Alternative Routes To U.S. Markets Impact Reporting Requirements For Chinese Companies

According to the U.S. Securities and Exchange Commission's Web site, there are currently 144 domestic Chinese companies registered with the Commission. This number is deceiving, however, since more and more Chinese companies are entering the U.S. through business combinations with U.S. domestic listed companies or through off-shore holding companies, utilizing the wholly-owned foreign enterprise (WOFE) structure. While the end result is the same ' a listing on a U.S. exchange ' the decision to 'domesticate' in the United States or remain a 'foreign private issuer' can have significant ramifications for the company's ongoing regulatory compliance obligations. Foreign private issuers continue to enjoy certain levels of relief from the U.S. compliance regime by virtue of the fact that they are also required to comply with their local, or 'home country', reporting requirements.

Paths to the U.S. Public Markets

The current favoured strategy for many Chinese companies is to consummate a reverse merger with an existing SEC reporting company, preferably one that is listed on Nasdaq or the AMEX. A long-standing M&A vehicle, this structure has been revitalised by the dynamics of today's capital markets into a quick and easy route to the U.S. public markets. The reverse merger is no longer driven principally by tax or other structural considerations; rather, it offers a public liquidity option for private investors, while providing a broadened institutional and retail investor base. Today's reverse merger is considered preferable to a traditional IPO, since it allows the company a gentler, more predictable foray into the continuing volatile U.S. public markets. In August 2006 alone, generally a 'quiet' month for market activity, 11 reverse mergers were completed and five more were announced, with activity showing no signs of weakening.

The reverse merger continues to garner market favour over a traditional IPO for several reasons. The capitalisation structure is negotiated in advance, including the ability to adjust the existing public float and allocation of control to desired post-transaction levels. Similarly, the pricing framework is negotiated as part of the merger agreement, leaving little opportunity for the transaction to stall as a result of valuation concerns. With an existing public shareholder base provided by the target-listed company, the transaction is far less susceptible to IPO market cycles. The once-private company, post-merger, now has 'acquisition currency' through its publicly-traded stock, which has become increasingly in demand in recent years.

Typically, the surviving corporation will be a controlled U.S. corporation, with the original investors in the Chinese company maintaining upwards of 90% of the outstanding share capital. This puts obvious pressure on the trading market, and a strategy to address liquidity issues should be developed prior to the close of the transaction.

To tackle this issue, most Chinese-U.S. reverse mergers will include a concurrent fundraising exercise, known as a PIPE financing or 'private investment in a public entity.' This is often designed to increase or diversify further the public investor base, and can include shares from current private investors seeking to sell-down their holdings. In addition, the PIPE provides a very valuable opportunity for the Chinese company to embark on an institutional roadshow to raise investor awareness and, ultimately, to support the after-market trading of the stock. Capital raises are typically designed to secure working capital or an acquisition war chest. The offering is conducted as a private placement with registration rights, with closing scheduled to coincide with that of the reverse merger or shortly thereafter.

Over the course of the past 18 months, PIPEs conducted in connection with a reverse merger have raised amounts equal to over half of the company's pre-money market capitalisation. This has created concerns at the SEC, where certain staff members may view the resale registration as, in fact, a primary offering by the company. Recent deals have been structured to account for this concern in order to avoid any delays by the Commission in declaring the registration statement effective.

After-market support is critical with any reverse merger, but particularly so for a Chinese company making its initial foray into the U.S. market. Chinese companies must ensure that they obtain good market makers and do not rely on those of their merger partner, who may be in a different industry or sector. Similarly, an investor-relations team needs to be secured early in the process. Without these key players, the company may struggle to develop an active trading market in its stock.

The majority of reverse mergers are affected with OTC Bulletin Board companies, although reverses have been done as well with AMEX, Nasdaq and even AiM listed companies. Two reasons are evident for the popularity of Bulletin Board companies. First, the acquisition price of the target-listed company can be significantly less than that of an AMEX or Nasdaq company. Prices for Bulletin Board companies have increased over 100% in the past 18 months and average in the $500,000-plus range. A 'clean' Nasdaq Capital Market company can cost over $1 million. This price inflation has caused a number of 'service providers' to register Form 10 shell companies with the SEC, solely to meet the demand of the burgeoning reverse merger market.

