20-F 1 a19-2996_120f.htm 20-F

Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

(Mark One)

 

o

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

OR

 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018.

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                       to                       

 

 

OR

 

 

o

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Date of event requiring this shell company report

 

Commission file number: 001- 37750

 

Yintech Investment Holdings Limited

(Exact name of Registrant as specified in its charter)

 

N/A

(Translation of Registrant’s name into English)

 

Cayman Islands

(Jurisdiction of incorporation or organization)

 

3rd Floor, Lujiazui Investment Tower

No.360 Pudian Road

Pudong District, Shanghai, 200125

People’s Republic of China

(Address of principal executive offices)

 

Wenbin Chen, Interim Chief Financial Officer

Telephone: +86 (21) 2028 9009

Email: wenbin.chen@yintech.cn

3rd Floor, Lujiazui Investment Tower

No.360 Pudian Road

Pudong District, Shanghai, 200125

People’s Republic of China

(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

American depositary shares
(each representing 20 ordinary shares, par value US$0.00001 per share)

 

The NASDAQ Stock Market LLC

(The NASDAQ Global Select Market)

Ordinary shares,
par value US$0.00001 per share

 

The NASDAQ Stock Market LLC

(The NASDAQ Global Select Market)

 


* Not for trading, but only in connection with the listing on The NASDAQ Global Select Market of American depositary shares. Currently, one ADS represents 20 ordinary shares.

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

 

 

1,428,942,175 ordinary shares, par value US$0.00001 per share, as of December 31, 2018.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes   x No

 

If this report is an annual or transaction report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

o Yes   x No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes   o No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

x Yes   o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

Non-accelerated filer o

 

Emerging growth company x

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards* provided pursuant to Section 13(a) of the Exchange Act. o

 

†The term ‘‘new or revised financial accounting standard’’ refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.

 

x U.S. GAAP

 

o International Financial Reporting Standards as issued
by the International Accounting Standard Boards

 

o Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

o Item 17   o Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes   x No

 

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

o Yes   o No

 


Table of Contents

 

TABLE OF CONTENTS

 


 

 

Page

Introduction

2

Forward-Looking Statements

3

Part I

4

Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

4

Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE

4

Item 3. KEY INFORMATION

4

Item 4. INFORMATION ON THE COMPANY

34

Item 4A. UNRESOLVED STAFF COMMENTS

55

Item 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

55

Item 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

74

Item 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

84

Item 8. FINANCIAL INFORMATION

85

Item 9. THE OFFER AND LISTING

86

Item 10. ADDITIONAL INFORMATION

87

Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

93

Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

94

Part II

95

Item 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

95

Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

95

Item 15. CONTROLS AND PROCEDURES

95

Item 16A. AUDIT COMMITTEE FINANCIAL EXPERT

96

Item 16B. CODE OF ETHICS

97

Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

97

Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

97

Item 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

97

Item 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

97

Item 16G. CORPORATE GOVERNANCE

97

Item 16H. MINE SAFETY DISCLOSURE

98

PART III

98

Item 17. FINANCIAL STATEMENTS

98

Item 18. FINANCIAL STATEMENTS

98

Item 19. EXHIBITS

98

 

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INTRODUCTION

 

Except where the context otherwise requires and for purposes of this annual report on Form 20-F only:

 

·                  “active account” refers to a tradable account that executed at least one trade through us in a given period;

 

·                  “ADSs” refers to our American depositary shares, each of which represents 20 ordinary shares, and “ADRs” refers to the American depositary receipts that evidence our ADSs; “BVI” refers to the British Virgin Islands;

 

·                  “China” or “PRC” refers to the People’s Republic of China, excluding, for purposes of this annual report, Hong Kong, Macau and Taiwan;

 

·                  “equity” refers to, with respect to online commodities trading, the value of a trading participant’s account, which is the net aggregate of its deposits, withdrawals, closed positions and open positions;

 

·                  “hedge” refers to economic hedging transactions we enter into with various counterparties to manage our market risk exposure;

 

·                  “liquidation” refers to, with respect to online commodities trading, the mandatory termination and settlement of a trading participant’s positions by the exchanges;

 

·                  “maximum leverage ratio” refers to, with respect to online spot commodity trading, the maximum ratio set by exchanges for the notional value of a position divided by the deposit required for such a position;

 

·                  “ordinary shares” or “shares” refers to our ordinary shares, par value US$0.00001 per share;

 

·                  “our company,” “we,” “us,” “our,” or “Yintech” refers to Yintech Investment Holdings Limited, a Cayman Islands exempted company with limited liability, and except where the context otherwise requires, all of its subsidiaries or where the context refers to any time prior to its incorporation, the business which its predecessors or the predecessors of its present subsidiaries were engaged in and which was subsequently assumed by it;

 

·                  “principal position” refers to the trading positions we have by serving as counterparty to our customers’ trades;

 

·                  “RMB,” “CNY” or “Renminbi” refers to the legal currency of China;

 

·                  “spread fee” refers to the difference, as set by the exchanges, between customers’ buying and selling prices quoted by the exchanges, which can be expressed either as a fixed amount per weight unit or a fixed percentage of the notional transaction value;

 

·                  “tradable account” refers to a customer account that has been activated for trading of spot and futures commodities contracts and has remained tradable as of the end of a given period; and

 

·                  “U.S. dollars,” “US$,” “USD” or “dollars” refers to the legal currency of the United States.

 

This annual report on Form 20-F contains translations of certain Renminbi (“RMB” or “CNY”) amounts into U.S. dollars (“USD”) at specified rates. For amounts not recorded in our consolidated financial statements included elsewhere in this annual report, unless otherwise stated, all translations from Renminbi to U.S. dollars were made at the exchange rate of RMB6.8755 to US$1.00, as set forth in the H.10 statistical release of the Federal Reserve Board on December 28, 2018. We make no representation that the RMB or U.S. dollar amounts referred to in this annual report could have been or could be converted into U.S. dollars or RMB, as the case may be, at any particular rate or at all. On April 19, 2019, the noon buying rate was RMB6.7032 to US$1.00. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding.

 

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FORWARD-LOOKING STATEMENTS

 

This annual report on Form 20-F contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to us. These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact in this annual report are forward-looking statements. These forward-looking statements can be identified by words or phrases such as “may,” “could,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “project” or “continue” or the negative of these terms or other comparable terminology. The forward-looking statements included in this annual report relate to, among others:

 

·                  our goals and strategies;

 

·                  our future business development, financial condition and results of operations;

 

·                  expected changes in our revenues and certain cost of expense items;

 

·                  our ability to attract and retain our customers and further enhance our brand recognition;

 

·                  our ability to provide new products and services;

 

·                  trends and competition in our industry;

 

·                  fluctuations in general economic and business conditions in the markets in which we operate; and

 

·                  relevant government policies and regulations relating to our industry.

 

These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, we cannot assure you that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in “Item 3. Key Information—D. Risk Factors” and elsewhere in this annual report. The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events.

 

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PART I

 

Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

 

Not Applicable.

 

Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable.

 

Item 3. KEY INFORMATION

 

A.                                    SELECTED FINANCIAL DATA

 

The following table presents the selected consolidated financial information for our company. The consolidated statements of comprehensive income data for the three years ended December 31, 2016, 2017 and 2018 and the consolidated balance sheet data as of December 31, 2017 and 2018 have been derived from our audited consolidated financial statements, which are included in this annual report beginning on page F-1. Our historical results do not necessarily indicate results expected for any future period. The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements and related notes, and “Item 5. Operating and Financial Review and Prospects” below. Our audited consolidated financial statements are prepared and presented in accordance with U.S. GAAP.

 

Consolidated Statements of Comprehensive Income Data

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

 

 

(unaudited)

 

 

 

(in thousands, except per share data)

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees, net

 

2,547,043

 

2,198,575

 

941,868

 

136,989

 

Trading gains/(losses), net

 

12,563

 

40,554

 

34,333

 

4,994

 

Interest and investment income

 

4,365

 

5,406

 

18,128

 

2,637

 

Other revenues

 

155,570

 

204,411

 

100,415

 

14,605

 

Total revenues

 

2,719,541

 

2,448,946

 

1,094,744

 

159,225

 

Expenses

 

 

 

 

 

 

 

 

 

Commission expense

 

 

 

(2,012

)

(293

)

Employee compensation and benefits

 

(839,024

)

(1,066,553

)

(808,292

)

(117,561

)

Advertising and promotion

 

(554,291

)

(424,865

)

(223,265

)

(32,473

)

Information technology and communications

 

(40,905

)

(41,170

)

(32,421

)

(4,715

)

Occupancy and equipment rental

 

(76,594

)

(123,680

)

(115,810

)

(16,844

)

Taxes and surcharges

 

(30,748

)

(21,080

)

(6,455

)

(939

)

Intangible assets amortization

 

(19,081

)

(56,547

)

(56,515

)

(8,220

)

Impairment of goodwill and intangible assets

 

 

 

(639,000

)

(92,939

)

Other expenses

 

(107,766

)

(78,509

)

(83,334

)

(12,120

)

Total expenses

 

(1,668,409

)

(1,812,404

)

(1,967,104

)

(286,104

)

Income/(loss) before income taxes

 

1,051,132

 

636,542

 

(872,360

)

(126,879

)

Income tax expense

 

(125,430

)

(169,556

)

(1,028

)

(150

)

Net income/(loss)

 

925,702

 

466,986

 

(873,388

)

(127,029

)

Less: Net loss attributable to non-controlling interests

 

(4,966

)

(13,678

)

(10,350

)

(1,505

)

Net income/(loss) attributable to Yintech

 

930,668

 

480,664

 

(863,038

)

(125,524

)

Earnings/(loss) per share

 

 

 

 

 

 

 

 

 

Basic

 

0.79

 

0.34

 

(0.60

)

(0.09

)

Diluted

 

0.75

 

0.33

 

(0.60

)

(0.09

)

Other comprehensive income/(loss)

 

 

 

 

 

 

 

 

 

Unrealized gains/(Loss) on available-for-sale investments, net of tax

 

 

(800

)

 

 

Foreign currency translation adjustment

 

42,696

 

(18,714

)

22,538

 

3,279

 

Comprehensive income/(loss)

 

968,398

 

447,472

 

(850,850

)

(123,750

)

Comprehensive loss attributable to non-controlling interests

 

(4,966

)

(13,678

)

(10,350

)

(1,505

)

Comprehensive income/(loss) attributable to Yintech

 

973,364

 

461,150

 

(840,500

)

(122,245

)

 

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Consolidated Balance Sheet Data

 

 

As of December 31,

 

 

 

2017

 

2018

 

 

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

(in thousands)

 

 

 

Assets

 

 

 

 

 

 

 

Cash

 

690,478

 

257,789

 

37,494

 

Entrusted bank balances held on behalf of customers

 

150,452

 

73,226

 

10,650

 

Short-term investments

 

1,212,006

 

1,479,109

 

215,127

 

Deposits with clearing organizations

 

1,152

 

34,215

 

4,976

 

Amount due from related parties

 

 

25,000

 

3,636

 

Equity method investment

 

 

24,730

 

3,597

 

Equipment and leasehold improvements

 

39,214

 

24,316

 

3,537

 

Deferred tax assets

 

34,431

 

31,239

 

4,544

 

Goodwill

 

1,096,972

 

637,147

 

92,669

 

Accounts receivable

 

171,156

 

180,230

 

26,213

 

Intangible assets

 

433,983

 

330,247

 

48,032

 

Other assets

 

311,281

 

155,648

 

22,639

 

Total assets

 

4,141,125

 

3,252,896

 

473,114

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Accounts payable (including accounts payable of the consolidated variable interest entities (“VIE”) and VIE’s subsidiaries without recourse to the Company of RMB1,985 thousand and RMB2,283 thousand as of December 31, 2017 and 2018, respectively)

 

197,516

 

119,469

 

17,376

 

Accrued employee benefits (including accrued employee benefits of the consolidated VIE and VIE’s subsidiaries without recourse to the Company of RMB12,299 thousand and RMB 19,708 thousand as of December 31, 2017 and 2018, respectively)

 

142,085

 

189,042

 

27,495

 

Income tax payable (including income tax payable of the consolidated VIE and VIE’s subsidiaries without recourse to the Company of RMB5,522 thousand and RMB11,042 thousand as of December 31, 2017 and 2018, respectively)

 

73,458

 

95,415

 

13,878

 

Deferred tax liabilities (including deferred tax liabilities of the consolidated VIE and VIE’s subsidiaries without recourse to the Company of nil and RMB 38,287 thousand as of December 31, 2017 and 2018, respectively)

 

106,315

 

79,618

 

11,580

 

Other liabilities (including other liabilities of the consolidated VIE and VIE’s subsidiaries without recourse to the Company of RMB8,625 thousand and RMB 62,645 thousand as of December 31, 2017 and 2018 respectively)

 

45,553

 

144,392

 

21,001

 

Total liabilities

 

564,927

 

627,936

 

91,330

 

Shareholders’ Equity

 

 

 

 

 

 

 

Ordinary shares (USD 0.00001 par value. 3,000,000,000 shares authorized, 1,425,282,175 shares issued and 1,413,951,095 shares outstanding as of December 31, 2017; 1,468,059,155 shares issued and 1,428,942,175 shares outstanding as of December 31, 2018)

 

93

 

96

 

14

 

Treasury stock (11,331,080 and 39,116,980 shares as of December 31, 2017 and 2018, respectively)

 

(36,973

)

(111,169

)

(16,169

)

Additional paid-in capital

 

2,058,312

 

1,927,854

 

280,395

 

Retained earnings

 

1,516,525

 

652,687

 

94,929

 

Accumulated other comprehensive income

 

24,423

 

47,761

 

6,947

 

Equity attributable to non-controlling interests

 

13,818

 

107,731

 

15,668

 

Total shareholders’ equity

 

3,576,198

 

2,624,960

 

381,784

 

Total liabilities and shareholders’ equity

 

4,141,125

 

3,252,896

 

473,114

 

 

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Summary Operating Data

 

The following table presents our summary operating data for the periods indicated:

 

 

 

As of December 31,

 

 

 

2016

 

2017

 

2018

 

Tradable accounts (1)

 

143,539

 

108,850

 

126,539

 

 


(1)         Tradable accounts refer to accounts that have been activated and have remained tradable as of the end of the period.

