David Huebner

My name is Rick Huebner, I'm President and CEO of Visual Technologies we're a local software company, we are proud to sponsor tonight, always nice to have that in the audience, thank you. And I'm here to introduce my brother David, he's a partner with Sheppard Mullin Richter and Hampton the six hundred lawyer, California based law firm where he heads the international practice and the international disputes department. He represents governments, corporations in many industry sectors in arbitrations before the ICC and other international tribunals. He has particular expertise in intellectual property and licensing infrastructure and state entity disputes and in various corporate compliance matters including the Foreign Corrupt Practices Act. He's admitted to the Bars of California, New York and the District of Columbia and is a solicitor in England and Wales. Dave is currently an adjunct professor of international arbitration, international business transactions and international intellectual property law, that's a lot of syllables for me to say as I do computer stuff, at the University of Southern California Law School. He's also commissioner and chairman of the California Law of Revision Commission. David has extensive experience in East Asia. Prior to joining Sheppard he was chairman and CEO of Coudert Brothers and spent about a quarter of his time in Coudert's China offices. He taught at Tsinghua University in Beijing and previously worked in Tokyo as special assistant to a member of the Japanese Diet. He is currently Sheppard's chief representative in China, David Huebner. Thank you. Now we'll see if this wireless thing works. Can anybody hear me? For Rick its always about the technology. Ok great, we can get started unless I subvert the technology in some way. There we go. A little mouse click, you can tell I am not an engineer. There we are. We'll great, thank you for having me; I'm delighted to be here. I'm very familiar with the World Affairs Council Program and I'm a member back in Los Angeles. I also went to law school just down the road at the other end of Route 91 and I spent a lot of time here in Hartford including having done some fund raising in a prior life, and I shouldn't mention anything political because he's in the wrong party, at least as far as my brother's concerned, but former Senator Lieberman, so I'm very familiar with Connecticut. Our topic tonight is one very near and dear to my heart, which is doing business in China. As Rick has said, I've spent a lot of time doing business in China both as a lawyer and as a CEO of a business because Coudert Brothers, at the time, opened the first foreign law offices in China about thirty years ago and we grew to at the end having four offices there which represented a substantial part of our receipts and our profits every year. There are three specific things that based on the executive forum nature of the evening I thought might be of interest to you. I'll go pretty quickly through these so we have time for questions and answers before everyone gets tired or hungry. The market environment, intellectual property and dispute resolution. Starting with the market or the business environment many of these things you will know from just reading the paper. China is the world's second largest economy. More than one third of the Fortune 500 companies have their headquarters not just in China but also within the greater Shanghai area. China is by far the largest buyer of U.S. debt, now well passed by Saudis and the market and the people who operate in the market are increasingly sophisticated. One of the biggest problems that American's face when they try to do business in China is they don't respect the environment. They view it in many ways as Northerners sometimes view rural counties in Mississippi and that's simply not the case. This is a large, very sophisticated market and you need to go in understanding what the market is about. The days are long past when knowing somebody who knows somebody who knows somebody gets what you need out of China. Its also a very, very entrepreneurial society and in many ways it's a kin in my view to American society. I've spent a lot of time traveling and doing business around the world and I find that American's and Chinese have much more in common from a business perspective than we do being Americans with some of our closest allies, like the French and the Germans, business environments much more similar than they are different. There are 1.3 billion people in China and all these statistics have ramifications, whether you're an investor or a manufacturer. The society graduates more than three hundred and fifty thousand engineers per year and last year it passed an interesting and perhaps discouraging line that is China now graduates more lawyers per year than the United States does. Its awarding more law degrees. 