JD.Com Founder's Iron Grip, Legal Woes Leave Investors in Dark

(Bloomberg) -- 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.

JD.Com Founder's Iron Grip, Legal Woes Leave Investors in Dark

The self-made billionaire took a major reputational hit this week as his mug shot from an arrest in a U.S. 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 any crimes and was released after about 16 hours behind bars and allowed to return to Beijing. His lawyers say charges won’t be filed, but authorities in Minnesota haven’t closed the case.

On Friday the Minneapolis Police said it wouldn’t provide further public updates on Liu’s case and would submit its findings to the County Attorney’s office once its initial investigation is completed. JD’s share price fell 1.1 percent during Friday trading.

Owing to an arcane corporate structure, known as variable interest entities (VIEs), popular among Chinese internet firm founders, any future legal liability for 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 $215 billion in goods over its various platforms. Much of that passed through the 11.6 million square meters of warehouse space the company controls and was paid for using JD Finance, an affiliated unit that is raising funds at a $19.5 billion valuation.

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

“The key man risk here is huge,” said Kok Hoi Wong, chief investment officer for APS Asset Management Pte in Singapore, which has a short position in JD’s stock. “It’s strange that a huge company like JD is controlled by one man even though he owns less than 20 percent.”

Underlying Risks

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

“VIE structures are relatively loose in terms of shareholder rights," said Frank Bi, a partner at the law firm Ashurst in Hong Kong, which focuses on IPOs, compliance and mergers and acquisitions. “Basically, you’re using contracts to control the fund flow and collect your dividends and profits so you could simply breach or not honor the terms that are in the contract.”

JD.Com Founder's Iron Grip, Legal Woes Leave Investors in Dark

The underlying risk for the Beijing-based company and investors is what happens if legal troubles make it difficult, or impossible, for Liu to run the company. JD shareholders in the U.S., where its stock has fallen 34 percent on the Nasdaq exchange this year, may find it difficult to sue the company as it’s unclear whether VIE contracts are recognized in the same way by U.S. and Chinese courts. And If Liu were to be charged by prosecutors, shareholders attempting to sue over any stock-price decline would face numerous challenges.

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

“This is a really, really weird clause,” Ashurst’s Bi said. “It certainly isn’t normal.”

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

In response to questions from Bloomberg, JD sent a link to a blog posting about the investigation, which it referred to as “the situation in Minnesota.” The blog said the company would “vigorously” defend itself in any class action lawsuits.

“There is no interruption to our day-to-day business operations,” the blog said. “We are aware that a few class-action law firms have publicly announced a desire to represent shareholders.”

If formal charges are filed against Liu, it’s uncertain whether he would be compelled to return to the U.S. to appear in court, given that the U.S. and China don’t have an extradition treaty. So far, the company says that Liu would cooperate with any further investigation.

The Foreign Ministry “will not make any prognosis since the case is still under investigation,” Chinese Foreign Ministry spokeswomen Hua Chunying said in a regular briefing when asked if China is willing to cooperate with the U.S. to extradite Liu if charges are brought against him.

Uncertain Times

Even at the highest levels of JD, there’s uncertainty over what would happen to the company’s leadership if Liu had to serve jail time abroad, according to a person familiar with its operations.

Liu’s drive and innovation (JD is exploring using drones for delivery and runs unmanned convenience stores) 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 percent stake and Walmart is another strategic investor, with about 10 percent, after merging its struggling China online operations into JD.com. In June, Google invested $550 million in the company.

The founder still makes the call on major decisions from mergers and acquisitions to global expansions and partnership deals. Before Google agreed to buy a stake in the e-commerce business, its Chief Executive Sundar Pichai met Liu late last year. “It’s really all riding on Richard,” the person familiar said. “Over time you want to corporatize things. But we’re still at the early stages.”

These ties are vital as the company attempts to expand abroad. It has major operations in Thailand and Indonesia, large stakes in a key Vietnamese e-commerce business and plans to enter Western Europe via France and Germany. In the U.S., Liu said he wanted to partner with Google, Walmart and social media giants like Facebook and Twitter to sell Chinese goods to American consumers.

JD.Com Founder's Iron Grip, Legal Woes Leave Investors in Dark

At home, Liu and his wife, Zhang Zetian, nicknamed the Milk Tea Sister, are social media darlings who readily shared details of their lives online. On the international stage, however, it’s Alibaba’s Jack Ma who as become one of the most visible corporate leaders in China. So in recent years, Liu has been trying to raise his international profile, even with the vast majority of his business remaining in the mainland.

Liu 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.
In New York, a gallery in the city’s Guggenheim Museum showed off a film and multimedia installation by the Chinese artist Cao Fei, featuring an assortment of JD-branded paraphernalia including a tricycle, uniforms and shipping labels.

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

©2018 Bloomberg L.P.