Editor: As special counsel at Kelley Drye, you focus your practice not only on China but also on Japan, Korea, Thailand, Indonesia and Mongolia. What types of work are you performing for Kelley Drye in regard to these countries?
Carter: My work falls into two categories: for non-U.S. companies I help with mergers and acquisitions, capital markets, and cross-border business transactions. The M&A side involves both buy and sell, and capital markets work involves generally representing companies in their need to generate working or long-term capital. The more interesting part for me is my involvement in cross-border business transactions. For example, I am currently representing a Chinese manufacturer of electronics who wants to get its products into Brazil. We will work with them to identify Brazilian distributors and then handle the legal work related to getting their products into Brazil.
The second category is the reverse: I work with Western companies that want to get into these markets, helping them solve any problems that have deterred them.
My work always begins with understanding the business before introducing the law side. It is necessary to first have a good business plan or solution. For an example of my cross-border work, I am in Japan now working with a pachinko company, pachinko being a form of gaming. The company wants to do an IPO, but for regulatory reasons cannot do an IPO in Japan, so my engagement is to design and implement a structure to permit them to effect an IPO in another country. We’ll find a better forum elsewhere as well as the best underwriter and placement agent, knowing that next in line will be heavy legal work. This is typical of my effort on behalf of foreign companies that need to do cross-border work.
Many times in representing American companies, it is a matter of helping them know where to go. Recently, one of my partners had a client who wanted to do business in China and needed a particular type of license but didn’t know how to secure it. I called some knowledgeable sources as well as helped them secure an opinion from one of three Chinese law firms. At the end of the day that’s what lawyers ought to be – problem solvers.
Editor: Please describe your work as president of the Asian Division of Siemens First Capital, a joint venture between Siemens AG and First Capital Financial Services.
Carter: First Capital was, and still is, an asset-based lender in the United States. As you know, asset-based loans are high risk and generally backed only by accounts receivable for the assets themselves. First Capital had a joint venture with Siemens to increase its footprint in Asia by expanding the portfolio of asset-based financings. To achieve this, as a business strategy, I began partnering with Asian banks, many of which had not been in asset-based lending before.
Editor: As of today, do you find that Chinese companies are active in the U.S. market?
Carter: Throughout Latin America and Asia markets they are still doing very well compared to the United States. There is a policy in China that encourages Chinese companies to make acquisitions in the United States to stimulate the economy in the United States.
Editor: Are Chinese companies still active in the IPO market in the U.S.?
Carter: Much less than previously. As you will remember, there has been a lot of discussion related to the accounting practices in China, and this has been reflected in market acceptance of publicly traded Chinese companies.
There are many Chinese companies that want to be publicly traded but cannot get into the market other than as an OTCBB, which is not attractive. One prevailing strategy is for a Chinese company, typically one that is an OTCBB bulletin board company, to perform a reverse merger with a company listed on the AMEX, NYSE or NASDAQ in order to gain access to a robust market, gain more liquidity, gain a larger number of shareholders and gain an opportunity to grow its capital base.
Editor: Is there a problem in terms of getting an accounting that can be relied upon by investors?
Carter: It’s no secret that smaller publicly traded Chinese companies have come under a lot of scrutiny over the accuracy of their financials. On the other hand, we look at the large Chinese companies, such as Citic, China Bank, Ag Bank – they are not getting the same criticism because they have adopted a Western culture system of internal controls. The smaller companies are the ones being challenged.
Editor: You were president of several Chinese companies in the energy, transportation and manufacturing areas. Please describe the products and services these companies provided.
Carter: One of the companies is called CCTC – Central China Transportation Corporation, a company similar to the old Greyhound Bus Company. We had about 6,000 buses that we operated, taking people from city A to city B – cities within 20 to 200 miles of one another. We moved about 4.5 million people a month. It was an all-cash business, making it a challenge in terms of internal controls – how do you take care of thousands of small transactions each day?
I also worked for Tincy Energy, which owned the drilling rights to the largest offshore heavy oil field in China, situated in the upper Bohai Bay. The company brought me in to help address some difficult issues: does the company raise hundreds of millions of dollars to drill or do we structure a joint venture with a larger company, and if we do, who is the right joint venture partner, what should the royalty rights be, how do we protect ourselves on the back-end if they don’t deliver? We joined with Petro China in a joint venture partnership, but we controlled the drilling rights for more than 25 percent of the total heavy oilfields offshore.