15% of the population is middle class or higher in terms of socio economics and this is an interesting bullet for those of us that are from the United States, national leadership is very well educated and very sophisticated, that might be a result of how they select their leaders but it would be unusually in the Chinese culture, in the Chinese political environment for someone who for example is, has to exterminator, to end up with the second highest ranking position in their national congress. That simply doesn't happen. When you look at the national leadership of China, its filled with Ph.D's, lots of economists, engineers who are focused on long term planning. I'm not saying its better or worse than what we are accustom to, but to understand how China functions one has to understand the nature of its leadership. In 2003, more than 300,000 patents filed there, more than 400,000 trademarks, China was the second largest oil importer, second only to the United States and interestingly consumed more well over 50% of the world's cement supply. In 2004, similar statistics, first in patents, first in trademarks, more than one hundred and four internet users, not occasional, but regular internet users, 160 million cell phone users, most of them with the cell phone as their only telecommunications device, the government is not focusing on land lines, its focusing on cell phone dissemination. More than 100 billion dollars in annual life insurance premiums paid and in 2004 a gross domestic product increase of 9.1%, which reached almost 10% in 2005, and in both years that is despite conscious government efforts to cool the economy down. These are numbers based on cooling the economy. If you take a look just at the corporate environment, moving from the bottom up you will see earnings growth in the China fortune 100 substantial, almost astronomical every year, except 2001, which was SARS. There was a dip because of SARS in 2001, moved back on track after SARS. If we're looking at the Fortune 100 again, there is strong capital spending focused on two things, restructuring existing corporate environments to make it more profitable and domestic and international expansion, which is translating into a global urge to merge, which is why regardless of what your businesses are involved in there is or will be a link with China at some point even if its only because the Chinese are out shopping and will be shopping for the next two decades. And unlike most other cultures where people are looking to merge the Chinese environment is cash flush. Its not debt that's being spent its cash. We in California, I'm from California by the way, we in California know that in particular because in two very well publicized attempts recently Chinese entities have attempted to buy port terminals in Long Beach and a California based oil company. Neither one of those ended up coming into fruition, in part because of political concerns in both cases they were state affiliated enterprises and the national government, although local governments had no problem with it, decided it would be embarrassing for the peoples liberation army to own 20% of the ports of Los Angeles. Part of the urge to merge is coming for the voracious need for natural resources. China does not have the resources necessary to support its economic growth and it is out looking for natural resources. That's a very important point not just for the business people in the room, but for policy makers who are focused on the American policy. The premier of China recently completed a significant trip to South America where he signed more than one hundred trade deals. The Chinese are focusing intense attention upon Latin America, to make up in part, or to take advantage of American neglect of its southern neighbors because there is a disproportionate share of the worlds natural resources in South America, which is part of why there have been new investment treaties signed between China and Venezuela, one of the worlds largest oil producers, and with Brazil and Argentina, two of the worlds largest forest product producers. Every barrel of oil and every tree that now goes west towards China is not going to becoming north towards the United States, if one looks at it simply. Now if we look at cross border (unidentified), which I abbreviated simply because I couldn't fit it on the slide further down. Cross Border (unidentified) over those years has been a declining percentage of foreign direct investments. At the same time cross border (unidentified) as a percentage of China's influx of foreign direct investment is increasing substantially. What this means is, its becoming easier and more attractive for companies outside of China not to engage in joint venture activity or try to start their own facilities but to begin acquiring existing assets, which is a very important economic trend we are starting to see develop. If you look at the third line, over these years you will see how the percentage of foreign direct investment flowing into China stacks up as a percentage of all foreign investment on earth. It reached approximately 10% in 2003, it looks as though 2005 is approximately 15% of all money spent by companies on investment outside of their own home district. The China percentage in terms of cross border (unidentified) has grown almost seven fold over the same period. Now obstacles to continue growth for foreign investment there is a very complex regulatory framework its fragmentary, its too complex and its incomplete. Now that's despite having a very well developed body of law. Its just its not yet fully coordinated, coordinated internally. Also, and this is not unique to China, the government still closes off what it considers strategic assets, it's a purchase. The problem is, in part like the American government you could not go