China Dream or China Nightmare

The Nightmare, by John Henry Fuseli. Don't let this become your China reality.

The frustrating thing about China is that even 15 years after China’s entry into the WTO, many of the attractive business opportunities in China are still closed to foreign investors. There are many examples: telecoms, insurance, transportation. And though foreign investors are frustrated, cash poor Chinese entrepreneurs are similarly frustrated because these “closures” make it difficult — sometimes impossible — for them to raise foreign capital to exploit these markets. With frustration on both sides, Chinese businesspeople are constantly working on schemes to evade China’s regulations. These schemes are then sold to foreign investors eager to share in the China dream.

The problem with these schemes is that they nearly always involve evading Chinese law. Foreign companies frequently come to the China lawyers at my law firm asking us to review one of these schemes. This is not good business for our firm, because where the scheme involves illegally investing money in China, we always warn against participation and then cease our legal representation going forward. On top of this, the foreign company often becomes frustrated with us, all but accusing us of having blocked them from their China fortune. My reply is to indirectly ask a simple question: now that you know the scheme is illegal, why do you think it will work to your benefit? They usually respond with one of the following:

1. They point out that other foreign investors have been permitted to invest in China under the same type of scheme. Our response is to agree that Chinese regulators often will look the other way in allowing foreign money to enter China. Nothing at all new here.

After conceding that China let these investors send money into China, I ask them if they can name even ONE of these foreign investors who was allowed to repatriate their investment back out of China with a reasonable profit. I have been asking this question for more than twenty years and nobody has ever come up with a single verifiable example of a foreign investor in an openly illegal investment scheme being allowed to take their money out of China at a profit.

What actually happens to these investors is that when the investor seeks to cash out, the Chinese regulators discover (again?) the irregularities and block any remittance of equity or profit. The rule on all of this is very simple and is one we have been preaching since we started this blog: it is easy to get money into China illegally, but it is nearly impossible to get the money back out. Of course, this rule applies mostly just to foreign suckers as Chinese nationals are often able to pull off the complete scheme. Their success is what often fools foreign investors into thinking the same program is open to them. It is not. Repeat after me: “It is not.”

2. An equally popular response is that the scheme is being promoted by a large and prosperous Chinese company, usually a national or regional state owned enterprise. The investor will then tell us that if this big government owned bank or insurance company or shipping company or whatever is promoting this scheme, how could it possibly be illegal in China? This kind of reasoning is just a trap.

Recently I was contacted by a U.S. securities trader who was being presented with a scheme for trading shares on the Shanghai stock market. As is generally known, foreign entities or persons are not permitted to trade A shares in Shanghai. This particular trader is expert at identifying risks, and he asked us to look at the scheme. We told him the scheme is illegal and though it will no doubt be easy to get your money into China, you will never be able to get it out.

He then asked how this could possibly be considered illegal when it is being promoted by one of the largest securities brokers in China and a state owned enterprise on top of that. There is no way this program (“scheme”) could have a better pedigree. I stuck to my guns.

Less than a week later I read in the Hong Kong press that Mr. Xu Gang , the Chairman of the Board of Citic Securities had been arrested together with seven of the company’s top executives. One of the charges against the Citic executives was for promoting illegal trading schemes. That is, the exact type of scheme that had been promoted to the savvy trader who contacted us. Had this savvy investor put his company’s money into this scheme, it is likely none of it would ever have come back.

Bottom Line.
 If a program is illegal in China, don’t do it. If you cannot make money in China by complying with Chinese law, invest elsewhere. Never believe a Chinese promoter who seeks to assure you that the Chinese government “looks the other way.” Do not allow your China Dream to turn into a China Nightmare.

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