Another reason to favour a Bulletin Board company over a Nasdaq or AMEX target is to avoid the more stringent listing requirements imposed by those exchanges. The Bulletin Board requires that a company remain current in its SEC filings, but does not impose the more demanding corporate governance controls of the main exchanges. This enables the Chinese company to ease itself into the U.S. reporting and compliance regime, develop its cost and support infrastructure on a more measured basis and then 'graduate' to a main exchange.

If, however, the Chinese company sets its sights on a main exchange, it must be certain that it can meet the demanding quarterly reporting schedule imposed by the SEC. The reporting and compliance regimen for U.S. domestic issuers is a principal reason that many Chinese companies choose to remain foreign private issuers and list their shares in the U.S. through an off-shore holding company, typically located in the British Virgin Islands, Hong Kong, or the Cayman Islands.

In recent months, there has been a developing twist on the reverse merger strategy, and that is to utilise a merger with a SPAC, or Special Purpose Acquisition Company, as a path to the public markets. The end result is the same: the privately held Chinese company becomes a public listed U.S. company. Most SPACs are listed on AMEX or the OTC Bulletin Board, as Nasdaq has taken a policy decision to exclude these entities from listing on its exchange. SPACs can also be listed on AiM and, notably, without the U.S. regulatory burden or structural restrictions. A SPAC offers the Chinese company a broader institutional investor base than is typically available in the reverse merger. This can be a significant advantage in establishing an active trading market for the surviving company. One issue that needs to be addressed in the merger negotiations is with respect to the management team of the surviving company. A SPAC will have a credible and accomplished management team, which is used to lure quality investors in the SPAC's initial public offering as well as to find and ultimately to merge with a target company. Arrangements will need to be made as between the SPAC management and the target's management with respect to the ultimate team in control of the surviving entity. However, this is less of an issue with a Chinese company, as there is more room for both management teams to co-exist, at least in the short term, with the U.S. team providing the local market support and access to institutional investors.

Recent SPACs have been formed solely with the intent of locating a suitable merger partner in China. For example, Great Wall Acquisition Corporation was formed in March 2004 with the intent of acquiring or merging with a China-based technology, media or telecommunications company. It eventually merged with ChinaCast Communication Corporation. Shanghai Century Acquisition Corporation, formed in April 2006, is not focused on any specific industry in China, whereas others, such as China Mineral Acquisition Corporation, are sector-specific. This trend in country-specific SPACs is expected to continue as the markets in China and other countries, such as India, present very attractive opportunities for institutional investors.

U.S. Reporting Requirements of Public Companies

Every company that has registered securities under the federal securities laws, which would include securities listed on a U.S. exchange or the OTC Bulletin Board, is required to file certain reports with the SEC. The company is required to file Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q, which must contain certifications of the company's chief executive officer and chief financial officer, along with Current Reports on Form 8-K of certain company events that should be brought to the prompt attention of the investing public. Annual Reports, which include audited year-end financial statements, must be filed with the SEC within 90 days of the fiscal year-end. Quarterly Reports, which also contain quarterly unaudited financial statements, must be filed within 45 days of the end of the respective quarter. This timetable can be onerous for many Chinese companies that may not initially have the infrastructure in place to allow them to comply on a timely basis.

Notably, a less onerous regime exists for foreign private issuers and therefore provides a significant incentive for Chinese companies to remain 'offshore'. Foreign private issuers are required to submit audited financial statements with respect to the year-end numbers within six months of the fiscal year-end in an Annual Report on Form 20-F. Interim financial statements, which must be provided at least semi-annually, need not be audited and are submitted to the SEC on a Form 6-K. The Form 6-K is akin to the Form 8-K report for U.S. domestic issuers and does not require the detailed disclosure of a quarterly report on Form 10-Q. This distinction in reporting requirements is not limited to annual and interim reporting, however.