to a document and identify what strategic assets means. Foreign ownership restrictions persist and probably most important for those of you interested in acquiring in China, corporate compliance and transparency roles are wither non-existent or well behind with what people in the West are accustomed to. Therefore, its very difficult to do diligence on an asset if you which to purchase it. You will not find the same kind of record keeping or statistics that would be common place here in Connecticut or elsewhere in the United States. You'll also encounter very different valuation methods when you attempt to do your do diligence because many of the prime assets are partially or fully government owned, which means there are a good number of hidden subsidies involved. It would be very much like what people encountered in Russia when we were handling Russian divestitures organization, entities look profitable until you realize, that you might accidentally encounter it or you might not encounter it until after the fact, that the heating and cooling costs in that business were never charged back to the company because the government simply paid it out of a general account, which if you were buying a factory in Moscow, would be a very significant problem with your profitability line after the purchase. Because of the amount of energy required simply to modulated temperature in factories in Moscow in the winter. Now just a couple of quick snapshots before we move on to the next topic. If we look at the banking industry, particularly commercial banking and we look at what 2008 has projected to be, you'll see the U.S. banks got about 1.2 trillion in revenues, China's banks only got about 230 billion, but we need to look at the percentages. Over these four years China's banks revenues will have increased fourteen percent while the American banks will only have increased their revenue by four, so we project that out a few years and we'll see what direction the banking system is heading as well. Assuming, and it's a big assumption, that China sustains its current trajectory. Also for those of you who are involved in manufacturing this is a very important slide. For those of you who might be involved in the labor movement or political figures it's a very scary slide. It shows 2003 and 2008 average hourly compensation in the manufacturing sector for production workers. If you look second at the bottom, and God Bless Germany, for charts, if you look second from the bottom, the average hourly wage in the U.S. in 2003 was about $22 per hour, its projected to go up about fifteen percent by 2009, so to $25. Look second from the top at China, in 2003 it was 80 cents, 80 cents by 2009 despite explosive growth in wage costs, it'll only be about a dollar and a quarter an hour. So when one is considering ones business models as manufacturers, you will see why so much is moving toward China. Because even as China super heats, 2009 projected average wage a dollar and a quarter, extremely low and continuing to be much lower than places like India or Russia where wages are low as well. A natural segue from low wages is the consumer market in China. Wal-Mart entered, is there anyone here from Wal-Mart? Wal-Mart entered the market in 1996 with its first super center in (unidentified), by 2004 it had forty-three super centers in 2005 alone it opened fifty new ones. The people at Wal-Mart had said publicly that they believed the only place outside of the United States where a model will work that big is China. And they're demonstrating it because these are all highly profitable organizations. The newest is the largest Wal-Mart on earth in (unidentified), which is itself an interesting case study. There is a map of China, (unidentified) is in the middle there and there are a few things here to look at. One is in the greater (unidentified) itself, which is the inset; you'll see all of the foreign companies with either major operations or headquarters it's a who's who of international companies and they're not along the coast. They're inland in (unidentified). If one studies the corporate placement you'll see a few interesting things. Nationalities tend to cluster together in developments and what we're seeing most recently are parts suppliers and other producers clustering near their end use users. So if you're to draw a line five mile radius around the Ford facility in (unidentified) you'd find a disproportionate number of parts manufacturers. So an entire vertical connection, arise are starting to develop in some of these Chinese metro areas. Now the reason for the westward move are two things. First, even at the low wages we see in China in the traditional economic zones along the coast from Hong Kong up through north of Shanghai, there is increasing wage pressure and in order to maintain and improve margins, Chinese companies as well as western companies were moving west into the province as far as there is also a specific government policy designed to move economic activity west. China itself is subject to similar political pressures and social pressures as any other major nation and the Chinese government it not tempting to more evenly spread the benefits of its economic developments by facilitating the movement of some of these jobs, many of them westward. And they're doing that in part by building major