RISK FACTOR

Chinese regulators flagged illegal practices at Alibaba months before its monster IPO

This article was updated Jan. 29 at 11am in Hong Kong with Alibaba’s response.

China’s top business regulator, the State Administration for Industry and Commerce, consulted Alibaba on “illegal business activities” on its online shopping platforms in July of 2014, two months before the company launched the world’s largest-ever IPO.

In a white paper released Jan. 28 (link in Chinese), the SAIC said its officials in Zhejiang province held an “administrative guidance forum” with “principal officers and management teams of core departments of Alibaba Group” on July 16, 2014 to talk about the practices. The meeting was not made public in order not to impact Alibaba’s IPO, the SAIC paper said.

Among other things, the paper accuses Alibaba’s shopping platforms of selling banned, dangerous, and counterfeit goods, dealing with unlicensed vendors, holding misleading sales promotions during its “Double 11” shopping bonanzas, having a flawed credit ranking system for sellers, and lax internal staff controls.

In an e-mailed response, an Alibaba spokesman said shopping platform Taobao was the victim, not beneficiary, of counterfeit products and was working hard to combat them. The company accused SAIC director Liu Hongliang of “procedural misconduct during the supervision process; irrational enforcement of the law; and obtaining a biased conclusion using the wrong methodology,” which is said “has inflicted irreparable and serious damage to Taobao and Chinese online businesses.” Taobao is filing a formal complaint with the SAIC, the statement said.

Alibaba started trading on Sep. 19 in New York, in a listing that valued the company at more than $230 billion. The company’s prospectus lists potential investigations and regulatory oversight as a potential risk factor (pdf, p. 39) but never mentions the SAIC specifically or the July meeting:

We have from time to time been subject to PRC and other foreign government inquiries and investigations, including those relating to website content and alleged third-party intellectual property infringement… None of these inquiries and investigations has resulted in significant restrictions on our business operations. However, as we continue to grow in scale and significance, we expect to face increased scrutiny, which will, at a minimum, result in our having to increase our investment in compliance and related capabilities and systems.

The fact that the government has made this fight with Alibaba public is particularly damning, and indicates a risk to shareholders, Muzhi Li, a Hong Kong-based analyst at Arete Research, told the Wall Street Journal. “The government is determined to further escalate this case,” he said.

David Webb, founder of corporate governance watchdog Webb-site.com, told Quartz that the paper “certainly raises questions about whether there was adequate disclosure in the IPO prospectus of ongoing regulatory actions and whether the SAIC even conspired with Alibaba to keep this information from IPO investors.”

Zheping Huang contributed reporting.

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