 

 

 

For the Year Ended December 31,

 

 

 

 

 

2016

 

2017

 

2018

 

 

 

Active accounts (2)

 

73,078

 

121,410

 

40,240

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

 

 

(unaudited)

 

Customer trading volume (in millions)

 

2,978,321

 

3,841,069

 

1,730,683

 

251,717

 

 


(2)         Active accounts refer to tradable accounts that have executed at least one trade during the period.

 

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EXCHANGE RATE INFORMATION

 

Our business is primarily conducted in China and substantially all of our revenues and expenses are denominated in Renminbi. This annual report contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, or at all. The PRC government imposes controls over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On April 19, 2018, the daily exchange rate reported by the Federal Reserve Board was RMB6.7032 to US$1.00.

 

B.                                    CAPITALIZATION AND INDEBTEDNESS

 

Not applicable.

 

C.                                    REASONS FOR THE OFFER AND USE OF PROCEEDS

 

Not applicable.

 

D.                                    RISK FACTORS

 

Risks Related to Our Business and Industry

 

Any change in trading rules of the trading exchanges could adversely affect our revenue and profitability.

 

We operate on the various trading exchanges such as the Shanghai Gold Exchange (“SGE”), Dalian Commodity Exchange and China Financial Futures Exchange, etc., which provide trading platforms and set trading model and rules for all participants on the exchanges. Those exchanges formulate their trading rules covering various aspects of trading, including but not limited to, commission and fee rates, leverage ratio, trade settlement procedures, membership qualifications, risk control mechanism, as well as information management. Those trading exchanges usually adjust their trading rules in response to changing market conditions and changes to these rules may adversely affect our revenue or business. In addition, futures companies have discretion to set the fee rates and the adjustments of the fee rates will have an impact on our income and profitability.

 

Any material changes in the trading rules of those exchanges may affect our business model, revenue composition, expenses associated with our operation, as well as costs to comply with new rules, which may adversely affect our results of operations and business. For instance, the max level of our trading commissions generated from spot commodities services we provided on the SGE is set by the SGE. If the SGE was to reduce such fee levels, for one purpose or another, our revenue and profit may suffer. If the SGE was to lower the maximum leverage ratio, it would reduce the maximum notional value of transaction a customer can conduct with a given amount of trading deposit, which may negatively affect our customers’ trading volume, thus negatively impact our commissions and fees as they are earned based on our customers’ trading volume. A lower maximum leverage ratio may negatively impact our customers’ trading volume and our commissions and fees. Another example is the fee rate and leverage ratio, which is determined by the futures companies subject to the changes made by exchanges as well as market condition then. If the fee rate in future exchanges decreases, our income will directly decline accordingly. If the leverage ratio drops, our trading notional will downslope and our income will be negatively affected.

 

A substantial portion of our business currently relies on collaboration with multiple financial members of SGE and futures companies. Our business will be adversely impacted if we are unable to maintain our relationship with them.

 

We have formed cooperative relationships with a number of financial members of SGE and futures companies. We introduce customers to open accounts and trade with those financial members of SGE and futures companies and, in turn, share the relevant commissions and fees income, refund from futures exchanges and interest income with those financial members of SGE and futures companies.

 

Our agreements with those financial members of SGE and futures companies are non-exclusive and do not prohibit them from working with our competitors or from offering competing services. Any of those financial members of SGE and futures companies could view that working with us is not in their best interest and hence decide to enter into exclusive or more favorable relationships with our competitors. In turn, those financial members of SGE and futures companies may not perform as expected under our agreements, including potentially being unable to accommodate our projected growth in customer base and trading volume. We could in the future have disagreements or disputes with those companies, which could negatively impact or threaten our relationship.

 

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We provide agent services to several financial members of SGE who are subject to supervision of SGE. And SGE is subject to the oversight of the People’s Bank of China. Any change of regulations to any or certain of our cooperative financial members could adversely impact our business. For instance, we were requested to suspend new business cooperation with two of those financial members in accordance with the internal rule stipulated by SGE that may result in high dependence on the fewer financial members that we could develop business relationship with and hence reduce our revenues generated from spot gold services.

 

The futures commodity business is subject to the oversight by the People’s Bank of China, the Banking Regulatory Commission, the China Securities Regulatory Commission (“CSRC”) and other regulatory authorities in China and other jurisdictions, and must comply with complex rules, regulations, licensing and examination requirements. We are an “introducing broker” and according to a rule stipulated in 2007, we cannot keep customers’ transaction records and account materials in our platform. We receive fees and commissions in accordance with the calculation sheet provided by those futures companies. If the futures companies conceal or wrongly calculate the fees or commissions, our income might be negatively affected.

 

Furthermore, according to an internal regulation notice, we, as an introducing broker, will subject our apps to the certification of those futures companies. It might also negatively affect our business as we primarily acquire new customers through the apps we designed and developed independently.

 

Our futures commodities trading business is subject to extensive and evolving regulatory requirements in China, any non-compliance with or changes in which may affect our business operations and prospects.

 

The PRC futures industry is highly regulated. Futures companies and other financial institutions that operate in this industry are subject to laws and regulations in various respects, including in relation to licensing, scope of permitted products and services, capital adequacy as well as trading and payment methods.

 

The regulatory authorities in China may conduct periodic inspections, examinations and inquiries in respect of our compliance with relevant regulatory requirements. Such laws and regulations may potentially impose additional costs on our business, increase the regulatory and compliance complexity of our operations, and reduce the demand for our services. There is no assurance that we will be able to comply fully with all the relevant laws and regulations. Any breach or non-compliance may result in sanctions, fines, penalties or other disciplinary actions

 

Moreover, the relevant rules and regulations in the futures industry may change from time to time based on the development of the futures markets or otherwise. New legislation, rules and regulations and changes in the interpretation or enforcement of existing ones may impact our business strategies, operations and prospects. In addition, changes in the rules and regulations could result in limitations on the business lines that we may conduct or modifications to our business practices or additional costs, which may materially and adversely affect our financial condition and results of operations.

 

Our customer trading volume in our commodities services sector is influenced by the general trading activities in the online spot commodity trading market and futures commodities market, which may be impacted by competing investment products, economic and market conditions and other factors that are beyond our control.

 

Our revenue generated from our commodities services sector depends in part on our customer trading volume, which is influenced by the general trading activities in the online spot commodity trading market and futures commodities market. Online commodities trading faces competition from  traditional investment products, including but not limited to, stock, wealth management products, as well as online finance products such as peer-to-peer lending and other investment products. These alternative investment products may divert investors from or reduce their activity levels in online commodities trading, which may adversely affect our trading volume, revenue and business.

 

In addition, the general trading activities in the commodities trading market may be impacted by movements and trends in the world’s commodity markets. Customer trading activities are to some extent influenced by the changes in commodity prices in international and domestic commodity markets. Periods of increased fluctuations of commodity prices often coincide with a larger amount of trading volume by our customers. As a result, period-to-period comparison of our results of operations may not be meaningful and our future operating results may be subject to significant fluctuations. The general trading activities in our industry are also directly affected by factors such as economic and political conditions, macro trends in business and finance, investors’ interest level in commodity trading and legislative and regulatory changes. Any one or more of these factors, or other factors, may reduce the trading activity level in the online commodities trading industry and adversely affect our business and results of operations and cash flows.

 

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The profitability of our clients’ investments is directly affected by elements beyond our control, such as economic and political conditions, broad trends in business and finance, changes in volume of securities transactions, changes in the markets in which such transactions occur and changes in how such transactions are processed. Furthermore, it is possible that some clients could solely rely on certain predictive statements made by other clients on our platform, ignoring our alert warnings that clients should make their own investment judgement and should not predict future performance based on historical records.

 

Any future change in the regulatory and legal regime for the securities brokerage industry may have a significant impact on our business.

 

We acquired Forthright Securities Company Limited, or Forthright, in the year of 2017 and thus began to offer online trading services for to individual investors to trade Hong Kong and U.S. stock. Firms in the securities brokerage industry have been subject to an increasingly regulated environment over recent years, and penalties and fines sought by regulatory authorities have also increased. This regulatory and enforcement environment has created uncertainties with respect to various types of products and services that historically had been offered by us and that were generally believed to be permissible and appropriate. Our model of operation and profitability may be directly affected by legislative changes in rules promulgated by government agencies and self-regulatory organizations in various jurisdictions that oversee our businesses, and changes in the interpretation or enforcement of existing laws and rules, such as the potential imposition of transaction taxes.

 

For example, Forthright does not hold any license or permit for doing securities brokerage business in China. Although we do not believe Forthright was engaging in securities brokerage business in China, there remain uncertainties as to the interpretation and implementation of relevant PRC laws and regulations. We face significant legal uncertainties as to whether the CSRC would require Forthright to get certain licenses or permits relating to its activities in China, or whether the CSRC would view our current or previous business operations in China as non-compliance with the relevant regulatory regime. We could be subject to disciplinary or other actions in the future due to being claimed or deemed non-compliance, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our securities business could be materially and adversely affected if we fail to generate reliable data and price quotes or other trading-related information on a real-time basis from the stock exchanges, or if we cannot maintain our current business relationships with our historical data providers on commercially reasonable terms.

 

We acquired Forthright in the year of 2017 and thus began to offer online trading services for Hong Kong and U.S. stock to individual investors around the world to receive commissions and interests through our platform. We also purchased market data and investment information from external data providers and then provide consolidated market data and industry analysis to our customers to help them make investment choices.

 

We rely on real-time stock, bond and mutual fund quotes and other trading-related information from the Shanghai and Shenzhen Stock Exchanges and any future securities exchanges in China. If those service providers were to fail to share reliable price quotes or other trading-related information on a real-time basis, it would be difficult for us to receive reliable real-time price quotes and other trading-related information from a different source, which could materially and adversely affect our business.

 

We cannot assure that the external data providers will be able to continue to provide data to meet our current needs in an efficient and cost-effective manner, or that they will be able to adequately expand their services to meet our needs in the future. An interruption in or the cessation of service by any external data provider as a result of system failures, capacity constraints, financial constraints or problems, unanticipated trading market closures or for any other reason and our inability to make alternative arrangements in a smooth and timely manner, if at all, could have a material adverse effect on our business, results of operations and financial condition. We cannot assure you that we will be able to enter into or maintain our business arrangements with our current primary and backup data providers on commercially reasonable terms or at all. In this case, it could take time for us to locate alternative providers of comprehensive historical data and information on commercially reasonable terms, which could cause disruptions to our operations and adversely affect our business. Even if we are able to find alternative data providers, they may fail to deliver to us reliable and comprehensive data and information in accordance with our specifications and requirements, which could materially and adversely affect our business.

 

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If we are unable to retain existing clients or attract new clients, our business, financial conditions and results of operations may be materially and adversely affected.

 

Our success depends largely on our ability to retain existing clients, in particular those that have highly frequent transactions. Our clients may not continue to place trading orders or increase the level of their trading activities on our platform if we cannot match the prices offered by other market players or if we fail to deliver satisfactory services. Failure to deliver services in a timely manner at competitive prices with satisfactory experience will cause our clients to lose confidence in us and use our platform less frequently, or even stop using our platform altogether, which in turn will materially and adversely affect our business. Even if we are able to provide high-quality and satisfactory services on our platform in a timely manner and at favorable price terms, we cannot assure you that we will be able to retain existing clients, encourage repeat and increased trading transactions due to reasons out of our control, such as our clients’ personal financial reasons or the deterioration of the capital markets condition.

 

Our customer base mainly comprises of individual customers. Although we offer services designed to educate, support and retain our customers, our efforts to attract new customers or reduce the attrition rate of our existing customers may not be successful. If we were unable to maintain or increase our customer retention rates or generate new customers in a cost-effective manner, our business, financial condition and results of operations would likely be adversely affected. Historically, we incurred RMB554.3 million, RMB424.9 million and RMB223.3 million (US$32.5 million) in advertising and promotion expenses, representing 20.4%, 17.3% and 20.4% of our revenues in the year of 2016, 2017 and 2018, respectively. Although we have spent significant financial resources on marketing expenses and plan to continue doing so, these efforts may not be cost-effective to attract new customers. We cannot assure you that we will be able to maintain or grow our customer base in a cost-effective way. If we are unable to maintain high-quality services, or maintain or reduce our service fee rate, or introduce new products and services, we may fail to attract new customers or lose our existing customers, which could adversely affect our growth and profitability.

 

The occurrence of cyber incidents, or a deficiency in our cybersecurity, could disrupt our services, cause damage to our brand and adversely affect our results of operations.

 

In the current environment, there are numerous and evolving risks to cybersecurity and privacy, including criminal hackers, hacktivists, state-sponsored intrusions, industrial espionage, employee malfeasance and human or technological error. High-profile security breaches at other companies and in government agencies have increased in recent years, and security industry experts and government officials have warned about the risks of hackers and cyber-attacks targeting businesses such as ours. In a number of public networks, hackers have bypassed firewalls and misappropriated confidential information, including personally identifiable information, for various reasons, including political, economic and commercial gain.

 

Our computer networks support all phases of our operation, including marketing, customer development and the provision of customer services, are an essential part of our technology infrastructure and they may be vulnerable to cyber incidents. Our computer system, the networks we use, the networks and online trading platforms of the exchanges and other third parties with whom we interact are potentially vulnerable to physical or electronic computer break-ins, viruses and similar disruptive problems and security breaches. Our electronic data may also be vulnerable to attacks, unauthorized access and misappropriation, which may corrupt our electronic data. Concerns over the security of Internet transactions and the safeguarding of confidential personal information could also adversely affect our customers’ intention to trade. A hacker who circumvents our cybersecurity measures could misappropriate proprietary information or cause interruptions, malfunctions or disruptions to our operations. We or our service providers may be required to invest significant resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. We have not experienced a major cybersecurity breach to date. However, if a major cybersecurity breach were to occur, particularly if it results in a loss of confidence in our services, our reputation, business, financial condition and results of operations could be adversely affected.

