The Reverse Merger in China: the Qihoo 360 Story

By Thomas P. Gross & Chenxi Liu

    The blank check/reverse merger mechanism is a well-known process in the United States for taking a privately held company to the public exchanges without a full section 5 review by the Securities and Exchange Commission (the “SEC”). Regulated by SEC Rule 419,[1] the SEC allows companies with virtually no assets and no stated business purpose—other than to acquire or merge with other companies—to file a section 5 application “to go public” in order to raise funds for those acquisitions. Specifically, as defined in Rule 419(a),[2] a blank check company is a company that “is a development stage company that has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person.” In essence, it is a publicly traded company with no hard assets, virtually no employees, and a vague business plan to merge or acquire another company.

     With virtually nothing to disclose, it is difficult for the SEC to review the application for full disclosure requirements, and also difficult for investors to determine whether the business plan and targeted company would fit the risk-return characteristics of their investment portfolio. Various provisions in Rule 419 provide notice and disclosure requirements to the investors so they may opt-in once a target company has been identified if they decide the disclosed acquisition/merger fits their investment objectives.[3] A variation of this theme is the Special Purpose Acquisition Company (“SPACs”) that serves the same purpose, but the price exceeds the penny stock price which is a requirement for a blank check company under Rule 419; hence it is a creative work-around by the industry to circumvent Rule 419. Nevertheless, SPACs are regulated by the rules of the Exchange where they are traded, and those rules have provisions similar to the SEC’s Rule 419.

    Although sometimes thought to be “shady,” a blank check company and the SPAC variation are legal and have been used successfully to restructure privately held companies. Among other things, that restructuring allows the new publicly traded company enhanced access to capital markets, new and more effective corporate financial structures, as well as significant corporate restructuring in order to fund their corporate objectives. In the case of Iridium, a privately held company that makes satellite cell phones, the reverse merger by GHL Acquisition Corp—a SPAC incorporated in Delaware—provided the much-needed capital, and associated access to the capital markets, to restructure itself and fund the corporate objectives. Because the merger required a transfer of the Federal Communication Commission’s issued licenses for the regulated spectrums, the details of that reverse merger are well documented in the Commission’s order approving the merger.[4] The “new” publicly traded Iridium currently trades on the NASDAQ (IRDM). Similarly, this type of reverse merger was used to take Burger King Worldwide Holdings to the public exchanges through a reverse merger with Justice Holdings, a SPAC.[5]

     On the other hand, these reverse mergers have been abused and have caused much concern for the SEC and investors who have been caught in the excitement of investing in a private company that goes public through one of these mechanisms. In March 2011, the Public Company Accounting Oversight Board (the “PCAOB”), created by Sarbanes-Oxley to oversee the accounting industry, issued its report on the use of reverse mergers for taking privately held Chinese companies to the U.S. public exchanges, i.e., the so-called “Chinese” reverse mergers (“CRMs”).[6] The Report, which covered a period from January 1, 2007 through March 31, 2010, showed, among other things, that the reverse merger was the preferred mechanism for taking privately held Chinese companies to the US public markets. Chinese reverse mergers accounted for, on average, 26 percent of all reverse mergers. Compared to the traditional registered Initial Public Offering (“IPO”), the Chinese Reverse Merger was used 159 times versus 56 standard IPOs, or 74 percent were CRMs vs. 26 percent for standard IPOs.[7]

     Understandably, the popularity of blank check companies/SPACS/reverse mergers declined significantly after the financial crisis of 2008, but since has steadily grown in popularity as the economy has recovered. SPAC data showed a decline from 66 SPACs in 2007 to only one in 2009, and back to 46 in 2018 as the economy has improved.[8] But what about use of reverse mergers in other countries such as China, the second largest economy? This article summarizes the interesting case of Qihoo 360, a publicly traded company on the U.S. exchange that was taken private, then moved to China where it re-emerged as a publicly traded company through the use of a reverse merger. Use of these reverse mergers to bring Chinese companies “back home” seems to be gaining popularity, both from a regulatory and investment perspective.

