguste@kramerlevin.com or elerner@kramerlevin.com with questions about this interview.