A U.S. domestic company also must comply with the SEC proxy rules when it solicits a shareholder vote or consent. Generally, the proxy rules require that a proxy statement be mailed to each shareholder of record in advance of every shareholders meeting, setting forth detailed information regarding the issues to be voted upon and certain matters related to the company and its management. All proxy solicitations must satisfy the proxy rules, which require that each time the company solicits proxies from its shareholders it must provide a proxy statement describing the matters being submitted to a vote of the shareholders, and other related information, together with a form of proxy on which shareholders can vote for or against each matter being submitted. If, however, the Chinese company remains offshore it is not subject to these proxy rules on the theory that it will comply with its home country requirements regarding shareholder meetings and the like.

Another issue which should not be overlooked by Chinese companies considering whether to domesticate or maintain an offshore domicile is with respect to the ability to 'deregister' from the U.S. reporting regime. The SEC proposed new rules in December 2005 for foreign private issuers seeking to deregister and final rules are expected before the end of 2006. In essence, the U.S. reporting and compliance regime under the Securities Exchange Act of 1934 precludes a company from truly exiting from the SEC's requirements once its securities have been registered. This is colloquially referred to as the 'roach motel' ' once you get in, you can never leave. A company can 'delist' from an exchange easy enough, but its obligations under the Exchange Act are merely 'suspended' until and unless it exceeds certain thresholds in terms of shareholders and assets, at which point it is again subject to full reporting.

Since the advent of the Sarbanes-Oxley Act of 2002, the volatility in the IPO markets, and other economic and market events, many non-U.S. companies have been reluctant to risk entering the U.S. public markets for fear that, if things do not turn out as well as expected, they will not be able to 'terminate' their U.S. reporting requirements. The final rules expected before year-end 2006 are expected to alleviate this concern. However, it is unclear whether U.S. domestic issuers will be afforded similar opportunities to terminate their reporting requirements.

Reporting Requirements of Certain Insiders

Many Chinese companies are unaccustomed to the extensive reporting obligations imposed on officers, directors and beneficial owners of more than 10% of the shares of the company by the U.S. federal securities laws. These persons are required to report transactions in company securities on Forms 3, 4 and 5, which are filed with the SEC. Form 3, an initial statement of beneficial ownership, must be filed within 10 days after the event by which a person becomes a reporting person. For Chinese companies entering the U.S. market for the first time through an initial public offering, reverse merger or other transaction, this initial obligation to report within 10 days is often overlooked. Form 4, a statement of changes in beneficial ownership, generally must be filed before the end of the second business day following the day on which a transaction resulting in a change in beneficial ownership is executed. Form 5, an annual statement of beneficial ownership, must be filed on or before the 45th day after the end of the company's fiscal year.

These persons are also subject to special rules concerning short swing profits recapture. In general, any such person that realises a profit on a purchase and subsequent sale, or a sale and subsequent purchase, of any class of equity securities of the company within a six-month period must return such profit to the company. Certain transactions, particularly under employee stock purchase plans and employee benefit plans, are exempt from short swing liability.

Like the annual and quarterly reporting requirements and proxy rules, these rules do not apply, however, to Chinese companies who remain offshore and maintain a foreign private issuer status.

In addition, beneficial owners of more than 5% of any registered class of the company's shares are subject to special reporting and disclosure requirements. Such owners are required to make certain disclosures by filing with the SEC either a Schedule 13D or Schedule 13G.

Sale of Restricted and Control Shares

Upon closing of the business combination, the company's outstanding registered or unrestricted shares of common stock will be freely tradable in the public securities markets. However, persons holding 'restricted securities' and 'affiliates' of the company may not sell their shares in the public market until a registration statement covering the sale of such securities has been declared effective by the SEC, or unless an exemption from registration is available. Rule 144 under the Securities Act of 1933 provides a safe harbour from such registration requirements and allows holders of restricted securities and affiliates to sell their shares subject to holding period, volume, current information, manner of sale and notice requirements. Such restrictions on resale lapse after 2 years for holders of restricted securities who are not also affiliates. Affiliates, however, remain subject to the Rule 144 requirements for public resales of all of their securities of the company. Executive officers, directors and holders of at least 10% of the company's equity securities are generally considered to be 'affiliates' for purposes of U.S. federal securities laws.