A. Background

     Qihoo 360 was founded in China in June 2005 as a leading Internet-Security company and was known for its anti-virus software product. According to its filing with the SEC, Qihoo 360 offers free internet browsing and security products, with more than 300 million monthly users in China. On March 30, 2011, after raising $175 million in the largest IPO by a Chinese company in the U.S., Qihoo 360 was officially listed (as QIHU) on the New York Stock Exchange (“NYSE”) and was 40 times subscribed, led by underwriters UBS Investment Bank and Citi.[9]

     Phase I: Privatization. About four years later, on December 18, 2015, Qihoo 360, led by its founder and CEO Zhou Hongyi, announced it would go private, and that it had entered into a privatization agreement to be acquired by a consortium of investors in an all-cash transaction valued at about 9.3 billion USD (61.5 billion RMB). The private funding for its privatization on NYSE came from mortgaging Qihoo 360’s building and a $3 billion loan from China Merchants Bank. The privatization was approved by China’s National Development and Reform Commission (“NDRC”) on April 26, 2016, a macroeconomic management agency under the Chinese State Council that balances economic development in China.[10]

     On July 15, 2016, Qihoo 360 finalized its privatization agreement. Subsequently, the CEO and founder of Qihoo 360 Hongyi Zhou, clarified its intentions when he stated that the privatization and delisting in the United States would allow Qihoo to move to China and become “a key member” of the country’s national cybersecurity strategy. According to a Reuters’ article, “national interest” was an important motivator for Qihoo to return to the Chinese domestic market.[11] China International Capital Corporation (“CICC”) estimated that moving Qihoo 360 back to the A-Share[12] market in China would increase its value as high as 61.3 billion USD (380 billion RMB), an increase more than six times above its U.S. value.[13]

     Phase II: The Qihoo 360 Reverse Merger. Qihoo’s privatization was only the first step, and its move to China was only part of the story. On November 3, 2017, Qihoo 360 announced its plan to return to China and to “go public” in China’s A-share market, by means of a reverse merger. The reverse merger was a 50.42 billion RMB (7.62 billion USD) deal with SJEC Corp., a public company on the Shanghai Stock Exchange (“SHSE”) that made elevators. The SJEC elevator business survived the reverse merger, but only as a subsidiary of Qihoo 360, indicating that the primary purpose of the reverse merger was to make Qihoo 360 the dominant surviving entity. After the reverse merger, Zhou Hongyi, the CEO of Qihoo 360, would hold 12.14% of Qihoo’s shares, and two other shareholding firms that he indirectly controls would hold 51.56% of the shares. This process would go through an asset swap and cash transfer.[14]

     On January 2018, the China Securities Regulatory Commission (the “CSRC”), China’s top securities regulator and counterpart of the SEC, approved the application. On February 28, 2018, Qihoo 360 emerged on the SHSE as A-Shares. The offering price was 7.89 RMB per Share with 6.37 billion shares outstanding.

B. The Reverse Merger in China

     The two players in this transaction are Qihoo 360 and SJEC. According to iResearch, Qihoo 360 Technology Co. Ltd. is the number one provider of Internet and mobile security products in China, offering high-quality Internet and mobile security products free of charge. Its primary revenue sources are generated from online advertising and internet value-added services. Its products include: 360 Internet security, 360 Mobile Security, 360 Safeguard, 360 Secure Browser, 360 Mobile Assistant, 360 Security, and 360 Total Security.

     Founded in 1992, SJEC Corp. was one of the leading elevators and escalators manufacturers in China. Its products have been sold to more than 30 countries and it has a solid reputation in its market. Since its establishment, the company’s export volume has been ranked first among domestic enterprises in China’s elevator industry. It was successfully listed on Shanghai Stock Exchange in 2012.

  1. CSRC approval

     In January 2018, the CSRC approved Qihoo 360’s reverse merger, signaling a significant change in direction by the regulator (and government policy) on reverse mergers for Chinese companies. Previously, for a period of about three years, the CSRC policies strongly favored traditional IPOs, and imposed strict requirements on reverse mergers. The reversal broke the CSRC silence regarding A-share reverse mergers by overseas-listed Chinese companies that were “coming home.” The first successful case was three years earlier in 2015 with Focus Media, a Chinese digital media and display advertising company, which delisted from NASDAQ and returned to the A-share market through a reverse merger. Even though Focus Media was the first successful case, its initial effort using a shell company was denied by the CSRC.