 

We have implemented solutions, processes, and procedures to help mitigate our exposure to these types of cybersecurity risks, but these measures do not guarantee that we will not in the future experience a major cybersecurity breach. Despite our efforts to safeguard the information of our customers, information leakage due to system malfunction, employee error, misconduct or other factors may still occur. As a result, we may be required to devote significant incremental amounts of resources to protect against the threat or perceived threat of these cybersecurity risks or to alleviate problems caused by cyber incidents, if and when they occur. Our insurance may not be adequate to cover all losses in connection with any cybersecurity breach or other incident, and we cannot be certain that our present coverage, or any future coverage we may obtain, will remain available to us on commercially reasonable terms or at all.

 

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Our proprietary technology is critical to our business and if we fail to keep our technology updated as the industry evolves, our growth, revenue and business prospects may be materially and adversely affected.

 

Our proprietary client software and client relationship management system are critical to our business operation. Our success in the past has largely been attributable to our sophisticated proprietary technology that has empowered the efficient operations of our platform. We have benefited from the fact that proprietary technology equivalent to that which we employ has not been widely available to our competitors. In order to remain competitive, our proprietary technology is under continuous development and upgrade.

 

Additionally, to keep pace with changing technologies and client demands, we must correctly interpret and address market trends and enhance the features and functionality of our technology in response to these trends, which may lead to significant research and development costs. We may be unable to accurately determine the needs of our users and clients or the trends in the online brokerage industry or to design and implement the appropriate features and functionality of our technology in a timely and cost-effective manner, which could result in decreased demand for our services and a corresponding decrease in our revenue. Also, any adoption or development of similar or more advanced technologies by our competitors may require that we devote substantial resources to the development of more advanced technology to remain competitive. The markets in which we compete are characterized by rapidly changing technology, evolving industry standards and changing trading systems, practices and techniques. Although we have been at the forefront of many of these developments in the past, we may not be able to keep up with these rapid changes, develop new technology, realize a return on amounts invested in developing new technologies or remain competitive in the future.

 

New lines of business or new services may subject us to additional risks.

 

From time to time, we may implement new lines of business or offer new services within existing lines of business. For instance, we commenced gold trading service on the SGE in November 2015. In August 2016, we acquired 100% equity interest in Gold Master (HK) Company Limited, or the Gold Master, which offers online spot commodity trading services to individual customers in PRC. We also established Financial Innovation Labs in Shanghai and Boston in November 2016 to focus on areas such as big data, artificial intelligence and trading strategies. Further, in 2017, we expanded our business to futures commodities trading services and securities services. In February 2018, we started investor advisory business to provide our individual customers with market insights and investment decision-making processes. In December 2018, we started to provide global asset allocation services after we acquired OTS Capital Management, a type-4 and type-9 license holder in Hong Kong. We may further expand into other business areas in the future.

 

There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new services may not be achieved and profitability targets may not prove feasible. External factors, such as compliance with regulations, competition and shifting market preferences, may also impact the successful implementation of a new line of business or a new service. Our personnel and technology systems may fail to adapt to the changes in such new areas or we may fail to effectively integrate new services into our existing operation and we may lack experience in managing new lines of business or new services. In addition, we may be unable to proceed with our operations as planned or compete effectively due to different competitive landscapes in these new areas. Even if we expand our businesses into new jurisdictions or areas, the expansion may not yield intended profitable results. Furthermore, any new line of business and/or new service could have a significant impact on the effectiveness of our internal control system. Failure to successfully manage these risks in the development and implementation of new lines of business or new services could have a material adverse effect on our business, results of operations and financial condition.

 

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If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to accurately report our financial results, prevent fraud or file our periodic reports in a timely manner.

 

Based on the criteria established in Internal Control — Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission, our management determined that our internal control over financial reporting was ineffective due to the presence of a material weakness. The material weakness identified relates to our lack of sufficient accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements and failure to establish and clearly communicate acceptable policies regarding U.S. GAAP financial reporting. A material weakness (as defined in Rule 12b-2 under the Exchange Act) is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented on a timely basis. This control deficiency creates a reasonable possibility that a material misstatement to the consolidated financial statements will not be prevented or detected on a timely basis, and therefore we concluded that the deficiency represents a material weakness in our internal control over financial reporting and our internal control over financial reporting was not effective as of December 31, 2018.

 

When we are no longer an emerging growth company under the federal securities laws, our independent registered public accounting firm will be required to issue an attestation report on the effectiveness of our internal control over financial reporting. Even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may conclude that there are material weaknesses or significant deficiencies with respect to our controls or the level at which our controls are documented, designed, operated or reviewed. Material weaknesses were once identified by our auditor in the past and may be identified during the audit process or at other times. If we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404.

 

The reporting obligations as a public company place a strain on our management, operational and financial resources and systems for the near future. If we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could in turn limit our access to capital markets, harm our results of operations, and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions.

 

We may pursue acquisitions or joint ventures that could present unforeseen integration obstacles, incur unpredicted costs or may not enhance our business as we expected.

 

We have made a few selective acquisitions to expand our business into new areas. We may in the future continue to pursue acquisitions and joint ventures as part of our growth strategy. In August 2016, we acquired 100% equity interest in Gold Master, which offers online spot commodity trading services to individual customers in the PRC on the SGE. Gold Master’s revenues for 2018 did not meet management’s expectations, therefore we performed an impairment test and recognized RMB 505 million (US$73 million) impairment loss for goodwill, RMB 78 million (US$11 million) impairment loss on customer list and RMB 56 million (US$8 million) impairment loss on trademark. In July 2017, we established a joint venture with SINA Corporation (NASDAQ: SINA), a leading online media company serving China and the global Chinese communities, to provide financial software, information and services to individual investors. In December 2018, we acquired OTS Capital Management, a type-4 and type-9 license holder in Hong Kong under the Securities and Futures Commission (“SFC”) to provide global asset allocation service. We also entered into securities advisory and asset management business through acquisitions.

 

Any future acquisition or joint venture may result in exposure to potential liabilities of the acquired companies, significant transaction costs and it may present new risks associated with entering additional markets or offering new products as well as integrating the acquired companies or newly established joint ventures. Potential liabilities may arise from deficiencies in due diligence findings and deficient track - record information. In addition, we may not have sufficient management, financial and other resources to integrate companies we acquire or to successfully operate joint ventures and we may be unable to profitably operate our expanded company. Additionally, any new businesses that we may acquire or joint ventures we may form, once integrated with our existing operations, may not produce expected or intended results.

 

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We may be subject to customer claims and litigation risk that could adversely affect our reputation, business, financial condition and results of operations.

 

We are subject to lawsuits and other claims in the ordinary course of our business. Our business operations entail substantial litigation and regulatory risks, including the risk of lawsuits and other legal actions relating to information disclosure, client on-boarding procedures, sales practices, product design, fraud and misconduct, control procedures deficiencies, as well as the protection of the personal and confidential information of our clients. We may be subject to arbitration claims and lawsuits in the ordinary course of our business. We may also be subject to inquiries, inspections, investigations and proceedings by regulatory and other governmental agencies. Actions brought against us may result in settlements, injunctions, fines, penalties, suspension or revocation of license, reprimands or other results adverse to us that could harm our reputation. Even if we are successful in defending ourselves against these actions, the costs of such defense may be significant to us. In market downturns, the number of legal claims and the amount of damages sought in legal proceedings may increase.

 

In addition, we may face arbitration claims and lawsuits brought by our users and clients who have used our online brokerage or other financial services and found them unsatisfactory. We may also encounter complaints alleging misrepresentation with regard to our platform and/or services. This risk may be heightened during periods when credit, equity or other financial markets are deteriorating in value or are volatile, or when clients are experiencing losses. Although we have prudent internal procedures and policies in place and we monitor employees’ interaction with customers and potential customers through our CRM system, it is difficult to detect and deter misconduct and inappropriate behavior of all of our employees, and the precautions we take to prevent and detect such behaviors may not be effective in all cases. Our employees could wrongly execute transaction orders placed by our customers via telephone, misappropriate customer information, conduct improper activities on behalf of our customers, make false or misleading statements, promise investment returns to attract customers to trade, misrecord or otherwise try to hide improper activities from us. In addition, employees’ misconduct could give rise to customer claims against us, including claims for negligence, fraud, failure to supervise, breach of fiduciary duty, transactions and intentional misconduct. These claims, regardless of their merits, could subject us to substantial losses and seriously harm our reputation. In addition, such customer claims may escalate into litigation.

 

We face intense competition in the industry of providing investment and trading services to individual investors in China, and if we do not compete effectively, our results of operations and our business prospects may be adversely affected.

 

We provide investment and trading services to individual investors in China and we encounter intense competition in all of our business lines. There are a variety of financial institutions in the PRC that provide investment and trading services to individual investors. We compete primarily with PRC commercial banks, securities firms, trust companies, funds and emerging internet-based financial companies. Our competitors may compete with us in the following ways:

 

·                  provide services that are similar to ours, or that are more attractive to customers than ours;

 

·                  provide products and services we do not offer;

 

·                  adapt at a faster rate to market conditions, new technologies and customer demands;

 

·                  offer better, faster and more reliable technology; and

 

·                  market, promote and provide their services more effectively.

 

We cannot assure you that we will be able to compete effectively or efficiently with current or future competitors. They may be acquired by, receive investment from or enter into strategic relationships with, established and well-financed companies or investors, which would help enhance their competitiveness. Furthermore, the current competitors and new entrants in the online brokerage industry may also seek to develop new service offerings, technologies or capabilities that could render some of the services that we offer obsolete or less competitive, and some of them may adopt more aggressive pricing policies or devote greater resources to marketing and promotional campaigns than we do. The occurrence of any of these circumstances may hinder our growth and reduce our market share, and thus our business, results of operations, financial condition and prospects would be materially and adversely affected.

 

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Our reputation is critically important to our business. If our reputation is harmed, or the reputation of the industry as a whole is damaged, our business, financial condition, results of operations or prospects may be materially and adversely affected.

 

Our ability to attract and retain customers may be adversely affected if our reputation is damaged. If we fail, or appear to fail, to deal with issues that may give rise to reputational risk, our business and prospects may be harmed. These issues include, but are not limited to, mishandling customer complaints, potential conflicts of interest, privacy breaches, customer data leak, improper sales practices, as well as failure to identify legal, credit, liquidity, and market risks inherent in our business. Failure to appropriately address these issues could reduce customer confidence in us or increase the customer attrition rate, which may adversely affect our reputation and business.

 

In addition, our ability to attract and retain customers may be adversely affected if the reputation of the industry as a whole is damaged. In recent years, certain illegal trading platforms have caused reputational damage to the entire online spot commodity trading industry. There have been news reports on alleged misappropriation of customer funds and other fraudulent activities by certain exchanges and exchange members. The perception of insufficient regulation and unfavorable reputation within the industry could materially and adversely affect our ability to attract and retain customers.

 

Any fraudulent or allegedly fraudulent activities in the online spot commodity trading industry, which is beyond our control, may damage the reputation of the entire industry and may adversely affect our business operations and reputation.

 

We may not be able to protect our intellectual property rights or may be subject to intellectual property claims from others.

 

We rely on a combination of trademark, copyright, trade secret and fair business practice laws in the PRC to protect our proprietary technology, intellectual property rights and brand. Although we have entered into confidentiality and invention assignment agreements with certain of our employees and/or relevant third parties and also rigorously control access to proprietary technology, it is possible that third parties may copy or otherwise obtain and use our proprietary technology without authorization of the company or otherwise infringe on our rights. We may also face claims of infringement that could interfere with our ability to use technology that is material to our business operations.

 

In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. Any such litigation, whether successful or unsuccessful, could result in substantial costs and the diversion of resources and the attention of management, any of which could adversely affect our business.

 

We may be liable to our clients for the disclosure of personal or confidential information, including personally identifiable information, system failures, errors or unsatisfactory performance of services which may adversely affect our business, reputation and results of operations.

 

We often have access to, and are required to collect and store, sensitive or confidential client information, including personally identifiable information. If any person, including any of our employees and subcontractors, penetrates our network security or misappropriates sensitive or confidential client information, including personally identifiable information, we could be subject to significant liability from our clients for breaching contractual confidentiality provisions or privacy laws. Despite measures we take to protect the client information or personally identifiable information of our clients, unauthorized parties, including our employees and subcontractors, may attempt to breach our clients’ confidence. Unauthorized disclosure of sensitive or confidential client information, including personally identifiable information, whether through employee misconduct, breach of our computer systems, systems failure or otherwise, may subject us to liabilities, damage our reputation and cause us to lose clients.

 

In addition, while we have taken steps to protect the client information that we have access to, our security measures may be breached. If a cyber-attack or other security incident were to result in unauthorized access to or modification of our customers’ data or our own data or our IT systems or in disruption of the services we provide to our customers, or if our products or services are perceived as having security vulnerabilities, we could suffer significant damage to our business and reputation.

 

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Our management team lacks experience in managing a U.S. public company and complying with laws applicable to such company, the failure of which may adversely affect our business, financial conditions and results of operations.

 

Our current management team lacks experience in managing a U.S. publicly traded company, interacting with public company investors and complying with the increasingly complex laws pertaining to U.S. public companies. We became a publicly traded company in April 2016, subjecting us to significant regulatory oversight and reporting obligations under the federal securities laws and the scrutiny of securities analysts and investors. Our management had limited experience in complying with such laws, regulations and obligations. These new obligations and constituents will require significant attention from our senior management and could divert their attention away from the day-to-day management of our business, which could adversely affect our business, financial conditions and results of operations.

 

Our lack of an Internet audio-visual program transmission license may expose us to administrative sanctions, which would materially and adversely affect our business, results of operations and financial condition.