It is common in a reverse merger for the original investors in the Chinese company to hold restricted shares in the surviving U.S. corporation as a result of the business combination. Generally, these investors are also affiliates. As a result, liquidity for their shares is limited unless the shares are registered for resale under the Securities Act. Alternatively, these affiliates can sell their shares pursuant to other available exemptions, such as in private offerings and PIPEs. In these situations, the purchaser will typically require the company to register the shares for resale as a condition to the purchase in order to provide the investor the desired liquidity.

Exchange Requirements

Listed U.S. companies are required to comply with various notification, corporate governance and reporting provisions imposed by the respective exchange upon which their securities are listed. Among other requirements, a company must provide notice of significant company events and must obtain shareholder approval of certain types of securities issuances. Additionally, corporate governance rules require that a majority of the company's board of directors be independent. The company's audit committee must be comprised of solely independent directors and the company's independent directors must approve of the compensation for the company's executive officers, including the chief executive officer, either by an independent compensation committee or by a majority of the independent directors meeting in executive session. In addition, companies must have a code of conduct applicable to officers (including senior financial officers), directors and employees.

The independence requirements, in particular, impose on Chinese companies an obligation to bring outsiders onto the Board of Directors as well as individuals with financial sophistication or expertise. These additional Board members are often U.S. based, providing not only Board support but a local U.S. presence for the company. This presence can be valuable for meetings with investors and pursuit of business opportunities.

Conclusion

The U.S. markets pose many attractions for Chinese companies, both with respect to an active and liquid trading market as well as a ready base for expansion of their operations through establishment of local operations. Opportunities to access the U.S. investor base have increased in recent years, providing viable alternatives to the traditional IPO. Whatever route is chosen, however, companies need to be prepared for the ongoing reporting and compliance obligations imposed by U.S. regulators. Companies should give sufficient forethought to the benefits of maintaining an offshore domicile and thereby reducing its obligations to the U.S. regime.

' 2006 KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.

According to the U.S. Securities and Exchange Commission's Web site, there are currently 144 domestic Chinese companies registered with the Commission. This number is deceiving, however, since more and more Chinese companies are entering the U.S. through business combinations with U.S. domestic listed companies or through off-shore holding companies, utilizing the wholly-owned foreign enterprise (WOFE) structure. While the end result is the same ' a listing on a U.S. exchange ' the decision to 'domesticate' in the United States or remain a 'foreign private issuer' can have significant ramifications for the company's ongoing regulatory compliance obligations. Foreign private issuers continue to enjoy certain levels of relief from the U.S. compliance regime by virtue of the fact that they are also required to comply with their local, or 'home country', reporting requirements.

Paths to the U.S. Public Markets

The current favoured strategy for many Chinese companies is to consummate a reverse merger with an existing SEC reporting company, preferably one that is listed on Nasdaq or the AMEX. A long-standing M&A vehicle, this structure has been revitalised by the dynamics of today's capital markets into a quick and easy route to the U.S. public markets. The reverse merger is no longer driven principally by tax or other structural considerations; rather, it offers a public liquidity option for private investors, while providing a broadened institutional and retail investor base. Today's reverse merger is considered preferable to a traditional IPO, since it allows the company a gentler, more predictable foray into the continuing volatile U.S. public markets. In August 2006 alone, generally a 'quiet' month for market activity, 11 reverse mergers were completed and five more were announced, with activity showing no signs of weakening.

The reverse merger continues to garner market favour over a traditional IPO for several reasons. The capitalisation structure is negotiated in advance, including the ability to adjust the existing public float and allocation of control to desired post-transaction levels. Similarly, the pricing framework is negotiated as part of the merger agreement, leaving little opportunity for the transaction to stall as a result of valuation concerns. With an existing public shareholder base provided by the target-listed company, the transaction is far less susceptible to IPO market cycles. The once-private company, post-merger, now has 'acquisition currency' through its publicly-traded stock, which has become increasingly in demand in recent years.