     Qihoo’s plan was approved in less than two months, compared to the usual three or four months, according to market participants. The expedited treatment raises the prospect that China may have big plans for Qihoo’s expertise in cybersecurity, which should be aligned with national interests. Zhou himself has publicly stated that Qihoo 360 is China’s largest cybersecurity firm protecting China’s sensitive networks. Moreover, he stated: “We have very deep collaboration with the military in cybersecurity protection in many ways, but those military licenses cannot be discussed.”[15]

  1. Hostile Environments for Chinese Companies

     The CSRC-Qihoo approval sends a message to Chinese companies listed overseas, especially in the tech industry, planning to return to the Chinese market: Chinese policies are changing, and overseas Chinese tech companies are welcome home. The reasons are varied but changing U.S. relations since the Trump Administration took control, tough U.S. sanctions imposed on China, and growing suspicions that Chinese technology with secret embedded capabilities may infiltrate the U.S. infrastructure, likely contributed to the change in policy.

     But perhaps most importantly is the view that China wants to build a strong cyber-security company on Chinese soil. While Qihoo 360 was listed overseas in the United States, it was subject to U.S. laws, SEC filing and disclosure requirements, and “oversight” by U.S law enforcement and national security agencies that most likely “monitor” its activities. In other words, having Qihoo 360 in a foreign country threatened the Chinese government’s ability to build, structure, and diversify its cybersecurity goals in a way that would promote Chinese interests, especially given that Qihoo 360 has “very deep collaboration with the military in cybersecurity protection. . . .” Moreover, U.S. intelligence agencies are building their own cybersecurity systems. These systems use advanced technologies such as quantum computers, blockchain technology, and other cybersecurity coding systems, all of which are in direct competition with Chinese technology. In short, Qihoo 360’s continued presence in the United States, and thus continued oversight by U.S. agencies, threatened the Chinese government’s ability to pursue covertly its national cybersecurity goals.

     Moreover, U.S. suspicions of Chinese companies and Chinese technology “spying on” or including “backdoors” to disable or incapacitate U.S. systems have been growing. During a September 2018 interview, Chris Wray, the FBI Director, stated:

I continue to be very concerned and I think the intelligence community continues to be very concerned about the threat to our telecommunications infrastructure presented by some of the kinds of companies that are beholden to foreign governments that don’t share our values… And the idea of letting the fox in the henhouse is something that I think people need to be really, really careful about before we find out that we’re gonna regret it.[16]

     Congress was so concerned about Chinese technology and its incorporation into the U.S. infrastructure, that it passed the John S. McCain National Defense Authorization Act for Fiscal Year 2019.[17] On August 13, 2018, President Trump signed the law which included section 889 that, among other things, restricted U.S. government purchases and use of “covered telecommunications equipment or services” produced by the Chinese company Huawei Technologies Co and its subsidiaries and affiliates.[18] Those restrictions have led to Huawei fighting back in its lawsuit filed March 6, 2019. In the lawsuit, Huawei alleges that the law violates the U.S. Constitution’s Bill of Attainder Clause, art. 1, §9, cl. 3, because it legislatively “blacklists” Huawei and impugns its reputation by asserting ties to the Chinese government without any due process and opportunity to refute these determinations.[19]

     Similarly, action by U.S. law enforcement against Chinese companies that attempt to circumvent U.S. laws and policies demonstrates a commitment to “crack down” on these violations. In 2017, the U.S. Department of Treasury’s Office of Foreign Assets Control (“OFAC”) announced its settlement with Zhongxing Telecommunications Equipment Corporation and its subsidiaries and affiliates (collectively “ZTE”) for violating U.S. sanctions against Iran. The OFAC Press Release dated March 7, 2017 summarized ZTE’s activities, in part, as follows:

From on or about 2010 to 2016, ZTE’s highest-level management developed, approved, and implemented a company-wide plan that utilized third-party companies to conceal and facilitate ZTE’s illegal business with Iran. Members of ZTE’s highest-level management were specifically aware of and considered the legal risks of engaging in such activities prior to signing contracts with Iranian customers and supplying U.S.-origin goods to Iran. Essential to the performance of such contracts was ZTE’s procurement of and delivery to Iran of U.S.-origin goods.