 

Our lack of an Internet audio-visual program transmission license may expose us to administrative sanctions, which would materially and adversely affect our business, results of operations and financial condition. Pursuant to the Administrative Provisions on Internet Audio-Visual Program Service, or the Audio-Visual Program Provisions, which was issued by the State Administration of Radio, Film and Television, or SARFT, and the Ministry of Industry and Information Technology, or MIIT coming into effect on January 31, 2008 and amended on August 28, 2015, online transmission of audio and video programs requires an Internet audio-Visual program transmission license and online audio-visual service providers must be either wholly state-owned or state-controlled. In a press conference jointly held by SARFT and MIIT to answer questions with respect to the Audio-Visual Program Provisions in February 2008, SARFT and MIIT clarified that online audio-visual service providers that had already been operating lawfully prior to the issuance of the Audio-visual Program Provisions may re-register and continue to operate without becoming state-owned or controlled, provided that such providers have not engaged in any unlawful activities. This exemption will not be granted to online audio/video service providers established after the Audio-Visual Program Provisions was issued.

 

While two of our PRC Subsidiaries, Sina Shi Jin (Shanghai) Information Technology Co., Ltd. and Shanghai Fu Dong Culture Media Co., Ltd. have obtained the radio and television program production license from the local counterpart of the SARFT which allows for engaging in the production and distribution business of radio and television programs in the PRC, we, however, currently do not possess an Internet audio-visual program transmission license. As a result, the relevant regulatory authorities may find our operations to be in violation of the applicable laws and regulations. We may receive a warning and be ordered to pay a fine of not more than RMB30,000. In the case of severe contravention, we may be ordered to cease transmission of audio and video programs, be subject to a penalty equal to one to two times of our total investment in the affected business and the devices we used for such operation may be confiscated. Furthermore, according to the Audio-Visual Program Provisions, the telecommunications administrative authorities may, based on written opinions of SARFT, and in accordance with the relevant laws and regulations on supervision of telecommunications and the Internet, close our platform and order the relevant network operation entity that provides us signal access services to stop such provision of services. Such penalties would materially and adversely affect our business, results of operations and financial condition.

 

Our lack of a license for provision of the value-added telecommunication services, or the ICP license, may expose us to administrative sanctions, which would materially and adversely affect our business, results of operations and financial condition.

 

Our lack of an operating license for value-added telecommunication business may expose us to administrative sanctions, which would materially and adversely affect our business, results of operations and financial condition. Pursuant to the Telecommunication Regulation of the People’s Republic of China, or the Telecom Regulations, promulgated by the State Council on September 25, 2000 and later amended on July 29, 2014 and February 6, 2016, “value-added telecommunication services” is defined as telecommunications and information services provided through public networks. According to the Telecom Regulations as well as the Measures on the Administration of Telecommunications Business Operating Licenses, or the Telecom License Measures released by MIIT and became effective on April 10, 2009 and later amended on July 3, 2017 with the effectiveness commencing on September 1, 2017, operators of value-added telecommunications services shall obtain operating licenses prior to commencing operations from the MIIT, or its provincial-level counterparts. The Catalogue of Telecommunications Business (2015), or the Catalogue, which was released by MIIT in 2015 and became effective on March 1, 2016, further identifies information services as value-added telecommunications services. Provision of information services including instant message belongs to the second type of value-added telecommunications services.

 

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We currently do not possess the aforementioned ICP license for us to provide the internet information services of instant messaging, which may result in the determination by relevant regulatory authorities that our provision of such service is in violation of the applicable laws and regulations. Pursuant to the Telecom Regulations and the Telecom License Measures, we may be ordered to rectify such violation and the illegal income will be confiscated; further, a penalty equal to three to five times the illegal income could be imposed, and in the event the illegal income is lower than RMB50,000, such penalty could be adjusted to the amount between RMB100,000 to RMB1,000,000. Such penalties would materially and adversely affect our business, results of operations and financial condition. However, we do not believe we face high risks of severe penalties in current regulatory environment.

 

We may be unable to effectively manage our rapid growth.

 

The rapid growth of our business during our limited operation history has placed significant demands on our management and other resources. As we grow, we may also need to expand and upgrade the reliability and scalability of our proprietary technology, network infrastructure and other aspects of our IT system. We may need to hire additional sales and marketing representatives, customer service, risk management as well as other personnel to serve the enlarged customer base. Implementation of new business arrangements, expansion of technology infrastructure and an increase in employee numbers may further increase our operational complexity and impose higher standards on every aspect of our operation. Our management team may fail to effectively cope with the increased operational complexity, and we may fail to integrate new resources into our existing operation system. Therefore, we may not be able to maintain current growth rate or manage our growth effectively.

 

We face risks related to natural disasters, health epidemics, terrorist attacks and other outbreaks, which could significantly disrupt our operations.

 

The occurrence of unforeseen or catastrophic events, including the emergence of a pandemic or other widespread health emergency, terrorist attacks or natural disasters, could create economic and financial disruptions, lead to operational difficulties that could impair our ability to manage our businesses, and expose our business activities to significant losses. On August 12, 2015, there were a series of explosions that killed over one hundred people which occurred at a hazardous chemical container storage station at the Port of Tianjin. Although our subsidiary located in Tianjin did not suffer any loss or experience any significant increase in costs resulting from such incident, any similar future incidents could materially affect our operations due to loss of personnel and damages to property, including our inventory and technology system. Our operations could also be severely disrupted if the exchanges we operate on were affected by natural disasters, health epidemics or man-caused disasters.

 

Our insurance coverage may be inadequate to cover risks related to our business and operation.

 

While we maintain certain insurance, such as employee commercial insurance, traffic compulsory insurance, vehicle commercial insurance, there is no assurance that our insurance coverage will be adequate to cover potential losses. Under PRC laws and regulations, we are not required to, and we do not, maintain any insurance in relation to our business operations, such as business interruption insurance, or liability insurance against liabilities arising from customer complaints and litigation or other aspects of our business. Our current insurance policies may not protect us against such losses and liabilities.

 

Although we believe that our insurance coverage is in line with industry practice in the PRC, if any of the incidents mentioned above occur and we have insufficient insurance to cover the liabilities associated with such incidents, it could have a material adverse effect on our financial condition, results of operations and business prospects.

 

Risks Related to Our Corporate Structure

 

We principally rely on dividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiaries to make payments to us, or the tax implications of making payments to us, could have a material adverse effect on our ability to conduct our business or our financial condition.

 

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We are a holding company, and we rely principally on dividends and other distributions on equity from our wholly-owned subsidiaries in China for our cash requirements, including the funds necessary to pay dividends to our shareholders and service any debt we may incur.

 

Current PRC regulations permit our subsidiaries in China to pay dividends to us only out of their respective accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our PRC subsidiaries is required to set aside at least 10% of its respective after-tax profits each year, if any, to fund certain statutory reserve funds until the aggregate amount of such reserve funds reaches 50% of its registered capital. At its discretion, each of our PRC subsidiaries may allocate a discretionary portion of its respective after-tax profits to staff welfare and bonus funds. These reserves may not be distributable as cash dividends. Furthermore, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Most of our assets are held by, and substantially all of our earnings and cash flows are attributable to, our PRC subsidiaries. Our cash flows are primarily derived from dividends paid to us by our PRC subsidiaries. As a result, our ability to distribute dividends largely depends on earnings from our PRC subsidiaries and their ability to pay dividends out of their earnings. If operating losses from our PRC subsidiaries were to continue to grow, our operating results and cash flows would be further adversely affected. Our PRC subsidiaries so far have not paid us any dividends. We cannot assure you that our PRC subsidiaries will generate sufficient earnings and cash flows in the near future to pay dividends or otherwise distribute sufficient funds to enable us to meet our obligations, pay interest and expenses or declare dividends.

 

We may be subject to penalties, including restrictions on our ability to inject capital into our PRC subsidiaries and our PRC subsidiaries’ ability to distribute profits to us, if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange regulations.

 

On July 4, 2014, the State Administration of Foreign Exchange, or SAFE, issued the Circular on Several Issues Concerning Foreign Exchange Administration of Domestic Residents Engaging in Overseas Investment, Financing and Round-Trip Investment via Special Purpose Vehicles (“Circular 37”), which replaced the previous Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles (“Circular 75”), effective on November 1, 2005. Circular 37 requires PRC individuals, institutions and foreign individuals who have a habitual residence in the PRC due to economic interests, or collectively referred as the PRC residents, to register with SAFE or its local branches in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests. Such offshore entity is referred to as an offshore special purpose vehicle. In addition, such PRC residents must update their foreign exchange registrations with SAFE when the offshore special purpose vehicle undergoes material events relating to any change of basic information (including change of such PRC residents, name and operation term), increases or decreases in investment amount, share transfers or exchanges, or mergers or divisions. According to the Circular on Further Simplifying and Improving the Administration of Foreign Exchange Concerning Direct Investment released on February 13, 2015 by the SAFE, local banks will examine and handle foreign exchange registration for overseas direct investment, including the initial foreign exchange registration and amendment registration, under the Circular 37 from June 1, 2015.

 

If any shareholder holding interest in an offshore special purpose vehicle, who is a PRC resident as determined by Circular 37, fails to fulfill the required foreign exchange registration with the local SAFE branches, the PRC subsidiaries of that offshore special purpose vehicle may be prohibited from distributing their profits and dividends to their offshore parent company or from carrying out other subsequent cross-border foreign exchange activities, and the offshore special purpose vehicle may be restricted in its ability to contribute additional capital to its PRC subsidiaries. Moreover, failure to comply with the SAFE registration described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.

 

We have requested that all of our current shareholders and/or beneficial owners disclose whether they or their shareholders or beneficial owners fall within the ambit of SAFE Circular 37 and we will urge relevant shareholders, upon learning that they are PRC residents, to register with the local SAFE branch as required under SAFE Circular 37. However, we may not be fully informed of the identities of all our shareholders or beneficial owners who are PRC residents, and we cannot provide any assurance that all of our shareholders and beneficial owners who are PRC residents will comply with our request to make, obtain or update any applicable registrations or comply with other requirements required by SAFE Circular 37 or other related rules in a timely manner.

 

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Shanghai Yin Sai Computer Technology Co., Ltd. (“Yin Sai”, formerly known as “Yin Tian Xia Technology”), Jin Xiang Yin Rui and Rong Jin Hui Yin were indirectly controlled by our ultimate individual beneficial owners, Mr. Wenbin Chen, Mr. Ming Yan and Ms. Ningfeng Chen, through nominee shareholder arrangements before these companies became wholly-owned subsidiaries of offshore holding companies. After a series of restructurings in the following years, Qian Zhong Su acquired these three companies and now they are indirectly owned by our ultimate individual beneficial owners through an offshore holding company. Our ultimate individual beneficial owners have contacted the local SAFE to make the applications under SAFE Circular 37 and other related rules, but were informed that their application would not be accepted in practice due to the previous nominee shareholder arrangements. Although our ultimate individual beneficial owners have undertaken to complete such registration as soon as the local SAFE would accept such applications, the timeframe for such registration remains unknown until new policies or practical guide lines explicitly allow or waive registrations made by companies with historical nominee shareholder arrangements. Although we are not currently prohibited from or limited in distributing dividends or profits to offshore entities, we may be so prohibited or limited in the future, which may negatively affect our financial conditions and results of operations, as well as our ability to distribute dividends to our investors.

 

If the PRC government deems that the contractual arrangements in relation to Ran Yu, Bei Xun, Hong Feng, and Shun Fu Hui, our consolidated variable interest entities, do not comply with PRC regulatory restrictions on foreign investment in the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.

 

Foreign ownership of certain business in the PRC is subject to restrictions under current PRC laws and regulations. For example, foreign investors are not allowed to own more than 50% of the equity interests in a value-added telecommunication service provider (except e-commerce), and any such foreign investor must have experience in providing value-added telecommunications services overseas and maintain a good track record in accordance with the Guidance Catalog of Industries for Foreign Investment promulgated in 2007, as amended in 2011, in 2015 and in 2017, respectively, and other applicable laws and regulations.

 

We are a Cayman Islands company and our PRC subsidiaries are considered foreign invested enterprises. To comply with PRC laws and regulations, we conduct certain operations in China through a series of contractual arrangements entered into among Shanghai Xie Luo Information Technology Co., Ltd., or Xie Luo, and four onshore VIE Entities and their respective shareholders in PRC, specifically as follows: (1) Xie Luo, Shanghai Ran Yu Information Technology Co., Ltd., or Ran Yu, and the shareholders of Ran Yu, entered into on January 3, 2017, (2) Xie Luo, Shanghai Bei Xun Industry Co., Ltd., or Bei Xun, and the shareholders of Bei Xun, entered into on July 1, 2017, (3) Xie Luo, Shanghai Hong Feng Assets Management Co., Ltd., or Hong Feng, and the shareholders of Hong Feng, entered into on October 17, 2017, (4) Xie Luo, Dalian Shun Fu Hui Business Information Consulting Co., Ltd, and shareholders of Shun Fu Hui entered into on July 31, 2018 (Ran Yu, Bei Xun, Hong Feng and Shun Fu Hui as our consolidated variable interest entities, together referred to as the “VIE Entities”, each a “VIE Entity”). As a result of these contractual arrangements, we exert control over the VIE Entities and will consolidate their operating results in our financial statements under U.S. GAAP for the fiscal year ending December 31, 2018.