Typically, the surviving corporation will be a controlled U.S. corporation, with the original investors in the Chinese company maintaining upwards of 90% of the outstanding share capital. This puts obvious pressure on the trading market, and a strategy to address liquidity issues should be developed prior to the close of the transaction.

To tackle this issue, most Chinese-U.S. reverse mergers will include a concurrent fundraising exercise, known as a PIPE financing or 'private investment in a public entity.' This is often designed to increase or diversify further the public investor base, and can include shares from current private investors seeking to sell-down their holdings. In addition, the PIPE provides a very valuable opportunity for the Chinese company to embark on an institutional roadshow to raise investor awareness and, ultimately, to support the after-market trading of the stock. Capital raises are typically designed to secure working capital or an acquisition war chest. The offering is conducted as a private placement with registration rights, with closing scheduled to coincide with that of the reverse merger or shortly thereafter.

Over the course of the past 18 months, PIPEs conducted in connection with a reverse merger have raised amounts equal to over half of the company's pre-money market capitalisation. This has created concerns at the SEC, where certain staff members may view the resale registration as, in fact, a primary offering by the company. Recent deals have been structured to account for this concern in order to avoid any delays by the Commission in declaring the registration statement effective.

After-market support is critical with any reverse merger, but particularly so for a Chinese company making its initial foray into the U.S. market. Chinese companies must ensure that they obtain good market makers and do not rely on those of their merger partner, who may be in a different industry or sector. Similarly, an investor-relations team needs to be secured early in the process. Without these key players, the company may struggle to develop an active trading market in its stock.

The majority of reverse mergers are affected with OTC Bulletin Board companies, although reverses have been done as well with AMEX, Nasdaq and even AiM listed companies. Two reasons are evident for the popularity of Bulletin Board companies. First, the acquisition price of the target-listed company can be significantly less than that of an AMEX or Nasdaq company. Prices for Bulletin Board companies have increased over 100% in the past 18 months and average in the $500,000-plus range. A 'clean' Nasdaq Capital Market company can cost over $1 million. This price inflation has caused a number of 'service providers' to register Form 10 shell companies with the SEC, solely to meet the demand of the burgeoning reverse merger market.

Another reason to favour a Bulletin Board company over a Nasdaq or AMEX target is to avoid the more stringent listing requirements imposed by those exchanges. The Bulletin Board requires that a company remain current in its SEC filings, but does not impose the more demanding corporate governance controls of the main exchanges. This enables the Chinese company to ease itself into the U.S. reporting and compliance regime, develop its cost and support infrastructure on a more measured basis and then 'graduate' to a main exchange.

If, however, the Chinese company sets its sights on a main exchange, it must be certain that it can meet the demanding quarterly reporting schedule imposed by the SEC. The reporting and compliance regimen for U.S. domestic issuers is a principal reason that many Chinese companies choose to remain foreign private issuers and list their shares in the U.S. through an off-shore holding company, typically located in the British Virgin Islands, Hong Kong, or the Cayman Islands.

In recent months, there has been a developing twist on the reverse merger strategy, and that is to utilise a merger with a SPAC, or Special Purpose Acquisition Company, as a path to the public markets. The end result is the same: the privately held Chinese company becomes a public listed U.S. company. Most SPACs are listed on AMEX or the OTC Bulletin Board, as Nasdaq has taken a policy decision to exclude these entities from listing on its exchange. SPACs can also be listed on AiM and, notably, without the U.S. regulatory burden or structural restrictions. A SPAC offers the Chinese company a broader institutional investor base than is typically available in the reverse merger. This can be a significant advantage in establishing an active trading market for the surviving company. One issue that needs to be addressed in the merger negotiations is with respect to the management team of the surviving company. A SPAC will have a credible and accomplished management team, which is used to lure quality investors in the SPAC's initial public offering as well as to find and ultimately to merge with a target company. Arrangements will need to be made as between the SPAC management and the target's management with respect to the ultimate team in control of the surviving entity. However, this is less of an issue with a Chinese company, as there is more room for both management teams to co-exist, at least in the short term, with the U.S. team providing the local market support and access to institutional investors.