ZTE’s unlawful business activities with Iran were publically disclosed in a media report in 2012. Shortly thereafter, ZTE learned of the U.S. government’s investigation into the company’s business activities with Iran. ZTE subsequently communicated to the U.S. government that it had wound down and ceased its Iran-related activities. However, ZTE’s highest-level leadership decided to surreptitiously resume its Iran-related business in 2013, which it continued until last year, when the Commerce Department suspended the company’s export privileges by adding it to the Entity List. Under the direction of its leadership, ZTE deleted evidence and provided the U.S. government with altered information to hide the fact that it had resumed its unlawful business with Iran.[20]

     The proposed settlement included “the imposition of $430,488,798 in combined criminal fines and forfeitures on ZTE as part of a plea agreement with the U.S. Department of Justice, and a $661,000,000 penalty—of which $300,000,000 is suspended during a seven-year probationary period—to the U.S. Department of Commerce.” OFAC characterized the settlement as the “largest ever against a non-financial entity and sends a powerful message that Treasury will aggressively pursue any company that willfully violates U.S. economic sanctions laws and obstructs federal investigations of such violations.”[21]

     More recently, the U.S. is seeking to extradite the CFO of Huawei, Meng Wanzhou (and daughter of Huawei founder Ren Zhengfei), from Canada on charges that Huawei and its officials committed bank fraud, wire fraud, money laundering, obstruction of justice, and export violations. The indictment returned by the Grand Jury in the Eastern District of New York, was summarized in a January 28, 2019 Press Release, in part, as follows:

The charges in this case relate to a long-running scheme by Huawei, its CFO, and other employees to deceive numerous global financial institutions and the United States government regarding Huawei’s business activities in Iran. Beginning in 2007, Huawei employees misrepresented Huawei’s relationship to an unofficial subsidiary in Iran called Skycom, and as a result falsely claimed that Huawei had only limited operations in Iran and that Huawei did not violate U.S. or other laws or regulations related to Iran. Most significantly, after news publications in late 2012 and 2013 disclosed that Huawei operated Skycom as an unofficial subsidiary in Iran and that Meng had served on the board of directors of Skycom, Huawei employees, and in particular Meng, continued to lie to Huawei’s banking partners about Huawei’s relationship with Skycom, falsely claiming that Huawei had sold its interest in Skycom to an unrelated third party in 2007 and also that Skycom was merely Huawei’s local business partner in Iran.  In reality, Skycom was Huawei’s longstanding Iranian subsidiary, and Huawei orchestrated the 2007 sale to appear as an arm’s length transaction between two unrelated parties although Huawei actually controlled the company that purchased Skycom.

* * *

Huawei relied on its global banking partners for banking services that included processing U.S.-dollar-denominated transactions through the United States. . . . One banking partner cleared more than $100 million worth of Skycom-related transactions through the United States between 2010 and 2014.

As a further part of this scheme to defraud, Huawei and its principals repeatedly lied to U.S. government authorities about the relationship between Huawei and Skycom in submissions to the U.S. government, and in responses to government inquiries. For example, Huawei provided false information to the U.S. Congress regarding whether Huawei’s business in Iran violated any U.S. law. Similarly, as indicated in the indictment, in 2007—months before Huawei orchestrated the purported sale of Skycom to another Huawei-controlled entity—Huawei’s founder falsely stated to FBI agents that Huawei did not have any direct dealings with Iranian companies and that Huawei operated in compliance with all U.S. export laws.

After one of Huawei’s major global banking partners (identified as Financial Institution 1 in the indictment) decided to exit the relationship in 2017 because of Huawei’s risk profile, Huawei allegedly made additional misrepresentations to several of its remaining banking partners in an effort to maintain and expand those relationships. Huawei and its principals are alleged to have repeatedly and falsely claimed that Huawei had decided to separate from Financial Institution 1, and not that Financial Institution 1 had decided to cause the separation. On the basis of these misrepresentations, those other banking partners continued their banking relationships with Huawei.