 

It is uncertain whether any new PRC laws, rules or regulations relating to variable interest entity structures will be adopted or if adopted, what they would provide. In particular, in January 2015, the Ministry of Commerce, or MOC, published a discussion draft of the proposed Foreign Investment Law for public review and comments. Among other things, the draft Foreign Investment Law expands the definition of foreign investment and introduces the principle of “actual control” in determining whether a company is considered a foreign invested enterprise, or an FIE. Under the draft Foreign Investment Law, variable interest entities would also be deemed as FIEs, if they are ultimately “controlled” by foreign investors, and that would be subject to restrictions on foreign investments. However, the draft law has not taken a position on what actions will be taken with respect to the existing companies with the “variable interest entity” structure, whether or not these companies are controlled by Chinese parties. It is uncertain when the draft would be signed into law and whether the final version would have any substantial changes from the draft. If the ownership structure, contractual arrangements and business of our company, Xie Luo , or the VIE Entities are found to be in violation of any existing or future PRC laws or regulations, or we fail to obtain or maintain any of the required permits or approvals, the relevant governmental authorities would have broad discretion in dealing with such violation, including levying fines, confiscating our income or the income of Xie Luo, or the VIE Entities, revoking the business licenses or operating licenses of Xie Luo, or the VIE Entities, shutting down our servers or blocking our online platform, discontinuing or placing restrictions or onerous conditions on our operations, requiring us to undergo a costly and disruptive restructuring, restricting or prohibiting our use of proceeds from our initial public offering to finance our business and operations in China, and taking other regulatory or enforcement actions that could be harmful to our business. Any of these actions could cause significant disruption to our business operations and severely damage our reputation, which would in turn materially and adversely affect our business, financial condition and results of operations. If any of these occurrences results in our inability to direct the activities of the VIE Entities, and/or our failure to receive economic benefits from the VIE Entities, we may not be able to consolidate their results into our consolidated financial statements in accordance with U.S. GAAP.

 

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We rely on contractual arrangements with the VIE Entities and their respective shareholders for a portion of our business operations, which may not be as effective as direct ownership in providing operational control.

 

We expect to rely on contractual arrangements with the VIE Entities and their respective shareholders in some operations. These contractual arrangements may not be as effective as direct ownership in providing us with control over our consolidated variable interest entity. For example, the VIE Entities and their respective shareholders could breach their contractual arrangements with us by, among other things, failing to conduct their operations, including maintaining our website and using the domain names and trademarks, in an acceptable manner or taking other actions that are detrimental to our interests.

 

If we had direct ownership of the VIE Entities, we would be able to exercise our rights as a shareholder to effect changes in the board of directors of the VIE Entities, which in turn could implement changes, subject to any applicable fiduciary obligations, at the management and operational level. However, under the current contractual arrangements, we rely on the performance by the VIE Entities and their respective shareholders of their obligations under the contracts to exercise control over the VIE Entities. The shareholders of the VIE Entities may not act in the best interests of our company or may not perform their obligations under these contracts. Such risks exist throughout the period in which we intend to operate our business through the contractual arrangements with the VIE Entities. Although we have the right to replace any shareholder of the VIE Entities under the contractual arrangement, if any shareholder of the VIE Entities is uncooperative or any dispute relating to these contracts remains unresolved, we will have to enforce our rights under these contracts through the operations of PRC laws and arbitration, litigation and other legal proceedings and therefore will be subject to uncertainties in the PRC legal system. See “—Any failure by the VIE Entities, or their respective shareholders to perform their obligations under our contractual arrangements with them would have a material adverse effect on our business” below. Therefore, our contractual arrangements with the VIE Entities, our consolidated variable interest entity, may not be as effective in ensuring our control over the relevant portion of our business operations as direct ownership would be.

 

Any failure by the VIE Entities or their respective shareholders to perform their obligations under our contractual arrangements with them would have a material adverse effect on our business.

 

We refer to the shareholders of each of our VIE Entities as its nominee shareholders because although they remain the holders of equity interests on record in each of our VIE Entities, pursuant to the terms of the relevant power of attorney, each such shareholder has irrevocably authorized the relevant WFOE to exercise his, her or its rights as a shareholder of the relevant VIE. However, if the VIE Entities, or their respective shareholders fail to perform their respective obligations under the contractual arrangements, we may have to incur substantial costs and expend additional resources to enforce such arrangements. We may also have to rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you will be effective under PRC laws. For example, if the shareholders of the VIE Entities were to refuse to transfer their equity interest in the VIE Entities to us or our designee if we exercise the purchase option pursuant to these contractual arrangements, or if they were otherwise to act in bad faith toward us, then we may have to take legal actions to compel them to perform their contractual obligations.

 

All the agreements under our contractual arrangements are governed by PRC laws and provide for the resolution of disputes through arbitration in China. Accordingly, these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal procedures. The legal system in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. Meanwhile, there are very few precedents and little formal guidance as to how contractual arrangements in the context of a consolidated variable interest entity should be interpreted or enforced under PRC laws. There remain significant uncertainties regarding the ultimate outcome of such arbitration should legal action become necessary. In addition, under PRC laws, rulings by arbitrators are final and parties cannot appeal arbitration results in court unless such rulings are revoked or determined unenforceable by a competent court. If the losing parties fail to carry out the arbitration awards within a prescribed time limit, the prevailing parties may only enforce the arbitration awards in PRC courts through arbitration award recognition proceedings, which would require additional expenses and delay. In the event that we are unable to enforce these contractual arrangements, or if we suffer significant delay or other obstacles in the process of enforcing these contractual arrangements, we may not be able to exert effective control over our consolidated variable interest entities, and our ability to conduct our business may be negatively affected.

 

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The shareholders of the VIE Entities may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

 

We have designated individuals who are PRC citizens to be nominee shareholders of our VIE Entities in China. Among all shareholders of our VIE Entities, Mr. Dikuo Bo currently serves as our Vice President. None of the VIE Entities’ shareholders beneficially owns more than one percent of the total outstanding ordinary shares of our company. Their interests in Ran Yu, Bei Xun, Hong Feng and Shun Fu Hui may differ from the interests of our company as a whole.

 

The shareholders of our VIE Entities may have potential conflicts of interest with us. These shareholders may breach, or cause our VIE Entities to breach, or refuse to renew, the existing contractual arrangements we have with them and our VIE Entities, which would have a material and adverse effect on our ability to effectively control our VIEs and receive economic benefits from them. For example, the shareholders may be able to cause our agreements with Ran Yu, Bei Xun, Hong Feng and Shun Fu Hui to be performed in a manner adverse to us by, among other things, failing to remit payments due under the contractual arrangements to us on a timely basis. We cannot assure you that when conflicts of interest arise, any or all of these shareholders will act in the best interests of our company or such conflicts will be resolved in our favor.

 

Currently, we do not have any arrangements to address potential conflicts of interest between these shareholders and our company, except that we could exercise our purchase option under the exclusive option agreement with these shareholders to request them to transfer all of their equity interests in Ran Yu, Bei Xun, Hong Feng and Shun Fu Hui to a PRC entity or individual designated by us, to the extent permitted by PRC laws. If we cannot resolve any conflict of interest or dispute between us and the shareholders of the VIE Entities, we would have to rely on legal proceedings, which could result in the disruption of our business and subject us to substantial uncertainty as to the outcome of any such legal proceedings.

 

Contractual arrangements in relation to the VIE Entities may be subject to scrutiny by the PRC tax authorities and they may determine that we, or the VIE Entities, owe additional taxes, which could negatively affect our financial condition and the value of your investment.

 

Under applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities determine that the VIE contractual arrangements were not entered into on an arm’s length basis in such a way as to result in an impermissible reduction in taxes under applicable PRC laws, rules and regulations, and which would adjust the income of our VIE Entities in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction of expense deductions recorded by our VIE Entities for PRC tax purposes, which could in turn increase their liabilities without reducing our WFOEs’ tax expenses. In addition, the PRC tax authorities may impose late payment fees and other penalties on our VIE Entities for the adjusted but unpaid taxes according to the applicable regulations. Our financial position could be materially and adversely affected if our VIE Entities’ tax liabilities increase or if it is required to pay late payment fees and other penalties.

 

Risks Related to Doing Business in China

 

PRC economic, political and social conditions as well as government policies could adversely affect our business and prospects.

 

We conduct businesses in the PRC, and therefore our financial conditions and results of operations are largely subject to influences from PRC’s economic, political and social conditions. The PRC economy differs from the economies of most developed countries in many respects, including the extent of government involvement, level of development, growth rate and control of foreign exchange and allocation of resources. The PRC government also exercises significant control over China’s economic growth by allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy, regulating financial services and institutions and providing preferential treatment to particular industries or companies.

 

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While the PRC economy has experienced significant growth in the past three decades, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall PRC economy, but may also have a negative effect on us. We cannot predict whether changes in the PRC’s economic, political and social conditions and in its laws, regulations and policies will have any adverse effect on our current or future business, financial condition or results of operations. In addition, many of the economic reforms carried out by the PRC government are unprecedented or experimental and are expected to be refined and improved over time. This refining and improving process may not necessarily have a positive effect on our operations and business development. For example, the PRC government has in the past implemented a number of measures intended to slow down certain segments of the economy, including the property industry, which the government believed to be overheating. These actions, as well as other actions and policies of the PRC government, could cause a decrease in the overall level of economic activity in the PRC and, in turn, have an adverse impact on our business and financial condition.

 

The current trade war between the U.S. and China, and on a larger scale internationally, may dampen growth in China and other markets where the majority of our customers reside, and our activities and results may be negatively impacted.

 

The U.S. government has recently imposed, and has recently proposed imposing additional, new or higher tariffs on specified products imported from China to penalize China for what it characterizes as unfair trade practices and China has responded by imposing, and proposing to impose additional, new or higher tariffs on specified products imported from the U.S. On September 17, 2018, President Trump announced his decision to impose a 10% tariff on the third list of US$200 billion in imports from China to the U.S. effective September 24, 2018. The 10% tariff was scheduled to increase to 25% on January 1, 2019. However, the U.S. government has agreed to postpone this increase until the beginning of March of 2019 to allow the U.S. and Chinese government time to negotiate an agreement on tariffs. We cannot assure you that the negotiations will result in an agreement by the deadline in March or that the 25% increase or other tariffs will not be imposed even if an agreement is reached. These tariffs are in addition to two earlier rounds of tariffs implemented against Chinese products on June 6, 2018 and August 16, 2018 that amount to tariffs on US$50 billion of Chinese products imported into the U.S. In response, China has imposed, and has proposed imposing additional, tariffs on a number of the U.S. goods, on a much smaller scale, in the current time.

 

Although we are not subject to any of those tariff measures, the proposed tariffs may adversely affect the economic growth in China and other markets and the financial condition of our customers. With the potential decrease in the spending powers of our target customers, we cannot guarantee that there will be no negative impact on our operations. In addition, the current and future actions or escalations by either the U.S. or China that affect trade relations may cause global economic turmoil and potentially have a negative impact on our business, financial condition and results of operations, and we cannot provide any assurance as to whether such actions will occur or the form that they may take.

 

The legal system of the PRC is not fully developed and there are inherent uncertainties that may affect the protection afforded to us.

 

Our business and operations in China are governed by PRC laws and regulations. The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential value.

 

Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various industries in China. However, as these laws and regulations are relatively new and continue to evolve, interpretation and enforcement of these laws and regulations involve significant uncertainties and different degrees of inconsistency. Some of the laws and regulations are still in the developmental stage and are therefore subject to policy changes. Many laws, regulations, policies and legal requirements have only been recently adopted by PRC central or local government agencies, and their implementation, interpretation and enforcement may involve uncertainty due to the lack of established practice available for reference. We cannot predict the effect of future legal developments in China, including the promulgation of new laws, changes in existing laws or their interpretation or enforcement, or the preemption of local regulations by national laws. As a result, there is substantial uncertainty as to the legal protection available to us. Furthermore, due to the limited volume of published cases and the nonbinding nature of prior court decisions, the outcome of dispute resolutions may not be as consistent or predictable as in other more developed jurisdictions, which may limit the legal protection available to us.

 

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PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from making loans or additional capital contributions to our PRC subsidiaries.

 

We are an offshore holding company conducting our operations in China through our PRC subsidiaries. Any capital contributions or loans that we, as an offshore entity, make to our PRC subsidiaries that are foreign-invested enterprises, including the proceeds of our initial public offering and private placement, are subject to PRC regulations. Loans made by us to our PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with the local counterpart of the SAFE. Currently, our PRC subsidiaries that are foreign-invested enterprises follow the statutory limit for the total amount of foreign debts which is the difference between the amount of total investment as filed with the Ministry of Commerce of the PRC, or MOFCOM, or its local counterpart and the amount of registered capital of such foreign-invested company.

 

We may also decide to finance our PRC subsidiaries by means of capital contributions. These capital contributions must be filed with the MOFCOM or its local counterpart. In 2015, the SAFE published the Circular of the State Administration of Foreign Exchange on Reforming the Management Approach regarding the Settlement of Foreign Exchange Capital of Foreign-invested Enterprises (“Circular 19”), which came into effect on June 1, 2015. According to Circular 19, foreign-invested enterprises are now allowed to convert their registered capital from foreign exchange to RMB and apply such funds to equity investment within the PRC, conditioned upon the investment target’s duly registration with a local bank of such reinvestment and open a corresponding special account pending foreign exchange settlement payment. Further, such conversion will be handled at the bank level and does not need to be approved by the SAFE. SAFE Circular 19 prohibits foreign-invested enterprises from, among other things, using an RMB fund converted from its foreign exchange capital for expenditure beyond its business scope, investment in securities, providing entrusted loans, repaying loans between nonfinancial enterprises or purchasing real estate not for self-use.

 

The SAFE promulgated the Circular on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account (“Circular 16”), effective on June 9, 2016, which reiterates some of the rules set forth in the SAFE Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested enterprise to issue RMB entrusted loans, to the prohibition against using such capital to issue loans to non-associated enterprises.

 

In 2017, the SAFE has published the Circular of the State Administration of Foreign Exchange on Further Advancing the Reform of Foreign Exchange Administration and Improving Examination of Authenticity and Compliance (“Circular 3”), which came into effect on January 26, 2017, and in case of any discrepancies between Circular 3 and previous provisions, Circular 3 shall prevail. According to Circular 3, transfer of funds under onshore guarantee for offshore loans for domestic use is permitted. A debtor may directly or indirectly transfer funds under the guarantee for domestic use by domestic lending, equity investment or otherwise. However, Circular 3 continues to implement and improve the policy for outward remittance of foreign exchange profit generated from direct investment.

