Tiger fight: China and Alibaba face off over fake goods

BEIJING (AP) – There’s a tiger fight going on in China.

Regulators on Wednesday issued a scathing report against one of the country’s biggest stars, accusing e-commerce giant Alibaba of failing to do enough to prevent fake goods from being sold on its websites. Uncowed, Alibaba fired back with charges of bias and misconduct by a named Chinese official. Such public defiance is almost unheard of in China.

Even more dubious is the timing of the sternly worded report. The State Administration of Industry and Commerce wrote the report in July after meeting with Alibaba management, but postponed issuing it to avoid affecting the company’s New York stock market listing. Alibaba disclosed the issue of counterfeit goods as a risk factor in its prospectus – but didn’t reveal any investigation by regulators before raising $25 billion in its September IPO.

The controversy dragged Alibaba’s U.S.-traded shares down about 4 percent to $98.45 on Wednesday. It also threatens to cause headaches for Yahoo Inc., which holds a 15 percent stake in the Chinese company. Today’s downturn shaved more than $1 billion from the value of Yahoo’s stake just hours after the California company said it would spin off Alibaba shares later this year.

“If the spinoff was going to occur at the end of this month, there would be nothing to worry about,” says Rosenblatt Securities analyst Martin Pyykkonen. “But if Alibaba’s stock is down by 20 percent six months now, then there could be problems.”

Alibaba’s issues with counterfeit goods are documented. Alibaba.com and Taobao were named in the U.S.’s “notorious markets” report each year from 2008 to 2011, though both marketplaces have since been removed from the list. But Wednesday’s report was the first time China has criticized one of its own, particularly a leading star in an Internet industry that communist leaders are eager to develop.

The report seems to be about “putting Jack Ma in his place,” says Gil Luria of Wedbush Securities.

SAIC has emerged as an aggressive regulator of business in China. It has pursued allegations of corruption and has pressed antitrust investigations against foreign companies including Microsoft and Chrysler. Foreign firms have complained of unfair treatment.

“Maybe SAIC is making the point that it can go after domestic companies as well as foreign companies,” says Nicholas Lardy, a China specialist at the Peterson Institute for International Economics. “What better to do than criticize somebody at the top of the food chain?”

SAIC said Alibaba allowed “illegal advertising” that misled consumers with false claims about low prices and other details. It claims some Alibaba employees took bribes and the company failed to deal effectively with fraud. The report said regulators and Alibaba would work together to improve management but gave no details of planned changes.

Alibaba swiftly accused the SAIC official in charge of Internet monitoring, Liu Hongliang, of unspecified “procedural misconduct” and warned it will file a formal complaint.

Alibaba, founded in 1999 by Jack Ma, a former English teacher, was one of China’s earliest Internet companies. Its IPO made Ma China’s richest entrepreneur with a net worth of $25 billion. Alibaba so far has enjoyed unusual freedom from government control. By lashing back at its accusers, it may be testing the limits of its autonomy, notes Nicholas Howson, who practiced law in China and is now a law professor at the University of Michigan.

In its prospectus filed in May, Alibaba said it has received notices in the past and likely will in the future about pirated, counterfeit or illegal items being sold on its online marketplaces by third parties. But there is no mention of any government investigation or impending report in any documents leading up to the IPO.

The report may be the biggest crisis for Alibaba since its founding, says Sam Hamadeh, CEO of IPO research firm PrivCo.

Alibaba would have had to know about the investigation because there would have been extensive requests for evidence documents and negotiations with Alibaba management and attorneys during the drafts of its F1 prospectus, says Hamadeh. If a U.S. company is being investigated by the Justice Department, for example, it would have to disclose that in its annual report.

The investigation also would have broadcast that Alibaba wasn’t a darling of the Chinese government.

“Chinese companies rely on being in one or two categories: blessed and favored by the government or not,” says Hamadeh. Disclosing the investigation would have taken the IPO in a different direction, he thinks.

“There’s no question the narrative would have started to change, there would have been questions at their road show. That would be true even for a U.S. company.”

If any material information was not disclosed in the prospectus, there could be lawsuits against Alibaba and its underwriters, notes Reena Aggarwal, a finance professor at Georgetown University’s McDonough School of Business.

Yahoo Inc. declined to comment, citing its policy not to comment on Alibaba’s business. Despite its large stake, Yahoo has little or no say in Alibaba’s operations.