Typically, when I went in as an executive, it was because the company was at a critical juncture, knowing that it needed Western expertise to set up a model organization with stronger controls. Many times they were in the process of negotiating large-dollar capital transactions with Western entities and needed some guidance.
Editor: What key considerations should U.S. businesses be aware of when making investments in China?
Carter: I always recommend to my clients that they get to know the other side. For example, the Chinese military is one of the largest investors in the country; it funds many companies either directly or indirectly. If the military is involved, it is wise to know this. You need to know who you’re doing business with, you need to know how they’re governed, you need to know what their priorities and motivations are; otherwise, you risk not closing the transaction. Understanding the cultural side is extremely important. We in the West tend to think that written documents are the right way to go whereas throughout Asia, particularly China, the written documents are not as important as the personal side because in their world, given what they have gone through, the only thing they can count on long term is people.
Editor: Why should U.S. companies with Chinese partners be especially due diligent in such areas as the Foreign Corrupt Practices Act and China’s Antibribery Law?
Carter: There are some pretty substantial differences in regulations. The United States has adopted statutes and regulations that establish rules such as the Foreign Corrupt Practices Act that are mandated on our side of the equation, whereas other countries, even China, do not have those same stringent rules. Your foreign partner can see nothing wrong with engaging in certain practices that in the U.S. would not be tolerated, such as extravagant entertainment or side business deals. In China it’s just a basic fact of life, and so reconciling those two differences is very important; otherwise you can find that you have an inadvertent violation.
Almost every country has non-bribery and business conduct statutes. While these may not be freely violated, the perception of what constitutes a violation is different. An example is what is called the “window company.” This is where a company will send a representative to another jurisdiction to set up an entity which serves as a pass-through company to create the illusion of a commercial transaction. For instance, a Chinese company sends a business associate to Hong Kong to establish a company to conduct business with the Chinese company. On paper, it appears to be an arms-length commercial transaction when, in fact, both sides are controlled by the Chinese company. The end result is that profits are generated in Hong Kong, not China. From a U.S. perspective, this structure is not appropriate, but in China (and in other parts of Asia), it is a functional “means to an end.”
Editor: How does one negotiate deals differently with Asian companies from the way one would negotiate an all-U.S. transaction?
Carter: Because I have spent so much time in Asia, I approach deals differently. When you’re dealing with Asian executives, it’s very important to build a relationship. I spend more time on the front end building the relationship and trying to understand their real motivation and, in turn, spend much time deliberating negotiations at the front end. They are remarkably risk adverse and don’t want to lose money, but to an even greater degree, they don’t want to embarrass themselves.
Editor: With the turnover in government in China, do you expect any greater moderation in the leadership?
Carter: China is going through a very complex process. This is only the second time that China has had a transition of power on a truly peaceful basis. They got there through a series of non-public negotiations and agreements between the different individuals who have power. Remember, in China, less than four percent of the population belongs to the Communist Party, which is run like a corporation with an HR department that decides on the criteria for holding certain positions. Every five years, a Party official can be relocated from one type of job to another. A very good friend who was at a Chinese embassy in a Western country found himself being put in the insurance business in Beijing. While, perhaps to a Western frame of mind, this appears dysfunctional, from a political perspective, it serves the purpose of preventing large political bases from being established. We’re seeing a shift from people who were largely more engineer-oriented to people who have a broader, more global experience. Whether they’re going to prove in the long run to be conservative or more liberal, time will tell.
I will note that, for the first time, the three largest economies in the world (U.S., China and Japan) are each experiencing in a 45-day period changes in their national government structure. It will be interesting to observe how these changes impact the world economy and stability.
Editor: Combating corruption was one of the main themes in a speech delivered by the outgoing president to the Chinese congress.
Carter: Retiring President Hu warned that corruption threatens both the existence of the Party and the existence of the state, and there will be a lot of discussion on what to do about it and how to deal with it.
Within China, there is growing frustration and concern over corruption. Every day there are articles in the major Chinese newspapers on this subject. On occasion, there have been large, visible demonstrations against corruption, and the government tries to respond to them. My personal belief is that, within China, there is an unwritten “social contract” between the people and the Party. In essence, the people will accept the tax structure, will comply with the laws and will tolerate the Party, so long as the Party fulfills its promise to take care of the people. When that promise is not fulfilled, as occurs when there is corruption within the government, there is a loss of confidence in the Party, and this, as former President Hu said, can threaten the existence of the Party and the state.