 

In 2018, the PBOC published the Circular of the People’s Bank of China on Further Improving Cross-Border RMB Service Policies to Promote Trade and Investment Facilitation (“PBOC Circular 3”). PBOC Circular 3 further facilitates direct investment in RMB of overseas investors. Where the RMB capital and overseas loans of a foreign-invested enterprise are used for wages, travel expenses, and minor purchase and other expenditures, such expenditures to the enterprise’s payment order could be handled directly by the bank on the basis of the three principles for business development. Profits, dividends, and other investment returns legally obtained within China by overseas investors could be settled and freely remitted out of China after examining the relevant supporting materials as required by banks.

 

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If we fail to comply with such regulations, our ability to capitalize the relevant PRC subsidiaries or fund our operations may be negatively affected, which could materially and adversely affect the liquidity of our relevant PRC subsidiaries or our business, financial condition, results of operations and growth prospects.

 

Restrictions on the remittance of RMB into and out of the PRC and governmental control of currency conversion may limit our ability to pay dividends and other obligations, and affect the value of your investment.

 

The PRC government imposes controls on the convertibility of RMB into foreign currencies and the remittance of currency out of China. We receive all of our revenues in RMB and all of our cash inflows and outflows are denominated in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC operating subsidiaries. We may convert a portion of our revenues into other currencies to meet our foreign currency obligations, such as payments of dividends declared in respect of our shares, if any. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries to remit sufficient foreign currency to pay dividends or other payments, or otherwise satisfy their foreign currency-denominated obligations.

 

Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior SAFE approval by complying with certain procedural requirements. However, approval from or registration with competent government authorities is required where the RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs and ordinary shares. Further, there is no assurance that new regulations will not be promulgated in the future that would have the effect of further restricting the remittance of RMB into or out of the PRC.

 

We may be adversely affected by the complexity, uncertainties and changes in PRC regulations of Internet-related businesses and companies, and any lack of requisite licenses, permits or approvals applicable to our business may have a material adverse effect on our business and results of operations.

 

The PRC government extensively regulates the Internet industry, including foreign ownership of, and the licensing and permit requirements pertaining to, companies in the internet industry. These Internet-related laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainties. As a result, in certain circumstances it may be difficult to determine what actions or omissions may be deemed to be in violation of applicable laws and regulations.

 

We only have contractual control over the entities that provide Internet information provision services in China. We do not directly own such entities due to the restriction on foreign investment in businesses providing value-added telecommunication services in China, including Internet information provision services. This may significantly disrupt our business, subject us to sanctions, compromise enforceability of related contractual arrangements, or have other harmful effects on us.

 

The evolving PRC regulatory system for the Internet industry may lead to the establishment of new regulatory agencies. For example, in May 2011, the State Council announced the establishment of a new department, the Cyberspace Administration of China (“CAC”), with the involvement of the State Council Information Office, the Ministry of Industry and Information Technology (“MIIT”), and the Ministry of Public Security. The primary role of this new agency is to facilitate the policy-making and legislative development in this field, to direct and coordinate with the relevant departments in connection with online content administration and to deal with cross-ministry regulatory matters in relation to the Internet industry.

 

In addition, our provision of certain services online may subject us to license requirements in China. For instance, we provide some recorded videos as a way of customer education and occasionally launch other audio-video contents on our platform and our community, which may result in audio-video license requirements from the State Administration of Press, Publication, Radio, Film and Television (“SAPPRFT”). We also provide some digital works on our website and APP, which may require online publishing service license issued by the SAPPRFT. In addition, we reprint some articles related to the stock market on our website and APP, and therefore may be subject to permit and approval requirements from the State Council Information Office. Furthermore, we also need to strictly follow the requirements applicable to online content providers set forth by the relevant regulatory authorities, especially for financial information. Failure to comply with these license or other requirements may subject us to penalties, which may adversely affect our business operations and reputation.

 

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The interpretation and application of the existing PRC laws, regulations and policies and possible new laws, regulations or policies relating to the Internet industry have created substantial uncertainties regarding the legality of the existing and future foreign investments in, and the businesses and activities of, Internet businesses in China, including our business. We cannot assure you that we have obtained all the permits or licenses related to our Internet related business in China that might be required for conducting our supporting functions in China or will be able to maintain our existing licenses or obtain new ones. In the event that the PRC government considers that we were operating without the proper approvals, licenses or permits, promulgates new laws and regulations that require additional approvals or licenses, or imposes additional restrictions on the operation of any part of our business, it has the power, among other things, to levy fines, confiscate our income, revoke our business licenses, and require us to discontinue our relevant business or impose restrictions on the affected portion of our business. Any of these actions by the PRC government may have a material adverse effect on our business and results of operations.

 

Fluctuations in exchange rates could have a material and adverse effect on our results of operations and the value of your investment.

 

Appreciation or depreciation in the value of RMB relative to U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business, financial condition or results of operations. RMB may appreciate or depreciate significantly in value against U.S. dollar in the long term, depending on the fluctuation of the basket of currencies against which it is currently valued, or it may be permitted to enter into a full float, which may also result in a significant appreciation or depreciation of RMB against U.S. dollar. If we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. In addition, appreciation or depreciation in the value of the RMB relative to U.S. dollars would affect our financial results reported in U.S. dollar terms regardless of any underlying change in our business or results of operations.

 

The value of the RMB against the U.S. dollar and other currencies is affected by changes in China’s political and economic conditions and China’s foreign exchange policies, among other things. On July 21, 2005, the PRC government changed its decades-old policy of pegging the value of the RMB to the U.S. dollar, and the RMB appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. The PRC government has allowed the RMB to appreciate slowly against the U.S. dollar again, and it has appreciated more than 10% since June 2010. On August 11, 2015, the PBOC allowed the RMB to depreciate by approximately 2% against the U.S. dollar. It is difficult to predict how long such depreciation of RMB against the U.S. dollar may last and when and how the relationship between the RMB and the U.S. dollar may change again.

 

The hedging options available in China to reduce our exposure to exchange rate fluctuations are quite limited. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to hedge our exposure adequately or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currency.

 

Certain of our leased property interests may be defective and our right to lease the properties affected by such defects may be challenged, which could cause significant disruption to our business.

 

We have entered into leases with various enterprises and individuals for our office space, warehouse, training centers and other purposes. Some of our leases have deficiencies. Our lease for Shanghai Zhenhua Enterprise Square, with an aggregate of approximately 3,919 square meters, the registered uses for such building and its underlying land do not include use by an industrial or commercial company like ours. Therefore, the lease of such a property to us shall be subject to approval by the competent government authorities and may be subject to payment of premium fees to the government by the lessor. We cannot ensure that the lessor has completed all or any of the necessary formalities with the relevant governmental authorities. Our lease for Shanghai Shangbo Park with an aggregate of approximately 5,293 square meters. Possible violation of relevant land reservation regulation will subject us to the risk of lease termination and relocation.

 

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Our group will re-arrange office leasing contracts in December 2019. We may deal with current leasing agreements and may be subject to substantial default payments.

 

We have not registered any of our lease agreements with relevant PRC governmental authorities as required by PRC law, and although failure to do so does not in itself invalidate the leases, we may not be able to defend these leases against bona fide third parties. Currently, we are not aware of any actions, claims or investigations being contemplated by government authorities with respect to the defects in our leased real properties or any challenges by third parties to our use of these properties. However, if third parties who purport to be property owners or beneficiaries of the mortgaged properties challenge our right to lease these properties, we may not be able to protect our leasehold interest and may be ordered to vacate the affected premises, which could in turn materially and adversely affect our business and operating results.

 

The enforcement of the Labor Contract Law of the People’s Republic of China, or the PRC Labor Contract Law, and other labor-related regulations in the PRC may increase our labor costs, impose limitations on our labor practices and adversely affect our business and results of operations.

 

On June 29, 2007, the Standing Committee of the National People’s Congress of China enacted the PRC Labor Contract Law, which became effective on January 1, 2008 and was amended on December 28, 2012. The PRC Labor Contract Law introduces specific provisions related to fixed-term employment contracts, part-time employment, probation, consultation with labor unions and employee assemblies, employment without a written contract, dismissal of employees, severance, and collective bargaining, which together represent enhanced enforcement of labor laws and regulations. According to the PRC Labor Contract Law, an employer is obliged to sign an unfixed-term labor contract with any employee who has worked for the employer for 10 consecutive years. Further, if an employee requests or agrees to renew a fixed-term labor contract that has already been entered into twice consecutively, the resulting contract must have an unfixed term, with certain exceptions. The employer must pay economic compensation to an employee where a labor contract is terminated or expires in accordance with the PRC Labor Contract Law, except for certain situations which are specifically regulated. In addition, the government has issued various labor-related regulations to further protect the rights of employees. According to such laws and regulations, employees are entitled to annual leave ranging from five to 15 days and are able to be compensated for any untaken annual leave days in the amount of three times their daily salary, subject to certain exceptions.

 

As a result of these regulations, which are designed to enhance labor protection, we expect our labor costs to increase, as the continued success of our business depends significantly on our ability to attract and retain qualified personnel. In the event that we decide to change our employment or labor practices, the PRC Labor Contract Law and its implementation rules may also limit our ability to effect those changes in a manner that we believe to be cost-effective. In addition, as the interpretation and implementation of these new regulations are still evolving, our employment practices may not be at all times deemed in compliance with the new regulations. If we are subject to severe penalties or incur significant liabilities in connection with labor disputes or investigations, our business and financial conditions may be adversely affected.

 

In addition, on December 28, 2012, the PRC Labor Contract Law was amended to impose more stringent requirements on labor dispatches, and such amendments became effective on July 1, 2013. For example, the number of dispatched contract workers that an employer hires may not exceed a certain percentage of the total number of employees to be decided by the Ministry of Human Resources and Social Security, and the dispatched contract workers can only engage in temporary, auxiliary or substitute work. According to the Interim Provisions on Labor Dispatch, or the Interim Provisions promulgated by the Ministry of Human Resources and Social Security on January 24, 2014, the number of dispatched contract workers hired by an employer shall not exceed 10% of the total number of its employees (including both directly hired employees and dispatched contract workers). The Interim Provisions further require the employer that is not in compliance with the above provisions to formulate a plan to reduce the number of its dispatched contract workers to below 10% of the total number of its employees prior to March 1, 2016. However, if any labor contract or labor dispatch agreement legally executed prior to December 28, 2012 will expire within two years after the date of implementation hereof, such contracts or agreements may continue to be performed until the expiry thereof in accordance with the applicable law. In addition, an employer is not permitted to hire any new dispatched contract worker until the number of its dispatched contract workers has been reduced below 10% of the total number of its employees. Such limitations on use of dispatched labor may increase our labor costs and impose limitations on our employment practices, which may adversely affect our business and profitability.

 

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Failure to make adequate contributions to various employee benefit plans as required by PRC regulations may subject us to penalties.

 

Companies operating in China are required to participate in various government-sponsored employee benefit plans, including certain social insurance, housing funds and other welfare-oriented payment obligations, and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of our employees up to a maximum amount specified by the local government from time to time at locations where we operate our businesses. The requirement to participate in employee benefit plans has not been implemented consistently by the local governments in China given the different levels of economic development in different locations. Our PRC operating entities incorporated in various locations in China have not made adequate employee benefit payments and we have recorded accruals for estimated underpaid amounts in our financial statements. We may be required to make up the contributions for these plans as well as to pay late fees and fines.

 

In December 2012, the PRC Labor Contract Law was amended to impose more stringent requirements on the use of employees of temporary staffing agencies, who are known in China as “dispatched workers.” Historically, we had engaged certain employment agencies to dispatch contract workers to work for us and terminated such arrangements in early 2014. Under such arrangements, these workers were employed by employment agent companies, and therefore such agent companies were responsible for paying contribution of social insurance and housing funds for the workers correspondingly. During the period that we had such arrangements with the third party employment agencies, they had shortfalls in making such contributions for the workers working for several of our subsidiaries. We have recorded accruals for estimated underpaid amounts in our financial statements. There is a risk that under the PRC law, we may be held by the labor authorities as jointly responsible together with third party employee agencies to make up the shortfall in the contribution to social insurance in relation to those workers dispatched to work for us and may be subject to additional penalties.

 

Regulators may impose penalties and fines with respect to shortfall in social insurance payment. A late payment fee at the rate of 0.05% per day of the outstanding amount from the due date may be imposed, and if such amounts remain outstanding beyond a prescribed time limit, a fine of one to three times the outstanding amount may be imposed. While there are no explicit quantitative statutory fines or penalties on late payments to housing funds as advised by our PRC counsel, the housing accumulation fund management center may order us to pay any housing fund shortfalls immediately. Although based on the opinion of our PRC counsel, the possibility that we will be subject to any fine or penalty is remote, if we become subject to such fines or penalties in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected.

 

Any failure to comply with PRC regulations regarding the registration requirements for employee share incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

 

Pursuant to the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company issued by SAFE in February 2012, employees, directors, supervisors and other senior management participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens residing in China for a continuous period of not less than one year, subject to a few exceptions, are required to register with SAFE through a domestic qualified agent, which could be a PRC subsidiary of such overseas listed company, and complete certain other procedures. We and our directors, executive officers and other employees who are PRC citizens or who reside in the PRC for a continuous period of not less than one year and who have been granted restricted shares, restricted share units or options will be subject to these regulations if those employees exercise such restricted shares, restricted share units or options. Separately, SAFE Circular 37 also requires certain registration procedures to be completed if those employees exercise restricted shares, restricted share units or options before listing. Failure to complete the SAFE registrations may subject them to fines and legal sanctions and may also limit our ability to contribute additional capital into our wholly foreign-owned subsidiaries in China and limit these subsidiaries’ ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive plans for our directors and employees under PRC law.

 

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In addition, the State Administration of Taxation (“SAT”) has issued certain circulars concerning employee share options or restricted shares. Under these circulars, the employees working in the PRC who exercise share options or are granted restricted share units will be subject to PRC individual income tax. The PRC subsidiaries of such an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees who exercise their share options. If the employees fail to pay or the PRC subsidiaries fail to withhold their income taxes according to relevant laws and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities or other PRC government authorities.

 

We may be deemed to be a PRC resident enterprise under the Enterprise Income Tax Law, and be subject to PRC tax on our worldwide income, which may significantly increase our income tax expenses and materially decrease our profitability or otherwise adversely affect the value of your investment.