Recent SPACs have been formed solely with the intent of locating a suitable merger partner in China. For example, Great Wall Acquisition Corporation was formed in March 2004 with the intent of acquiring or merging with a China-based technology, media or telecommunications company. It eventually merged with ChinaCast Communication Corporation. Shanghai Century Acquisition Corporation, formed in April 2006, is not focused on any specific industry in China, whereas others, such as China Mineral Acquisition Corporation, are sector-specific. This trend in country-specific SPACs is expected to continue as the markets in China and other countries, such as India, present very attractive opportunities for institutional investors.

U.S. Reporting Requirements of Public Companies

Every company that has registered securities under the federal securities laws, which would include securities listed on a U.S. exchange or the OTC Bulletin Board, is required to file certain reports with the SEC. The company is required to file Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q, which must contain certifications of the company's chief executive officer and chief financial officer, along with Current Reports on Form 8-K of certain company events that should be brought to the prompt attention of the investing public. Annual Reports, which include audited year-end financial statements, must be filed with the SEC within 90 days of the fiscal year-end. Quarterly Reports, which also contain quarterly unaudited financial statements, must be filed within 45 days of the end of the respective quarter. This timetable can be onerous for many Chinese companies that may not initially have the infrastructure in place to allow them to comply on a timely basis.

Notably, a less onerous regime exists for foreign private issuers and therefore provides a significant incentive for Chinese companies to remain 'offshore'. Foreign private issuers are required to submit audited financial statements with respect to the year-end numbers within six months of the fiscal year-end in an Annual Report on Form 20-F. Interim financial statements, which must be provided at least semi-annually, need not be audited and are submitted to the SEC on a Form 6-K. The Form 6-K is akin to the Form 8-K report for U.S. domestic issuers and does not require the detailed disclosure of a quarterly report on Form 10-Q. This distinction in reporting requirements is not limited to annual and interim reporting, however.

A U.S. domestic company also must comply with the SEC proxy rules when it solicits a shareholder vote or consent. Generally, the proxy rules require that a proxy statement be mailed to each shareholder of record in advance of every shareholders meeting, setting forth detailed information regarding the issues to be voted upon and certain matters related to the company and its management. All proxy solicitations must satisfy the proxy rules, which require that each time the company solicits proxies from its shareholders it must provide a proxy statement describing the matters being submitted to a vote of the shareholders, and other related information, together with a form of proxy on which shareholders can vote for or against each matter being submitted. If, however, the Chinese company remains offshore it is not subject to these proxy rules on the theory that it will comply with its home country requirements regarding shareholder meetings and the like.

Another issue which should not be overlooked by Chinese companies considering whether to domesticate or maintain an offshore domicile is with respect to the ability to 'deregister' from the U.S. reporting regime. The SEC proposed new rules in December 2005 for foreign private issuers seeking to deregister and final rules are expected before the end of 2006. In essence, the U.S. reporting and compliance regime under the Securities Exchange Act of 1934 precludes a company from truly exiting from the SEC's requirements once its securities have been registered. This is colloquially referred to as the 'roach motel' ' once you get in, you can never leave. A company can 'delist' from an exchange easy enough, but its obligations under the Exchange Act are merely 'suspended' until and unless it exceeds certain thresholds in terms of shareholders and assets, at which point it is again subject to full reporting.

Since the advent of the Sarbanes-Oxley Act of 2002, the volatility in the IPO markets, and other economic and market events, many non-U.S. companies have been reluctant to risk entering the U.S. public markets for fear that, if things do not turn out as well as expected, they will not be able to 'terminate' their U.S. reporting requirements. The final rules expected before year-end 2006 are expected to alleviate this concern. However, it is unclear whether U.S. domestic issuers will be afforded similar opportunities to terminate their reporting requirements.

