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Road to IPOs in China Remains Long and Murky

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China's IPO action has been locked in ice since October by China Securities Regulatory Commission (CSRC) officials intent on boosting investor confidence and improving scrutiny of stock market hopefuls.

Yet the heat is on for aspiring executives at more than 800 companies who, despite the freeze, have continued lobbying CSRC for permission to launch initial public offerings on the Shanghai and Shenzhen exchanges.

No one knows when CSRC might thaw the market for new listings. So executives have been busy door-knocking deep inside the commission at its dual "public offering departments" – one that reviews IPO applications for the Shenzhen Stock Exchange's ChiNext growth board, the other for the Shanghai Stock Exchange A-share market.

They've also been busy wining, dining and warming up to members of CSRC's elite Public Offering Review Committee (PORC), which ultimately decides the fate of every IPO application that's survives the commission's lengthy company review process.

(Read More: China Lowers Threshold for Overseas IPOs)

In pursuit of warm relations, Caixin has learned, some IPO-hungry company executives have played along with rent-seeking CSRC officials. They've also paid intermediaries who charge enormous fees for access to key CSRC officials. Tens of millions of yuan may have traded hands in recent years.

Since taking office in October 2011, CSRC Chairman Guo Shuqing has tried to clean up the agency via a large-scale personnel shuffle. As part of the change, many public offering department and PORC officials have traded their positions with other CSRC staffers. But problems persist.

Unique among the world's securities market regulators, CSRC strictly controls new listings by thoroughly investigating financial conditions for each IPO applicant. But IPO approval power is concentrated inside the public offering departments, each of which assigns only two review staffers and two directors per application, and the PORC.

Ten application process steps and "11 key people can decide life or death for a public offering," said an executive at a private company that's applied for an IPO. The executive, like most sources for this story, spoke with Caixin on condition of anonymity.

Buying Votes

C'est La Vie is an upscale restaurant near CSRC's headquarters on Beijing's west side that serves shark's fin soup, abalone and other delicacies. A single tab can run up to 1,000 yuan per diner.

Even pricier than the meals, however, are the deals negotiated around the restaurant's tables when executives from IPO-applicant companies get a chance to treat one or more CSRC officials.

A separate expense for an applicant is what's paid to an intermediary agent whose job is to arrange get-togethers at C'est La Vie and similar venues. An agent in charge of a single night's meal can pocket more than 100,000 yuan.

On top of that, sources said, a single CSRC official who plays a role in an application review can demand an illegal payoff in the 300,000-500,000 yuan range per IPO hopeful.

Company executives, intermediaries and executives working for the underwriters of proposed IPOs confirmed for Caixin the secretive process through which a company can basically buy CSRC's approval for an IPO.

Among those at the receiving end of the money train are members of PORC, which assigns seven of its 60 members to a single case. Members review public offering department reports and ultimately judge an IPO plan worthy of the market or not.

Most PORC staffers work full-time for CSRC, while the rest are hired from law and accounting firms to review applications as needed. At times, CSRC officials draft lawyers and/or accountants to serve on a PORC. Law and accounting firms are happy to accommodate because typically a link to PORC is a boon to their business.

In a normal year, a single PORC member can review up to 50 companies, said a source close to the process, adding that about 80 percent of the applications are approved.

Simple math points to the considerable financial advantages available to those PORC members who accept payoffs. The source said a single corrupt CSRC official can make about 10 million yuan a year.

"Of course, not every member accepts money," the source said. "Those who do (accept) don't take money from every company" because "security is the No. 1 concern."

A source at a securities firm's underwriting office said "all kinds of measures are used to give favors to" a rent-seeking PORC member who is tapped to vote on an IPO application. "It's an open secret."

Caixin contacted several PORC members. None would discuss these allegations of malfeasance.

More from Caixin Online:

The Big Eleven

It's been argued that the groundwork for graft was laid when CSRC instituted a lengthy, generally opaque IPO application process in 1999 and strengthened it with a 2006 amendment to the Securities Law that made preliminary reviews of IPOs mandatory.

The process usually starts at the narrow, front-door security checkpoint at CSRC's headquarters at the Fukai Office Tower in Beijing. That's where anxious representatives from securities firms daily line up with heavy boxes filled with IPO application documents.

Some documents eventually reach the ChiNext public offering department on the sixth floor or the Shanghai exchange department on the 11th floor.

Some light was shed on the murky process of reviewing and deciding the fate of IPO applications in May 2006, when CSRC outlined procedures for review committees. But details of the procedures were kept out of the light of public scrutiny until last year.

CSRC established a step-by-step process that every aspiring company must follow. Two public offering department staff members give each application a preliminary review, with one official focusing on legal issues and the other accounting.