 

Under the Enterprise Income Tax Law (“EIT Law”) that took effect on January 1, 2008, partly amended and newly effective on February 24, 2017, enterprises established outside of China whose “de facto management bodies” are located in China are considered to be “resident enterprises” and will generally be subject to a uniform 25% corporate income tax on their global income (excluding dividends received from “resident enterprises”). In addition, a circular issued by SAT on April 22, 2009 and amended on January 29, 2014 sets out certain standards for determining whether the “de facto management body” of an offshore enterprise funded by Chinese enterprises as controlling shareholders is located in China. Although this circular applies only to offshore enterprises funded by Chinese enterprises as controlling shareholders, rather than those funded by Chinese or foreign individuals or foreign enterprises as controlling shareholders (such as our Company), the determining criteria set forth in the circular may reflect SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of how they are funded. Although our Company is not funded by Chinese enterprises as controlling shareholders, substantial uncertainty remains as to whether our Company or any of our other non-PRC entities will be deemed PRC resident enterprises for EIT purposes. If we or any of our subsidiaries registered outside the PRC are deemed a “resident enterprise” under the EIT Law, our income tax expenses may increase significantly, and our profitability could decrease materially.

 

You may be subject to PRC income tax on dividends from us or on any gain realized on the transfer of our ADSs.

 

Under the EIT Law and its implementation rules, subject to any applicable tax treaty or similar arrangement between the PRC and your jurisdiction of residence that provides for a different income tax arrangement, PRC withholding tax at the rate of 10% is normally applicable to dividends from PRC sources payable to investors that are non-PRC resident enterprises, which do not have an establishment or place of business in the PRC, or which have such establishment or place of business if the relevant income is not effectively connected with the establishment or place of business. Any gain realized on the transfer of ADSs or shares by such non-PRC resident enterprise investors is also subject to a 10% PRC income tax if such gain is regarded as income derived from sources within the PRC unless a treaty or similar arrangement otherwise provides. Under the PRC Individual Income Tax Law and its implementation rules, dividends from sources within the PRC paid to foreign individual investors who are not PRC residents are generally subject to a PRC withholding tax at a rate of 20% and gains from PRC sources realized by such investors on the transfer of ADSs or shares are generally subject to a 20% PRC income tax, in each case, subject to any reduction or exemption set forth in applicable tax treaties and PRC laws. Although substantially all of our business operations are in China, it is unclear whether dividends we pay with respect to our ADSs, or the gain realized from the transfer of our ADSs, would be treated as income derived from sources within the PRC and as a result be subject to PRC income tax if we were considered a PRC resident enterprise, as described above. If PRC income tax were imposed on gains realized through the transfer of our ADSs or on dividends paid to our non-resident investors, the value of your investment in our ADSs may be materially and adversely affected. Furthermore, our ADS holders whose jurisdictions of residence have tax treaties or arrangements with China may not qualify for benefits under such tax treaties or arrangements.

 

The heightened scrutiny over acquisition transactions by the PRC tax authorities may have a negative impact on our business operations, our acquisition or restructuring strategy or the value of your investment in us.

 

In connection with the EIT Law, the Ministry of Finance and SAT jointly issued, on April 30, 2009, the Notice on Issues Concerning Process of Enterprise Income Tax in Enterprise Restructuring Business, or Circular 59. On February 3, 2015, SAT issued the Announcement of the State Administration of Taxation on Several Issues concerning the Enterprise Income Tax on the Indirect Transfers of Properties by Non-Resident Enterprises , or the SAT Announcement 7, partly amended on October 17, 2017 and December 29, 2017. By promulgating and implementing the above, the PRC tax authorities have strengthened their scrutiny over the direct or indirect transfer of equity interest in a PRC resident enterprise by a non-PRC resident enterprise. Pursuant to SAT Announcement 7, if a non-resident enterprise, or referred as a transferor, transfers its equity in an offshore enterprise which directly or indirectly owns PRC taxable assets, including ownership interest in PRC resident companies, or the Taxable Properties, without a reasonable commercial purpose, such transfer shall be deemed as a direct transfer of such Taxable Properties. The payer, or referred as a transferee, in such transfer shall be the withholding agent, and is obligated to withhold and remit the enterprise income tax to the relevant PRC tax authority. Factors that may be taken into consideration when determining whether there is a “reasonable commercial purpose” include, among other factors, the value constitution of the transferred equity, the offshore taxable situation of the transaction, the offshore structure’s economic essence and duration and trading fungibility.

 

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If an equity transfer transaction satisfies all the requirements mentioned above, such transaction will be considered an arrangement with “reasonable commercial purpose.”

 

We may conduct acquisitions and restructuring. We believe, as advised by our PRC legal advisor, that these historical transactions do not constitute “direct or indirect transfer of the Taxable Properties,” and therefore are not subject to SAT Announcement 7. We cannot assure you that the PRC tax authorities will share this view. As a result, the PRC tax authorities may, at their discretion, impose additional PRC taxes or penalties on capital gains we generated from such historical transactions, which would incur additional costs on us.

 

Certain preferential tax treatments currently offered to some of our PRC subsidiaries may be discontinued, and such discontinuation or imposition of any additional taxes could adversely affect our business, financial condition and results of operations.

 

Yin Sai, our PRC subsidiary, received the “certified software enterprise” from Shanghai Municipal Commission of Economy and Informatization in August 2014. It also qualified as a “high-tech enterprise” in March 2019 and extended this qualification from 2018 to 2020. Yin He You, our PRC subsidiary, received the “certified software enterprise” and “certified software products” qualifications from Shanghai Software Industry Association in April 2016 and April 2015, respectively. Gold Master Technology, our PRC subsidiary, received the “certified software enterprise” and “certified software products” qualifications from Shanghai Software Industry Association in December 2016 and October 2016, respectively. Under the relevant PRC laws, regulations and rules, these subsidiaries enjoy certain preferential tax treatments, under which Yin Sai’s income tax rate is 15% from 2018 to 2020, Yin He You’s income tax rate is 0% in 2015 and 2016 and 12.5% from 2017 to 2019, and Gold Master Technology’s income tax rate is 0% in 2016 and 2017 and 12.5% from 2018 to 2020. Furthermore, the subsidiaries may be qualified to receive a refund on value added tax, or VAT, from its sale of self-developed and self-produced software products. The refund-upon-collection policy shall be applied to the portion of actual VAT burden in excess of 3% after VAT has been collected at a tax rate of 16% after tax reforms in May 2018. If the subsidiaries fail to maintain their qualification or if the preferential period expires without being renewed, they may lose the tax preferential treatments, which could have a material adverse effect on our business, financial condition and results of operations.

 

The audit report included in this annual report is prepared by an auditor in PRC that is not subject to the inspection by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

 

Auditors of companies that are registered with the United States Securities and Exchange Commission, and traded publicly in the United States, including our independent registered public accounting firm, must be registered with the Public Company Accounting Oversight Board (“PCAOB”), and are required by the laws of the United States to undergo regular inspections by the PCAOB to assess their compliance with the laws of the United States and professional standards. Because we have substantial operations within the PRC and the PCAOB is currently unable to conduct inspections of the work of our auditors as it relates to those operations without the approval of the Chinese authorities, our auditor’s work related to our operations in China is not currently inspected by the PCAOB. On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in China. However, it remains unclear what further actions the SEC and PCAOB will take to address the problem.

 

Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

 

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The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

Risks Related to the ADSs

 

The trading prices of our ADSs are likely to be volatile, which could result in substantial losses to investors.

 

The trading prices of our ADSs are likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, like the performance and fluctuation in the market prices or the underperformance or deteriorating financial results of other similarly situated companies that have listed their securities in the United States in recent years. The securities of some of these companies have experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in the trading prices of their securities. The trading performances of these companies’ securities after their offerings may affect the attitudes of investors toward such companies listed in the United States, which consequently may affect the trading performance of our ADSs, regardless of our actual operating performance. In addition, securities markets may from time to time experience significant price and volume fluctuations that are not related to our operating performance, such as the large decline in share prices in the United States and other jurisdictions.

 

In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

·                  variations in our revenue, earnings and cash flow;

 

·                  announcements of new investments, acquisitions, strategic partnerships, or joint ventures;

 

·                  announcements of new services and expansions by us or our competitors;

 

·                  changes in financial estimates by securities analysts;

 

·                  changes in the number of our users;

 

·                  fluctuations in our operating metrics;

 

·                  failure on our part to realize monetization opportunities as expected;

 

·                  additions or departures of key personnel;

 

·                  release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities;

 

·                  detrimental negative publicity about us, our competitors or our industry;

 

·                  regulatory developments affecting us or our industry; and

 

·                  potential litigation or regulatory investigations.

 

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

 

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In the past, shareholders of a public company often brought securities class action suits against us following periods of instability in the market price of that company’s securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations, which could harm our results of operations and require us to incur significant expenses to defend the suit. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

 

We may grant employee share options and other share-based awards in the future. We will recognize share-based compensation expenses in our consolidated statements of comprehensive income and other comprehensive income in accordance with U.S. GAAP. Any additional grant of employee share options and other share-based awards in the future may have a material adverse effect on our results of operations.

 

We have adopted and may adopt employee share option plans for the purpose of granting share-based compensation awards to our employees, officers and directors to incentivize their performance and align their interests with ours. As of March 31, 2019, restricted share units and options to purchase 96,191,420 ordinary shares are issued and outstanding under the Amended and Restated 2013 and 2014 Share Scheme and the Pre- IPO RSU Scheme. As a result, we incurred share-based compensation of RMB163.8 million in 2016, RMB169.7 million in 2017 and RMB27.1 million (US$3.94 million) in 2018. For more information on these share incentive plans, see “Item 6. Directors, Senior Management and Employees—B. Compensation—Share Incentive Plans.” We expect to continue to incur significant share-based compensation expenses in the future. The amount of these expenses is calculated based on the fair value of the share-based awards. We account for compensation costs for all share options using a fair-value-based method and recognize expenses in our consolidated statements of comprehensive income and other comprehensive income in accordance with U.S. GAAP. The expenses associated with share-based compensation will decrease our profitability, perhaps materially, and the additional awards issued under share-based compensation plans will dilute the ownership interests of our shareholders, including holders of our ADSs. However, if we limit the scope of our share-based compensation plan, we may not be able to attract or retain key personnel who expect to be compensated by share-based awards.

 

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, the market price for the ADSs and trading volume could decline.

 

The trading market for the ADSs will depend in part on the research and reports that securities or industry analysts publish about us or our business. If research analysts do not establish and maintain adequate research coverage or if one or more of the analysts who covers us downgrades the ADSs or publishes inaccurate or unfavorable research about our business, the market price for the ADSs would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which, in turn, could cause the market price or trading volume for the ADSs to decline.

 

We will incur increased costs as a result of being a public company, particularly after we cease to qualify as an “emerging growth company.”

 

The Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and NASDAQ, imposes various requirements on the corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly.

 

As a company with less than US$1.07 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, as amended, or the JOBS Act.  The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

 

We cannot predict if investors will find our ADSs less attractive because we may rely on these exemptions. If some investors find our ADSs less attractive as a result, there may be a less active trading market for our ADSs and our ADS price may be more volatile.

 

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The sale or availability for sale, or perceived sale or availability for sale, of substantial amounts of our ADSs could adversely affect their market price.

 

Sales of substantial amounts of our ADSs in the public market, or the perception that these sales could occur, could adversely affect the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future. As of March 31, 2019, we had 1,428,666,855 ordinary shares outstanding. Among these shares, 337,317,980 ordinary shares are in the form of ADSs. All our ordinary shares represented by ADSs were without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. We may also issue additional options in the future that may be exercised for additional ordinary shares. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of our ADSs.

 

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are registered under Cayman Islands law.

 

We are an exempted company limited by shares incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our Memorandum & Articles of association, the Companies Law of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by our minority shareholders and the fiduciary duties of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

 

Shareholders of Cayman Islands exempted companies like ours have no general rights under Cayman Islands law to inspect corporate records or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our existing articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

 

Certain corporate governance practices in the Cayman Islands differ significantly from requirements for companies incorporated in other jurisdictions such as the United States. Currently, we choose to rely on home country practice with respect to certain corporate governance matters. As a result, our shareholders may be afforded less protection than they otherwise would have under rules and regulations applicable to U.S. domestic issuers.

 

As a result, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would have as public shareholders of a company incorporated in the United States.

 

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

 

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act, or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of the ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

 

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Judgments obtained against us by our shareholders may not be enforceable in our home jurisdiction.

 

We are a Cayman Islands exempted company and a substantial majority of our assets are located outside of the United States. A significant percentage of our current operations are conducted in China. In addition, a significant majority of our current directors and officers are nationals and residents of countries other than the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the United States federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands, China and other jurisdictions where we operate may render you unable to enforce a judgment against our assets or the assets of our directors and officers.

 

There are uncertainties as to whether Cayman Islands courts would:

 

·                  recognize or enforce against us, judgments of courts of the United States based on certain civil liability provisions of U.S. securities laws; and

 

·                  impose liabilities against us, in original actions brought in the Cayman Islands, based on certain civil liability provisions of U.S. securities laws that are penal in nature.

 

There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will under certain circumstances recognize and enforce a final and conclusive non-penal judgment of a foreign court of competent jurisdiction.

 

The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except under limited circumstances, which could adversely affect your interests.

 

Under the deposit agreement for the ADSs, if you do not give instructions for voting the ordinary shares underlying your ADSs, the depositary will give us a discretionary proxy to vote those ordinary shares at the shareholders’ meeting unless:

 

·                  we have failed to timely provide the depositary with notice of meeting and related voting materials;

 

·                  we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

·                  we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;

 

·                  a matter to be voted on at the meeting would have a material adverse impact on shareholders; or

 

·                  the voting at the meeting is to be made on a show of hands.

 

The effect of this discretionary proxy is that you cannot prevent our ordinary shares underlying your ADSs from being voted at the shareholder meeting, except under the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

 

If we do not pay dividends in the future, you must rely on price appreciation of our ADSs for return on your investment.