freeways, canals, dams, extensive infrastructure networks as well as becoming more lenient in approving licenses in non-traditional locations. At the moment I'm at the middle, and its not a manufacturing industry, its a legal services company, but I'm in the process of obtaining the licenses for my firm to open an office in Shanghai. Much easier and much more user friendly than if we were attempting to open an office in Beijing in part because provincial and national government planning is attempting to move more financial and legal services operations into the Shanghai area because there's a focus on developing the Shanghai area as the future center of those industries in China rather than Hong Kong. Just a few miscellaneous issues before we get to IP, one is supply chain risk, which is related to the political risk, internal and external. Liz Claiborne is an interesting example. Liz Claiborne recently, Liz Claiborne a couple years ago had developed a plan to move over 80% of its manufacturing to China. Then what happened? The textile wars- the wage pressure and the concentration of economic activity, because it relates to social and political issues, causes reaction. So there are supplemental duties on textiles now at the E.U., textiles coming out of China. There are similar pressures with regard to the United States. If Liz Claiborne had moved such a high percentage of their manufacturing to China and then faced supplemental duties or even bars in the transit of their product made in China, it would have been disruptive, highly disruptive to that organization. So in factoring the economic benefit one has to factor the political push back and what that might do to your economic benefit as well. If your moving into the market you need to be concerned about the last one, price points. In an environment where the average annual wage is a dollar and a quarter, where you might make twenty dollars over a normal work week, you're not going to be able to spend on Procter and Gamble shampoo what you would spend here in the United States. What we're finding are the major consumer manufacturers from outside China are developing products pitched between the somewhat lower quality, lower cache Chinese domestic products and the normal branded products, for example Procter and Gamble. They're clearly labeled for Procter and Gamble but a different brand name for the product and pitched more cheaply. Now that was after years of various substantial consumer products companies being unable to sell in China and not being able to understand the simple equation of wage differentials, disposable income differentials. Now intellectual property, and apologies for speaking so quickly, but I'm sensitive to the value of your time. The good news, there are a very significant set of intellectual property laws that came into being in the 1980's. Also, China successfully joined the WTO in 2001and as a result many of the IPR laws were amended, annulled or revoked to make way for new ones that fit within the World Trade Organization's framework. China also made extensive commitments to improve the environment. Now with any good news, I learned years ago, comes bad news. The bad news, no matter what it is good news always has a dark cloud and that's not just the lawyer speaking here. The problem is counterfeiting. It's estimated that 20% of all products returned to the U.S. from China are counterfeit. That's an astounding statistic. With piracy internally, more than ninety percent of all foreign, quote, movies, motion pictures and software in circulation are pirated, I have not been able to nail this down because people don't like talking about it, but the year the Titanic was released it appears that there was an excess of 6 million VHS and DVDs in circulation of the Titanic, absolutely none of which produced revenues for the producers of the movie because they were all pirated. In my home state, its estimated alone that every year, the California economy looses 34.5 billion dollars because of pirated product of California based intellectual property companies. Another dimension is employee theft in a low wage environment, which is becoming an increasing dynamic in terms of employee movement; there are substantial employee theft issues. Just to summarize, if you look just at the U.S. customs, in 2003 about two thirds of all seizures of infringing products were from China which is an astronomical percentage given the number of other manufacturing countries on earth. There are similar problems elsewhere, but not to the same degree. There has also not yet been a substantial change in the Chinese criminal law, so although the law is well developed on the criminal side, it is sometimes difficult to have the penalties in public imposed than you would like. Now within the room, how many people are involved with intellectual property, whether developing it, defending it or otherwise manipulating it? Great, good number of people, so some of this will be old hat. Patents. We'll walk through each of the general areas quickly, in patents, as they are everywhere else, they're territorial. If you're moving to China with patent rights that are essential to your business, patent them in China. China is a first to file country so you need to get in and file, the fact that you're using it doesn't protect you, you need to file. The Chinese tend to file