Reporting Requirements of Certain Insiders

Many Chinese companies are unaccustomed to the extensive reporting obligations imposed on officers, directors and beneficial owners of more than 10% of the shares of the company by the U.S. federal securities laws. These persons are required to report transactions in company securities on Forms 3, 4 and 5, which are filed with the SEC. Form 3, an initial statement of beneficial ownership, must be filed within 10 days after the event by which a person becomes a reporting person. For Chinese companies entering the U.S. market for the first time through an initial public offering, reverse merger or other transaction, this initial obligation to report within 10 days is often overlooked. Form 4, a statement of changes in beneficial ownership, generally must be filed before the end of the second business day following the day on which a transaction resulting in a change in beneficial ownership is executed. Form 5, an annual statement of beneficial ownership, must be filed on or before the 45th day after the end of the company's fiscal year.

These persons are also subject to special rules concerning short swing profits recapture. In general, any such person that realises a profit on a purchase and subsequent sale, or a sale and subsequent purchase, of any class of equity securities of the company within a six-month period must return such profit to the company. Certain transactions, particularly under employee stock purchase plans and employee benefit plans, are exempt from short swing liability.

Like the annual and quarterly reporting requirements and proxy rules, these rules do not apply, however, to Chinese companies who remain offshore and maintain a foreign private issuer status.

In addition, beneficial owners of more than 5% of any registered class of the company's shares are subject to special reporting and disclosure requirements. Such owners are required to make certain disclosures by filing with the SEC either a Schedule 13D or Schedule 13G.

Sale of Restricted and Control Shares

Upon closing of the business combination, the company's outstanding registered or unrestricted shares of common stock will be freely tradable in the public securities markets. However, persons holding 'restricted securities' and 'affiliates' of the company may not sell their shares in the public market until a registration statement covering the sale of such securities has been declared effective by the SEC, or unless an exemption from registration is available. Rule 144 under the Securities Act of 1933 provides a safe harbour from such registration requirements and allows holders of restricted securities and affiliates to sell their shares subject to holding period, volume, current information, manner of sale and notice requirements. Such restrictions on resale lapse after 2 years for holders of restricted securities who are not also affiliates. Affiliates, however, remain subject to the Rule 144 requirements for public resales of all of their securities of the company. Executive officers, directors and holders of at least 10% of the company's equity securities are generally considered to be 'affiliates' for purposes of U.S. federal securities laws.

It is common in a reverse merger for the original investors in the Chinese company to hold restricted shares in the surviving U.S. corporation as a result of the business combination. Generally, these investors are also affiliates. As a result, liquidity for their shares is limited unless the shares are registered for resale under the Securities Act. Alternatively, these affiliates can sell their shares pursuant to other available exemptions, such as in private offerings and PIPEs. In these situations, the purchaser will typically require the company to register the shares for resale as a condition to the purchase in order to provide the investor the desired liquidity.

Exchange Requirements

Listed U.S. companies are required to comply with various notification, corporate governance and reporting provisions imposed by the respective exchange upon which their securities are listed. Among other requirements, a company must provide notice of significant company events and must obtain shareholder approval of certain types of securities issuances. Additionally, corporate governance rules require that a majority of the company's board of directors be independent. The company's audit committee must be comprised of solely independent directors and the company's independent directors must approve of the compensation for the company's executive officers, including the chief executive officer, either by an independent compensation committee or by a majority of the independent directors meeting in executive session. In addition, companies must have a code of conduct applicable to officers (including senior financial officers), directors and employees.

The independence requirements, in particular, impose on Chinese companies an obligation to bring outsiders onto the Board of Directors as well as individuals with financial sophistication or expertise. These additional Board members are often U.S. based, providing not only Board support but a local U.S. presence for the company. This presence can be valuable for meetings with investors and pursuit of business opportunities.

Conclusion

The U.S. markets pose many attractions for Chinese companies, both with respect to an active and liquid trading market as well as a ready base for expansion of their operations through establishment of local operations. Opportunities to access the U.S. investor base have increased in recent years, providing viable alternatives to the traditional IPO. Whatever route is chosen, however, companies need to be prepared for the ongoing reporting and compliance obligations imposed by U.S. regulators. Companies should give sufficient forethought to the benefits of maintaining an offshore domicile and thereby reducing its obligations to the U.S. regime.

' 2006 KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.