In 2017, when Huawei became aware of the government’s investigation, Huawei and its subsidiary Huawei USA tried to obstruct the investigation by making efforts to move witnesses with knowledge about Huawei’s Iran-based business to the PRC, and beyond the jurisdiction of the U.S. government, and by destroying and concealing evidence of Huawei’s Iran-based business that was located in the United States.[22]

     These allegations led to Meng Wanzhou’s arrest in Vancouver, Canada on Dec. 1, 2018, and subsequent extradition efforts which are ongoing and, at the time of this article, set for hearing on May 6, 2019.[23]

     Sen. Cory Gardner from Colorado is Chair of the U.S. Senate Foreign Relations Subcommittee on East Asia, The Pacific, and International Cybersecurity Policy. On April 12, 2019, while commenting on China’s decision to support the “Venezuelan strongman” Nicolas Maduro through, among other things, the sale of technology, stated:  “China’s goal is to displace the United States, and they can do that by wreaking havoc in the Western Hemisphere. . . . The more China becomes intertwined with our Western Hemisphere nations, the more likely it is they can surveil, they can monitor, they can surround the United States.” [24] 

          On May 15, 2019, U.S concerns about China’s interference with U.S. infrastructures moved “front and center” to the international community when the President issued an Executive Order targeting foreign actions.  That Order states in part:

“. . . foreign adversaries are increasingly creating and exploiting vulnerabilities in information and communications technology and services, which store and communicate vast amounts of sensitive information, facilitate the digital economy, and support critical infrastructure and vital emergency services, in order to commit malicious cyber-enabled actions, including economic and industrial espionage against the United States and its people.  I further find that the unrestricted acquisition or use in the United States of information and communications technology or services . . .  constitutes an unusual and extraordinary threat to the national security, foreign policy, and economy of the United States.” [25]

The Executive Order authorizes the Secretary of Commerce, in conjunction with other U.S. Departments, to “design or negotiate measures to mitigate concerns” about the integrity, operation and security, among other things, of the national security of the U.S.

     Although the Executive Order is drafted in broad terms, without identifying Huawei specifically, to encompass all foreign actions that pose a threat, it has been widely understood that the Order was initially motivated to address concerns about Huawei’s role in the U.S. high speed  5G communications sector. [26] Nevertheless, it is expected that Huawei will be the target of that Order.

     Taken together, these events clearly demonstrate growing suspicions about Chinese technology and increasing hostilities towards Chinese companies doing business in the U.S., and in turn are creating a hostile environment to Chinese companies. It is not surprising that these companies, with the backing of Beijing, would seek a friendlier environment. 

  1. Financial Incentives to “Come Home”

     Significantly, at the time of the reverse merger, the A-share market in China was experiencing a bull market, meaning that Qihoo would likely show good appreciation and significant profits for its investors. Indeed, in his November 3, 2017 statement in Beijing, Li Gao, a CSRC spokesperson addressing Qihoo 360’s reverse merger plan in a press conference, stated:

 Currently, China’s macroeconomic situation is stable and improving, and its financial market and A-share market are becoming more attractive. The CSRC will support good and qualified overseas-listed Chinese companies, within a certain scale, core technology and development goal consistent with China’s national industry strategy to join A-share market in mergers, acquisitions and restructuring.[27]

According to its first quarter financial statement released on April 26, 2018, Qihoo 360 achieved that increase. Compared to previous years, Qihoo’s total revenue in the first quarter increased by 12.86%, while net profit surged by 42.34%.  Furthermore, Qihoo is ranked in the top five by market capitalization among Internet listed companies in China—Qihoo is ranked fifth while Tencent tops the list. Its progress for 2019 indicates further positive development.

