JD.com founder's iron grip and legal woes leave investors in dark

Beijing

WHENEVER a corporate leader faces claims of possible criminal wrongdoing, the ramifications are significant for employees, customers and shareholders.

All the more so in the case of Richard Liu, the founder, chief executive officer and chairman of JD.com Inc, who enjoys an iron grip over voting shares and the company's board, and owns the strategic assets of China's largest e-commerce company after Alibaba Group Holding Ltd. The self-made billionaire took a major reputational hit this week as his mug shot from an arrest in a US sexual misconduct case rifled around the Internet.

Liu Qiangdong, as he's known in China, was arrested last weekend in Minneapolis on suspicion of rape. He wasn't charged with a crime and was released after about 16 hours behind bars and allowed to return to Beijing. His lawyers say charges won't be filed, but the authorities in Minnesota haven't closed the case.

Owing to an arcane corporate structure known as variable interest entities (VIEs) and popular among Chinese Internet firm founders, any future legal liability for Mr Liu could have potentially grave implications for the online retailing empire he oversees - as does its incorporation in the Cayman Islands.

In China, JD is the equivalent of a combined Amazon, Federal Express and Visa. During the year ended June 30, some 313.8 million shoppers ordered more than US$215 billion in goods over its various platforms. Much of that passed through the 11.6 million sq m of warehouse space the company controls, and was paid for using JD Finance, an affiliated unit that is raising funds at a US$19.5 billion valuation.

Mr Liu maintains tight control over all this, owing to a dual-share structure in which his 15.5 per cent equity stake represents 79.5 per cent of voting shares. He enjoys unusual power over the board, which can't effectively convene without his approval.

Kok Hoi Wong, chief investment officer for APS Asset Management in Singapore, has a short position on JD's stock. He said: "The key-man risk here is huge. It's strange that a huge company like JD is controlled by one man even though he owns less than 20 per cent of it."

Under the VIE corporate structure, sensitive assets like operating licenses and core technologies are controlled by Mr Liu and a handful of employees. JD.com, the listed entity, in turn signs contracts with Mr Liu and others for the right to glean profits and dividends from the business.

Frank Bi, a partner at the law firm Ashurst in Hong Kong, which focuses on IPOs, compliance and mergers and acquisitions, said: "VIE structures are relatively loose in terms of shareholder rights. Basically, you're using contracts to control the fund flow and collect your dividends and profits so you could simply breach or not honour the terms that are in the contract." The underlying risk for the Beijing-based company and investors is what happens if legal troubles make it difficult, or impossible, for Mr Liu to run the company.

JD shareholders in the US, where its stock has fallen 34 per cent on the Nasdaq exchange this year, may find it difficult to sue the company as it is unclear whether VIE contracts are recognised in the same way by US and Chinese courts. And if Mr Liu were to be charged by prosecutors, shareholders attempting to sue over the decline of any stock price would face numerous challenges.

Nor is JD exactly a paragon of corporate governance. Under current by-laws, its board of directors can't achieve a quorum without him, even if he has been kidnapped or arrested.

The company hasn't convened an annual shareholder meeting since going public in 2014, noted investment research firm MSCI ESG Research LLC, which ranked the company in the bottom five in a corporate-governance survey of companies in its China Index.

In response to questions from Bloomberg, JD sent a link to a blog posting about the investigation. The blog said the company would "vigorously" defend itself in any class-action lawsuits, and that it was business as usual in the company.

If formal charges are filed against Mr Liu, it's uncertain whether he would be compelled to return to the US to appear in court, given that the US and China don't have an extradition treaty.

Mr Liu's drive and innovation has been crucial to JD's ability to attract investors at home and abroad. According to data compiled by Bloomberg, Tencent owns a 20.2 per cent stake; Walmart is another strategic investor, with about 10 per cent, and Google recently invested $550 million in the company.

At home, he and his wife, Zhang Zetian, nicknamed the Milk Tea Sister, are social media darlings who readily share details of their lives online. But on the international stage, it's Alibaba's Jack Ma who as become one of the most visible corporate leaders in China. Mr Liu has thus been trying to raise his international profile, even with the bulk of his business remaining in the mainland.

He gave interviews at Davos during the World Economic Forum, spoke at the World Retail Congress in Madrid and hobnobbed at the Brainstorm Fortune Conference in Aspen, Colorado.

Now, he has gained global attention for all the wrong reasons. And given the ties that bind him and his company, that could pose real challenges for JD and its shareholders ahead. BLOOMBERG