September 3, 2018 / 9:34 AM / 3 months ago

Breakingviews - JD CEO's arrest steps on governance landmine

JD.com founder Richard Liu attends a Reuters interview in Hong Kong, China June 9, 2017. REUTERS/Bobby Yip

HONG KONG (Reuters Breakingviews) - JD.com shareholders just got an abrupt reminder about their investment. Richard Liu, the founder and chief executive of the $45 billion Chinese e-commerce company, was arrested in the United States for alleged sexual misconduct and released. Even if he is cleared – JD says the accusation is “unsubstantiated” – the episode renews questions about corporate governance and the use of legally untested structures.

In what Minnesota authorities call an active investigation, there are many implications for JD. First, the #MeToo movement against sexual harassment and assault has been gaining traction in Asia. The allegations could put off JD employees and customers.  

Second, it is not entirely clear how JD might operate if Liu is detained or incapacitated for a long stretch. Liu owns a 16 percent economic stake in the company, but controls 80 percent of the vote thanks to a feudal shareholder system that was cemented in the 2014 initial public offering. It means even heavyweight backers such as Tencent, Walmart and Alphabet’s Google have limited say.

What’s more, in a further abuse of good governance practices, Liu holds the chairman’s seat as well as serving as CEO. There is no obvious second-in-command or successor. JD would be essentially paralysed without him. Under the articles of association, “our board of directors will not be able to form a quorum without Mr. Richard Qiangdong Liu for so long as Mr. Liu remains a director,” the company said in documents submitted to U.S. regulators in April.

These concerns are compounded by JD’s use of variable interest entities, a tortuous form of ownership. Laws in the People’s Republic restrict foreigners from investing in sensitive industries such as technology, so Liu, along with two other employees, personally control JD’s core operations and internet licenses through their ownership of the VIEs. It has not been established, however, that the various contracts and agreements between the New York-listed, Cayman Islands-based JD and the VIE owners are legally recognised and enforceable in Chinese courts. It leaves overseas investors in a legal gray area.

JD has been under significant pressure already. Its shares have slumped 25 percent over the past year against a 27 percent rise in the Nasdaq. Concerns are mounting about slowing growth and tougher competition with Alibaba. However Liu’s case turns out, it underscores some deeper concerns.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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