     Everything seemed to be on track as predicted, until President Trump threatened U.S-China relations by imposing 10% tariffs on $200 billion Chinese imports on Sept. 24, 2018 and threatened a 25% increase by March 2, 2019.[28] The increase took place on May 10, 2019. [29] It is clear that the U.S. imposed sanctions have had a severe impact on the Chinese markets. The Chinese A-share index fell 16.82% in the last quarter of 2018 since the trade war officially started on March 22, 2018, compared with the S&P 500 index that increased 6.13% during the same period. Negotiations between the U.S. and China continue and the future of those discussions at the time of this article are uncertain. More importantly, CSRC is indeed welcoming Chinese companies that are listed on overseas exchanges. According to Caixin Global, since June in 2017, the Chinese regulators have approved 24 listed companies to merge, acquire, or restructure their business, most of which are reverse mergers.[30]

  1. Why A Reverse Merger, not an IPO?

     Approvals of IPOs in China are strictly regulated with policies that are not always transparent. The China Securities Regulatory Commission’s Public Offering Review Committee (“PORC”) decides how many IPOs are to be approved and which companies are qualified. According to VoxChina, CSRC suspended all IPOs in 2008 as the world financial crisis unfolded, resumed approval in 2009; then again suspended IPOs in November 2012, but resumed approvals in 2014.

Figure A: Number of IPOs and RMs over time[31]

     Moreover, the review process can be time-consuming and arduous because approvals must coincide with government policies and objectives which are not always stated publicly.[32]

Figure A1: The Reverse Merger Process[33]

     Given the hurdles to approval and the stop-and-go policies of the Chinese regulator, many firms view reverse mergers as an easier alternative to an IPO.[34]

     Moreover, the regulations for listed companies are still in its infancy and are evolving since the Chinese capital market was established in 1990. It took about 20 years for regulators to sort out and improve the restructuring policies for listed companies. On May 18, 2008, the file [No.53] Measures for the Administration of the Material Asset Restructurings of Listed Companies[35] was officially implemented by CSRC. It was subsequently revised three times, in 2011, 2014, and 2016, and now includes Acquire & Merger, an essential part in the file. In particular, the regulatory policies of Reverse Mergers were not clarified until the 2011 version, which consolidates the regulatory framework and blocks major loopholes in market operations, including detailed provisions on reverse mergers, shares to purchase assets, and financing. Significantly, unlisted companies going through reverse mergers had confusing standards, depending on whether the merger was conducted under the 2011, 2014, or 2016 versions.[36]

     Interestingly, reverse mergers in China appear to perform better after the reverse merger compared to IPOs. In Going Public in China: Reverse Mergers Versus IPOs, Lee, Qu, and Shen found that companies that go through a reverse merger consistently report higher profits and sales growth compared to companies that used an IPO. Based on the analysis chart, they found that in the first six months of listing, the cumulative return on reverse merger firms exceeded that of the industry-size matched IPO firms by an annualized return of 22%. Also, companies listed through reverse mergers are better able to raise capital. In their analysis, 23.3% of reverse merger companies issue equity to raise cash in the first year after being listed; by comparison, only 3% of IPO firms issue equity.[37]

C. Conclusion

     China remains a communist country, but it has adopted various aspects of western capitalism that promote policy objectives that are consistent with its government structure. Although Chinese policies and decision-making are less than transparent, this unique blend makes China an interesting experiment in capitalism, communism, and market function. But its implementation of these traditional western capital concepts in a communist, government-controlled environment is experiencing “starts and stops” as government’s central controls are adjusted to changing circumstances and policy objectives, both domestically and internationally.

     The timing of Qihoo’s reverse merger and journey home was critical. U.S. suspicions of Chinese “spy” technology being integrated into western infrastructure had grown, and continue to grow today, threatening its market share. Suspicions of Chinese corporations being “misused” to bypass U.S sanctions and launder money to banned countries and entities are increasing, as evidenced by the U.S. effort to extradite Huawei‘s CFO to the U.S. for criminal conduct involving export sanctions and money-laundering.

     The bull market in China provided an added incentive for Qihoo to return to its home base. Favorable relations with the Chinese domestic market, the Chinese government, and strong non-public licenses with the military gave Qihoo a strong incentive and foundation to grow on its own territory on its own terms.

     The rapidly growing internet usage in China was tied to the economic boom. With internet usage increasing 3584% from 2000 to 2019, China has been the lead country of internet users in the world, according to the statistics from Internet World Stats. [38] This significant growth led to a high demand for security in the internet market, which created a huge potential for Qihoo returning home with internet value-added services.

