By staff reporters Wang Heyan, Yu Ning, Fu Tao and Liang Dongmei

From Caijing Magazine

Since August, virtually every Chinese government regulatory department involved in foreign investment has been affected by a stormy investigation into high-level corruption.

A half-dozen officials have been forced to step down from the Ministry of Commerce (MOFCOM) and State Administration for Industry and Commerce (SAIC). Lawyers who served as brokers for questionable deals were punished as well.

Guo Jingyi

Guo Jingyi, an official at MOFCOM’s Treaty and Law Department, was detained in mid-August by the Communist Party’s disciplinary arm. Also arrested were two lawyers, Zhang Yuzhu, director for the Beijing legal firm Seafront Law Office, and his former colleague Liu Yang.

In late September, authorities arrested Deng Zhan, a former deputy administrator of foreign investment at MOFCOM, on charges of accepting bribes. Du Baozhong, from MOFCOM’s treaty department, was detained in late October. And later Liu Wei, a deputy chief for foreign investment registration at SAIC, was arrested.

Guo and Deng were detained by party discipline inspectors in connection with their roles in approving foreign mergers and acquisitions. Liu was a link in the process and worked closely with Guo and Deng.

The cases of Zhang, charged with commercial bribery, and Deng, who allegedly accepted bribes, have been forwarded to judicial authorities.

Deng Zhan

Like a loose string pulled on an old sweater, the investigations of Guo and his associates also may unravel the flawed regulatory system that affects the entire foreign investment field.

The cases reflect the shortcomings of gray-zone rules for approving startups, mergers and acquisitions involving foreign companies. Guo and his lawyer friends allegedly took advantage of these and other regulations for reasons still unclear.

At the same time, the cases have exposed the reality of the country’s often vague foreign investment regulations, which apparently lack administrative power in some areas and appear to be too restrictive in others.

A lawyer specializing in mergers and acquisitions involving foreign investment said, “To a large extent, Guo Jingyi’s rent-seeking behavior was all within the scope free discretion and in fact cleared administrative hurdles for normal business activities. This is really sad.”

Unraveling System

The curtain lifted when Guo and his lawyers were detained August 13. Their case actually opened in early 2008, when investigators received several reports from sources familiar with businesses competing for mergers and acquisitions involving foreign investment.

Guo was in charge of drafting, amending and interpreting laws and regulations involving foreign investment. Indeed, he was involved in almost every legal and regulatory decision involving foreign investment since joining MOFCOM 20 years earlier.

Liu Wei

MOFCOM has the authority to approve startups, investments and acquisitions from a management perspective. Also involved are four other agencies – SAIC, the State Administration of Foreign Exchange, the National Development and Reform Commission, and the State-owned Assets Supervision and Administration Commission (SASAC).

Less than a month after Guo’s apprehension, Deng was detained for accepting bribes. He was placed under “double regulation,” or shuanggui, a form of extralegal detention by party diciplinary officials.

After Guo’s arrest, Deng was initially spared detention because he was undergoing medical treatment. But as the Guo investigation deepened, authorities found sufficient evidence against Deng – and detained him in his hospital room.

MOFCOM’s Du was charged with taking bribes in connection with litigation against the ministry filed by a foreign investor for a Guizhou Province hotel project in 2004. He also was accused of embezzling to fill his private coffer to buy housing properties.

Du stepped down October 22. Five days later, Liu was arrested.

Close Connections

Guo, 44, joined MOFCOM after graduating from the Department of Law at Beijing University. Caijing learned from acquaintances that Guo is considered a competent professional with a lot of connections who tends to brag and seek for own interests.

Deng followed a similar career track. After graduating from Beijing Science University, he joined MOFCOM, specializing in foreign investment. Coworkers described him as good-looking and charming, with substantial knowledge of foreign business. He’s also one of the few officials in the ministry who is not a party member.

Deng’s work at the ministry involved drafting laws and regulations for foreign investment, which linked him to Guo.

While serving at the Department of Foreign Investment, Deng had frequent contact with Beijing-based attorneys Zhang and Liu, who were arrested with Guo in August.

The law firm Seafront, where Zhang and Liu practiced, is attached to MOFCOM and claims to serve more than half of the 200 foreign investment firms in China. But according to lawyers familiar with the firm, it’s mainly involved in obtaining regulatory approvals for acquisitions sought by foreign investors.

Several agencies review these requests, but MOFCOM is the most important. Critical decisions are made by its Department of Foreign Investment and the Department of Treaty and Law. Deng and Guo served in key positions at these departments.

According to an insider who asked that his name not be revealed, Deng accepted bribes from Zhang in the form of property in exchange for his assistance with securing approval for foreign acquisitions.

Guo also did business with SAIC’s Liu, who graduated from the law school at Ji Lin University and who also works as an arbitrator at China’s International Economic and Trade Arbitration Commission. Liu specializes in international trade law, and his former department is responsible for drafting measures and guidelines for foreign investment registrations, as well as supervising registrations.

Foreign investment

According to a knowledgeable source, the deal-making relationship between Guo, Deng and their associates was called the “Seafront village commitment.” As the senior member of the pact, Deng accepted the title of village chief. Guo was called vice chief, Liu was village party committee head, and Zhang watched the books.

The same source said Seafront gave Guo a Toyota Camry as a gift, even paying its road fees. Guo owns two mansions worth a combined 8.5 million yuan, as well as upscale apartments in downtown Beijing.

When the government officials stepped down, China’s official media accused them of “legislative corruption,” saying they deliberately allowed regulatory flaws to leave room for rent-seeking from foreign investors.

But officials dispute this claim. One MOFCOM official said it would be impossible for such a small group of people to directly write regulations, which are approved only after broad discussion and input from various departments.

But as the importance of foreign investment grew, conflicts involving foreign investment approvals have intensified. In some cases, approval requirements tightened. But many transactions managed to get around the system, distorting the market. The gap between rules and implementation of the rules reached a climax in 2006 after the government released new guidelines for foreign investors who want to buy Chinese companies.

Foreign investors generally follow a specific path while vying for mergers, acquisitions, or when trying to follow China’s anti-monopoly laws. MOFCOM’s Department of Foreign Investment is responsible for receiving applications for M&A projects, transferring them to different administrative agencies for review before ultimately replying to applicants. The ministry’s Department of Treaty and Law is responsible for reviewing interpretations of laws and regulations. And if a case involves “M&A return” -- that is, an acquisition for domestic enterprises that want to set up offshore holding companies – another stamp is needed from the China Securities Regulatory Commission.

A MOFCOM official who refused to be named said that the foreign investment department is supposed to have ultimate power. But it’s only on paper, since all department reviews must be countersigned by the treaty department after legal reviews.

Because Guo and Deng held their respective positions for more than 20 years, a source said, they were able to build a pipeline for approvals. “One was in charge of interpretation of policy, the other one implemented it,” the source said. “They cooperated well.”

SAIC officials also play an integral part in the process with the foreign investment and treaty departments at MOFCOM. Liu’s oversight of registrations and annual reviews for foreign-invested enterprises gave him considerable power.

According to many legal experts, the case underscores the need for fundamental reform of the foreign investment system.

More is involved than bribery among so-called chiefs of the Seafront village. The case also exposed the shortcomings of foreign investment laws and regulations, and reflected poorly on the discretionary power of administrative agencies.