lots of design patents and utility patents and they have a weak review system. So its relatively easy to get something patented, which is generally bad news for those of you with patent properties. The good news is transparency. The examination guidelines as well as their patent database are both online, easy to access. Now I realized as we were driving over here, I meant to access it to see if it's in English. I think it is bilingual, but I will have to check that, even if it is not its there in Chinese. In trademarks, generally territorial, if you look not just in a snapshot, but over an extended period of time, the China trademark office was the most active in the world. Again, transparency, you can find the rules, the guidelines and the database on line. That's very useful on checking on pirates and piracy. The problem is, because of the volume there are pendency problems with the timeliness of things getting on to the database. So if you're using the database be sensitive to the timeline problem. With trademarks there are a good number of practical things you should be focusing on and which is surprising number of western companies don't do. First make sure you incorporating fully your trademarks into your contracts and marketing strategies, deal with it. Require your agents supply in employee contracts to protect the mark, make sure the contracts deals specifically with the mark. If you're assigning a trademark do it very carefully. Think about reversion rights when a contract expires, be careful about the uses you're assigning the mark for and evaluate your contracts periodically and change them based on any problems you are seeing with trademark infringement under your existing contracts, you have to be very proactive about it and file defensively. Always file defensively, when in doubt, file. Now on trade secrets we all know what a trade secret is the definition is up there, you don't need to register it. Again, be very careful with your contracts; be very careful with your contracts. Unfortunately the WTO regime requires that trade secrets be protected if you meet the definition and the standards. Now if you drill down into Chinese law it's a little difficult to do because its in Chinese, there are three things you should be aware of, again, good news and bad news. First one is good news- if you're negotiating a contract whether the contract is completed or not, the trade secret is protected in China. Its not contractually based. The bad news, and this is what surprises people, number two, under the labor code, employees are not obliged to protect your trade secrets after you fire them or they move on unless you provide them reasonable compensations. So its very important to deal with terminations, downsizes or movements carefully so that there is a reasonable compensation which then would be viewed as a contractual agreement after your employment contract ends to preserve trade secrets in other IPR. And finally, this should be no surprise, but it often is, when you import technology in China and an improvement that is made, the improvement does not belong to the owner of the basic right. It belongs to whoever made the improvement. Ok, copyright, massive problem- those of you who practice in the area now you don't have to register it, its therefore useful in other infringement cases if you can make it up and make and argument that there was a copyright and there are major internet issues for a variety of reasons. The rapid growth and the use of the Internet in China causes a very fertile field for problems with copyright infringement. Its now the case that organized crime is now heavily involved in Internet commerce in China on the Internet. Legally the criminal law is not yet fully developed although there are protections in the copyright law that you can use. And fortunately, China has now exceeded to the WIPO, the World Intellectual Property Organization Internet Treaties, so there is now transnational law that might be of use to you in China. Again, institutionally multiple organizations with jurisdiction, so dealing with enforcement can be difficult. When you face enforcement challenges, look in four directions at the same time, look at administrative enforcement through the government. Look at civil enforcement through the courts, look at criminal enforcement through prosecutors in the courts and always and this is the one people miss, look at customs enforcement. In a prior life, in a prior firm, I focused heavily on trademark and copyrighting infringement and we represented the company that manufactured and developed Beanie Babies and one of the things we did was develop relationships at the ports in China, so that we would know, when large shipments of Beanie Babies, which weren't really Beanie Babies, were on their way toward the United States. So you do the leg work in China, you run the calculation, you know when the ship has landed when you get there the day before and you deal with customs so that they know when that ship arrives the Beanie Babies don't get off the boat or customs takes the Beanie Babies, verifies that they're infringements and then does what to them? They destroy them. That's one of the most effective ways to deal with infringement but you've got to do the legwork so that you're able to do it. Other things to do in advance develop a strategy, most