     China’s Security Regulatory Commission’s quick approval of Qihoo’s reverse merger has sent a signal to other Chinese companies listed overseas: you are welcome home to a friendlier environment. Indeed, that message was followed by a substantial increase in overseas-listed Chinese companies seeking opportunities in the Chinese A-shares market.

     This is a rapidly evolving area with significant economic, technological, and national security implications, as Chinese companies are using the reverse merger to return home as publicly traded companies. A friendly Chinese regulatory policy is encouraging their return in an effort to grow these technologies on their “home turf” while at the same time pursuing and enhancing Beijing’s nationalist policies.

The Authors.

Thomas P. Gross is an Adjunct Professor in the Graduate Business School at The George Washington University and a Partner in the Cogent Law Firm in Washington, DC. His practice includes complex transactions and international law. He holds advanced degrees in Applied Physics and Law from Stanford University and Case Western Reserve University.

Chenxi Liu Chenxi Liu earned a Master of Science in Finance (MSF) from the Graduate Business School at the George Washington University in May 2019 and received her Bachelor of Science degree in Financial Mathematics & Statistics at University of California, Santa Barbara in 2016.

[1] Rule 419 implements the Penny Stock Reform Act of 1990 which is limited to penny stocks. A Special Purpose Acquisition Company is not covered by this statute and Rule 419 because the price exceeds the penny stock price. 17 C.F.R. § 230.419.

[2] 17 C.F.R. § 230.419(a).

[3] See 17 C.F.R. § 230.419(b)–(d).

[4] See Iridium Holdings LLC, Memorandum Opinion and Order and Declaration Ruling, IB Docket 08-232 (Fed. Commc’n Comm’n August 14, 2009), at

[5] See Peter Lattman & Michael J. De La Merced, Burger King to Return to Public Markets, NY Times (April 3, 2012),

[6] Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region: January 1, 2007 through March 31, 2010, PCAOB (March 14, 2011),

[7] The concern with Chinses Reverse Mergers is evident in the report. Because the blank check company/SPAC target company never goes through a section 5 review by the SEC, the true condition of the company does not emerge until after it is the acquisition is completed and the new entity makes the complying public filings with the SEC (e.g., quarterly and annual reports). When the true value of the Chinese company emerges, the stock price plummets, the SEC stops trading, and investors lose their investment. The Report questions the role of the accounting firms, specifically U.S. accounting firms with Chinese offices that are performing the audits of the target company.

[8] See Real Time Updates, SPAC Data, (last visited April 6, 2019).

[9] See Joan E. Solsman & Nisha Gopalan, Qihoo Tops Chinese IPOs in U.S. This Year, Wall St. J. (March 30, 2011),

[10] See Qihoo 360’s Privatization Approved by NDRC, ChinaTechNews (April 27, 2016),

[11] See Qihoo 360 chairman cites national interest in Shanghai backdoor listing, Reuters (Nov. 6, 2017),

[12] A-share (Chinese: A股), is ordinary stock of RMB traded in Shanghai and Shenzhen Stock Exchanges in Mainland China. The Chinese stock market is composed of the A-share market, the B-share market, and the H-share market. The A-shares are listed in Mainland China and dominated in RMB for local investors; B-shares are listed in Mainland China and dominated in foreign currency for foreign investors; H-shares are listed in Hong Kong and dominated in Hong Kong dollars for anyone. All of these markets are regulated by the Chinese Securities Regulatory Commission.

[13] See Zhou Hongyi Makes Bold Move: Qihoo 360 Returns to Chinese Index Via Shell Company, pandaily (Nov. 6, 2017),

[14] See Zhang Jie, Qihoo 360 set to return to China’s A-share market, CHINADAILY (Nov. 3, 2017),

[15] See Qihoo 360 chairman cites national interest in Shanghai backdoor listing, Reuters (Nov. 6, 2017),

[16] FBI Director Christopher Wray says China is agency’s top counterintelligence priority, CBS News (Sept. 13, 2018),

[17] National Defense Authorization Act, Pub. L. No. 115-232.

[18] Id. at § 889.

[19] See Huawei Complaint, at

[20] Treasury Department Reaches $100 Million Settlement With Zhongxing Telecommunications Equipment Corporation, U.S. Dept. of the Treasury (March 7, 2017), (emphasis added).

[21] Id.