A preliminary review staff can quickly sift through documents and decide whether an applicant is eligible for further review. If the light is green, the public offering department's directors meet with a pair of preliminary review staff members to discuss qualifications and compile a list of follow-up questions for company representatives.

Company executives and their underwriters soon thereafter may be summoned to meet these CSRC officials and give a 10-minute presentation. They are then allowed a short discussion with the review staffers and directors.

CSRC's follow-up questions are later sent to the company and underwriters. Additional materials and explanations may be requested, and answers must be received within 30 days.

Since ChiNext was formed, CSRC records show the commission voided applications from 37 companies seeking a trading slot because they failed the question-and-answer test.

A company that answers all questions to satisfaction and on time is rewarded with a preliminary announcement of its stock market intentions on the CSRC website. Public scrutiny is then invited.

Under the Securities Law, CSRC bears the responsibility to investigate any report of fraudulent activities involving an applicant. An entire service sector has grown up around this rule.

And the sector has a dark side. For example, as Caixin reported in June 2012, a number of public relations companies, media organizations and law firms have profited by sniffing out problems at IPO hopefuls and using this information for extortion schemes centered around threats of negative media coverage.

(Read more: Will 2013 Bring More Pain or Gain for China Stocks?)

A CSRC official who spoke with Caixin insisted negative publicity about a company would never color an IPO decision. "We make our own, objective judgments," the official said. "Reports from a company's competitors are usually more to the point and useful" than media reports in helping officials identify problems.

After public notification comes the sixth step toward an IPO approval: A preliminary hearing that functions as the key to the whole decision-making process because it's attended not only by the original application review staffers and the public offering office directors, but also by all seven members sitting on the assigned PORC.

At the hearing, PORC members read the public offering department's staff report on the legality and financial accountability of an applicant. Then, each member can comment. All remarks are on the record.

Hearings for main board and ChiNext applicants are unlike, a CSRC official said, in that the latter usually determines a company's fate but the former does not.

After the hearing, all relevant documents including records of PORC members comments are sealed and closed to public access. At this point, an application may be rejected. Companies that survive, though, are invited to a 45-minute hearing that makes up the procedure's ninth step.

Five days before the formal hearing, another CSRC announcement on its website names the company and members of the IPO application review committee.

After the hearing a so-called "significant events report" mechanism begins. In this way, legal and financial intermediaries are obliged to tell CSRC – and have their input included in the company's prospectus – any information they have on major lawsuits or any other "important events" involving the applicant.

This step holds underwriters accountable for an application's truthfulness. Any honesty gaps that come to light later can have serious consequences.

For instance, CSRC chastised the securities firm Guotai Junun last year after its underwriting client, a Shenzhen-based manufacturer of solar batteries called Jiawei Corp., reported financial trouble a few months after listing on ChiNext. The company posted a 94 percent decline in net profit, undermining the credibility of its prospectus. CSRC banned the Guotai Junan office handling Jiawei from underwriting for three months.

The underwriters "knew about the profit slump for the first quarter but didn't disclose it," a CSRC source said. "All of the accountants and lawyers signed (the prospectus) without reading the files."

If all goes well, and a company wins PORC's blessing, it's technically ready for an IPO. But in fact, the full public offering department controls the green light and can flip the switch, or wait, as it sees fit based on market conditions and other factors.

CSRC's campaign to boost investor confidence before allowing more IPOs has forced the department to keep its finger off the switch for scores of pending IPOs.

More than 90 of the 800-plus companies seeking a public listing have passed each of the first, nine steps of the process. As of early February, each was awaiting a go signal to proceed to the 10th step: formal permission and a launch.

Transparency Calls

The significance of a meal at C'est La Vie and subsequent under-the-table deals is clear in light of the long, thinly transparent CSRC procedure that gives what is arguably too much power in the hands of just 11 people – the preliminary review staffers, the public offering department directors, and the seven-member PORC.

In addition to Guo's personnel changes, efforts are under way to make the whole IPO review process less opaque.

The shift to more transparency began in 2010, before Guo took office, when CSRC officials decided that any company whose IPO application was rejected during a review process must be told the reasons within a month.

Moreover, CSRC in April 2012 promised to make public more information about the entire review process, release the names of each PORC member, and issue a monthly status update on companies under review.

Rules that require PORC members to participate in preliminary hearings came into force in 2012, helping them better understand each applicant-company and its needs.

Nevertheless, specific information about exactly how CSRC officials go about deciding whether to approve or reject an application is still carefully guarded. And no one at the agency will talk about the allegations of vote-buying and shark's fin soup.

Industry sources and scholars have said more transparency should be injected into the IPO review process. They also want application review meetings and PORC voting records to be made public. One advocate is Guo Li, a law professor at Peking University.

"Based on the power CSRC enjoys," he said, "it should meet the highest standards of transparency."

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