[22] Chinese Telecommunications Conglomerate Huawei and Huawei CFO Wanzhou Meng Charged with Financial Fraud, Dept. of Justice (Jan. 28, 2019), (emphasis added).

[23] See Bloomberg, Huawei CFO Meng’s Extradition Hearing Set for May 8 in Vancouver, Fortune (March 6, 2019),; US to formally seek extradition of Huawei executive Meng Wanzhou: Report, CNBC (Jan. 21, 2019),

[24] China selling high-tech tyranny to Latin America, stoking US concern, The Washington Examiner (April 12, 2019), (emphasis added).

[25] See Executive Order on Securing the Information and Communications Technology and Services Supply Chain, The White House (May 15, 2019),

[26]  See Trump bans Huawei in U.S. markets, saying Chinese firm poses security threat, LA Times, (May 15, 2019)

[27] See the CSRC Report, at

[28] The initial planned date for the additional tariffs was January 1, 2019, but was extended to March 1, 2019 pending good faith negotiations on a trade deal, hence the March 2, 2019 date. That date was extended based on the Trump Administration’s perception that negotiations were on track and may eventually lead to a Summit Meeting. David J. Lynch, Trump promises ‘epic’ trade deal with China, but holds off on summit with XI Jinping for now, Wash. Post (April 4, 2019), 

[29] See The US just raised tariffs on Chinese goods. China says it will hit back, CNN (May 10, 2019),

[30] See China Oks More Mergers in June, Caixin Global (July 6, 2017),

[31] This chart created by The Cost of China’s IPO Regulations on the Functional Efficiency of its Financial System, VoxChina (Nov. 7, 2017),

[32] See Charles M. C. Lee, Yuanyu Qu, & Tao Shen, Going Public in China: Reverse Mergers Versus IPOs (Stanford Graduate School of Business, Working Paper No. 3655), at

[33] This chart created by Charles M. C. Lee, Yuanyu Qu, & Tao Shen, Going Public in China: Reverse Mergers Versus IPOs (Stanford Graduate School of Business, Working Paper No. 3655), at

[34] See The Cost of China’s IPO Regulations on the Functional Efficiency of its Financial System, VoxChina (Nov. 1, 2017),

[35] Measures for the Administration of the Material Asset Restructurings of Listed Companies are issued by the China Securities Regulatory Commission.

Article 1: To regulate the material asset restructuring of listed companies, protect the lawful rights and interests of listed companies and investors, make listed companies constantly improve their quality, maintain the order of the securities market, and protect the public interest, these Measures are developed pursuant to the Company Law, the Securities Law, and other relevant laws and administrative regulations.

[36] In 2014, the revised [No. 109] Measures for the Administration of the Material Asset Restructurings of Listed Companies was implemented on November 23. Importantly, the updated version improves the definition of reverse merger and clarifies the requirement:

Article 13 (7): The business entity whose assets are purchased by the listed company shall be a joint-stock company or limited liability company and shall meet other offering conditions as set out in the Measures for the Administration of Initial Public Offering and Listing of Stocks.

Even though more detailed definitions and requirements of a reverse merger have been emphasized in version 2014, it was still an optimistic market for unlisted companies looking for a reverse merger. Qihoo 360’s reverse merger with SJEC also meets the conditions of a material asset restructuring, based on the Article 12, which defines the criteria:

Article 12: Where a purchase or sale of assets by a listed company or any company held or controlled by it reaches any of the following criteria, it constitutes a material asset restructuring: (1) The total assets purchased or sold account for 50% or more of the ending total assets as specified in the listed company’s audited consolidated financial statements for the last fiscal year; (2) The operating income from the purchased or sold assets in the last fiscal year accounts for 50% or more of the operating income as specified in the listed company’s audited consolidated financial statements for the same period. (3) The net assets purchased or sold account for 50% or more of the ending net assets as specified in the public company’s audited consolidated financial statements for the last fiscal year, and exceed 50 million yuan.

[37] See Charles M. C. Lee, Yuanyu Qu, & Tao Shen, Going Public in China: Reverse Mergers Versus IPOs (Stanford Graduate School of Business, Working Paper No. 3655), at

[38] See Internet World Stats, at

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