 

Although we intend to pay dividends to our shareholders, we do not guarantee the payment of any dividends in the future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

 

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Our board of directors may from time to time declare dividends or authorize other distributions to our shareholders, subject to certain restrictions under Cayman Islands law, namely that our company may only pay dividends out of profits or share premium, and provided always that in no circumstances may a dividend be paid out of share premium if this would result in our company being unable to pay its debts as they fall due in the ordinary course of business. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiary, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors.

 

Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

 

You may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them, if it is illegal or impractical to make them available to you.

 

To the extent that we decide to pay a dividend or make other distributions in the future, the depositary of our ADSs has agreed to pay to you such cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses.

 

You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

 

You may be subject to limitations on transfer of your ADSs.

 

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays in the United States. The depositary may refuse to deliver, transfer or register the transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary think that it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason in accordance with the terms of the deposit agreement. As a result, you may be unable to transfer your ADSs when you wish to under these circumstances.

 

Our three founders may exert substantial influence over us and may not act in the best interests of our independent shareholders.

 

Our three founders, who are also our major shareholders, including Mr. Wenbin Chen, Mr. Ming Yan and Ms. Ningfeng Chen, own, in the aggregate, approximately 70.60% of our outstanding shares, as of March 31, 2019. These three founders will be in a position to exert significant influence over the affairs of our company and will be able to influence the outcome of any ordinary shareholders’ resolutions, irrespective of how other shareholders vote. The interests of these three shareholders may not necessarily be aligned with the interests of our shareholders as a whole, and this concentration of ownership may also have the effect of delaying, deferring or preventing a change in control of our company.

 

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There can be no assurance that the company will not be a passive foreign investment company for U.S. federal income tax purposes for any taxable year, which could result in adverse U.S. federal income tax consequences to U.S. Holders of ADSs or ordinary shares.

 

Depending upon the value of our ADSs and ordinary shares and the nature and composition of our assets and income over time, we could be classified as a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes. Based on the expected composition of our income and assets and the value of our assets, including goodwill, we do not expect to be a PFIC for the taxable year ending December 31, 2019 or in the foreseeable future. Despite our expectation, there can be no assurance that we will not be a PFIC in the current taxable year or any future taxable year as PFIC status is tested each taxable year and will depend on the composition of our assets and income and the value of our assets in each such taxable year. Our PFIC status for the current taxable year 2019 will not be determinable until the close of the taxable year ending December 31, 2019.

 

We will be classified as a PFIC for any taxable year if either (i) at least 75% of our gross income for the taxable year is passive income or (ii) at least 50% of the value of our assets (based on a quarterly value of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. Passive income generally includes interest, and cash and loans are generally considered passive assets. In determining the average percentage value of our gross assets, the aggregate value of our assets will generally be deemed to be equal to our market capitalization (determined by the sum of the aggregate value of our outstanding equity) plus our liabilities. Accordingly, we could become a PFIC if our market capitalization were to decrease significantly while we hold substantial cash, cash equivalents or other assets that produce or are held for the production of passive income such as loans to customers. Furthermore, we could also be a PFIC if we were not treated as the owner of our consolidated affiliated entities for U.S. tax purposes. Because there are uncertainties in the application of the relevant PFIC rules, it is possible that the Internal Revenue Service (“IRS”) may challenge our classification of certain income and assets as non-passive or our valuation of our tangible and intangible assets, which could result in a determination that we were a PFIC for the subsequent taxable years.

 

If we were a PFIC in any taxable year in which a U.S. investor holds our ADSs or ordinary shares, the U.S. investor would generally be subject to additional taxes and interest charges on certain ‘‘excess’’ distributions we make and on the gain, if any, recognized on the disposition or deemed disposition of such U.S. investor’s ADS or Class A ordinary shares, even if we are no longer a PFIC in the year of distribution or disposition. Moreover, such U.S. investor would also be subject to special U.S. tax reporting requirements.

 

Item 4. INFORMATION ON THE COMPANY

 

A.                                    HISTORY AND DEVELOPMENT OF THE COMPANY

 

We established Rong Jin Hui Yin on May 18, 2011 and commenced operation in July 2011. Rong Jin Hui Yin focuses on providing commodity trading and other related services. Jin Xiang Yin Rui, another major subsidiary of ours, was incorporated in the PRC by our founders on October 24, 2012 and commenced operation on the Guangdong Precious Metals Exchange in August 2013. Its primary focus is to provide commodity trading and other related services on the Guangdong Precious Metals Exchange. We also established a number of other subsidiaries in the PRC to provide technical and other support for our online spot commodity trading business, and to sell software applications and provide supporting services to related parties and third parties.

 

In 2013 and 2014, we completed a series of restructurings to consolidate Rong Jin Hui Yin, Jin Xiang Yin Rui and various other PRC subsidiaries as wholly-owned PRC subsidiaries of Win Yin Financial and Information Service Company Limited, or Win Yin Financial, a company incorporated in the Cayman Islands by our founders. Mr. Wenbin Chen, Mr. Ming Yan and Ms. Ningfeng Chen, through their respective wholly-owned holding companies, held 40%, 30% and 30% of the equity interest in Win Yin Financial, respectively.

 

Our company, Yintech, was incorporated on November 4, 2015 in the Cayman Islands. Yintech acquired all of the ordinary shares of Yintech Enterprise from Win Yin Financial on November 6, 2015 at par value. As a result, Qian Zhong Su, Yintech Enterprise’s wholly-owned PRC subsidiary, became Yintech’s wholly-owned subsidiary. In November 2015, Qian Zhong Su initiated a series of transactions to acquire from our ultimate shareholders, Rong Jin Hui Yin, Jin Xiang Yin, Rui, Yin Sai, and their subsidiaries, as its wholly-owned PRC subsidiaries. The acquisitions were completed on November 18, 2015. On November 16, 2015, Qian Zhong Su acquired from third parties Sheng Ding, which commenced operation on the Guangdong Precious Metals Exchange in October 2015, to further expand our business on that exchange. In November and December 2015, we established Jin Dou and Jin Yi to carry out business on the Shanghai Gold Exchange (“SGE”). In March 2016, we acquired 70% equity interest in Da Xiang, which focused on mobile platform based products on the Guangdong Precious Metals Exchange. We have also established additional BVI and Hong Kong subsidiaries under Yintech for future business activities.

 

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In April 2016, we completed an initial public offering of 7,500,000 ADSs (including the ADSs sold in connection with the over-allotment offering), representing 150,000,000 ordinary shares. On April 27, 2016, our ADS were listed on the NASDAQ Global Select Market under the symbol “YIN.” In conjunction with the completion of our initial public offering, we issued and sold 1,164,814,815 ordinary shares via private placement to MeMeStar Limited, a wholly-owned subsidiary of SINA Corporation (NASDAQ: SINA), a leading online media company serving China and the global Chinese communities.

 

In August 2016, we acquired 100% equity interest in Gold Master (HK) Company Limited (“Gold Master”), which offers online spot commodity trading services to individual customers in the PRC on the SGE. Leveraging the integration of Gold Master, we believe we will be able to extend our leadership from spot trading of silver to gold and further enhance our operation on the SGE.

 

In November 2016, we established Yintech Financial Innovation Labs in Shanghai and Boston, which focus on areas including big data, artificial intelligence and trading strategies, to provide our customers with more advanced trading strategies, reliable risk management toolkits, and intelligent services.

 

In July 2017, we established a joint venture with SINA to provide financial software, information and services to individual investors.

 

In August and November 2017, we disposed all of our subsidiaries that provided customers with services for the trading of spot commodities on the Guangdong Precious Metals Exchange and the Tianjin Precious Metals Exchange, including Rong Jin Hui Yin, Jin Xiang Yin Rui, Sheng Ding, Da Xiang and Yin Ru Yi.

 

In December 2017, we acquired 100% equity interest in Forthright Securities Company Limited, which was regulated by the Securities and Futures Commission of Hong Kong, to provide brokerage services to individual and institutional customers for a variety of securities and financial products traded on global capital markets.

 

In 2017, we have also established and acquired certain subsidiaries to provide futures commodities trading services, securities advisory and information platform services, and asset management services.

 

On December 4, 2018, Forthright Financial Holdings Company Limited, a wholly-owned subsidiary of Yintech, acquired OTS Capital Management Co., Ltd. (“OTS”), a Securities and Futures Commission (“SFC”) registered asset management firm based in Hong Kong focusing on fundamental and value investment strategies in secondary market. Established in 2015, OTS is a licensed corporation permitted to carry out Type 4 regulated activity (advising on securities) and Type 9 regulated activity (asset management) under the Securities and Futures Ordinance. OTS is regulated by the SFC and provides asset management services to individual and institutional customers for a variety of financial products traded on global capital markets, including stocks, bonds, ETFs and commodities.

 

Our principal executive offices are located at 3rd Floor, Lujiazui Investment Tower, No.360 Pudian Road, Pudong New Area, Shanghai 200125, People’s Republic of China. Our telephone number at this address is +86-21-2028-9009. Our registered office in the Cayman Islands is located at Walkers Corporate Limited, Cayman Corporate Centre, 27 Hospital Road, George Town, Grand Cayman KY1-9008, Cayman Islands. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., located at 400 Madison Avenue, Suite 4D, New York, New York 10017.

 

B.                                    BUSINESS OVERVIEW

 

Overview

 

Yintech Investment Holdings Limited (“Yintech” or the “Company”) is a leading provider of comprehensive investment and trading services primarily for individual investors in China. We strive to provide best-in-class financial information, investment tools and services to individual customers utilizing the latest financial technology and mobile platform. We have grown to be the No.1 online provider of spot commodity trading for the years of 2014-2016 according to Euromonitor. Since the second half of 2017, we have steadily expanded our products and portfolio of services to provide diversified investment choices to our customers with various risk preferences. After a year and a half, we have transformed from a single service provider to a comprehensive financial trading and investment service provider and have formed five lines of products and services. We currently are focusing on providing two categories of services: (i) commodities services, which include the trading of spot and futures commodities; and (ii) securities services, including securities advisory and information platform services, overseas securities trading services, and asset management services.

 

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We have achieved substantial growth since our commencement of operation from to the first half of 2017. In the second half of 2017, our business experienced downturn primarily because of our business transformation, resulting in a slight decline in total revenues in 2017, and dramatic drop of total revenues in 2018. Our revenues was RMB2,719.5 million in 2016 and slightly dropped to RMB2,448.9 million in 2017, and further dropped to RMB1,094.7 million (US$159.2 million) in 2018. We recorded net income of RMB925.7 million and RMB467.0 million in 2016 and 2017. We incurred net loss of RMB873.4 million (US$127.0 million) in 2018 as a result of the aforementioned business transformation.

 

Commodities Services

 

Our commodities services consist of services provided for spot commodities trading on the SGE, futures commodities trading mainly on the Shanghai Futures Exchange, Dalian Commodity Exchange and Zhengzhou Commodity Exchange.

 

In 2018, we generated net commissions and fees from commodities services of RMB604.4 million (US$87.9 million), compared to RMB2,177.9 million in 2017.

 

Spot Commodities Trading

 

We facilitate the trading by individual customers of gold, specifically, Au (T+D) and mAu (T+D) and silver, specifically Ag (T+D) on the SGE, which was established and supervised by the People’s Bank of China.

 

We provide our customers with comprehensive services, including account opening for institutional customers as a comprehensive member of SGE, investor education, market information, research, live discussion boards and real-time customer support. Most services are delivered online through our proprietary client software and call center, and we do not operate physical branches. Our client software provides not only market information and analysis, but also interactive functions including live discussion boards and instant messaging with customer service representatives, which we believe enhance our customers’ engagement. Internally, we collect and analyze customer behavior and communications data from our client software, customer relationship management system and the exchanges, which allow us to better understand, attract and serve our customers.

 

Trading Model

 

Trading participants on the SGE mainly include individual and institutional customers, financial members, comprehensive members and proprietary members (members trading for their own accounts). Trading participants may submit orders to buy or sell a certain commodity with a specified price and quantity, which will be matched with other participants’ orders to sell or buy such commodity, and the trade is executed via the exchange’s trading system. The proprietary member is only allowed to conduct proprietary trading, while the comprehensive member and financial member are allowed to conduct proprietary trading and agent business for institutional customers. In addition, a financial member could also conduct agent business for individual customers. A financial member may use agents to develop and service customers. We are a comprehensive member and an agent of several financial members on the SGE. The majority of our spot commodities business is conducted as an agent to financial members on SGE.

 

Deposit and Cash Settlement

 

The SGE typically designates one or more banks to serve as depositaries for all trading participants. The SGE opens its segregated deposit accounts and enters into custodian arrangements with such designated banks for fund deposit and withdraw made by its members or members’ customers. A member will enter into a tri-party depositary service agreement with each of its customers and the designated bank, pursuant to which the customers’ accounts will be set up under such member’s account, instead of under the exchange’s account. All customers’ and members’ sub-accounts are segregated from each other and could only be freely withdrawn or funded by the corresponding member or customer, subject to the minimum deposit requirement.

 

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Cash settlement is carried out on a “mark-to-market” basis by the deposit banks according to clearing instructions from the SGE during settlement hours of each trading day. If a member opens and closes a position on the same day, the profit or loss minus fees and expenses will be credited or debited to the member’s deposit account (as settlement reserve). When the settlement reserve is insufficient, the member should make up the margin within a specified time limits. Otherwise, its contract will be forced to liquidate. The same system applies to the individual customer of members as well. When a customer’s margin is insufficient, the member will request the increase of the margin. Otherwise, the member will has the right to forcibly liquidate the contract in accordance with the transaction agency agreement held by the customer.

 

Futures Commodities Trading

 

In May 2017, we expanded our commodities trading business from the SGE with the launch of introducing brokerage business for futures commodities trading.

 

Serving as an introducing broker, we introduce our customers to a number of futures companies that we cooperate with for the engagement of futures brokerage business provided by those futures companies. As an intermediator of futures, we recommend potential investors (customers) to futures companies in accordance with the qualifications for futures investors stipulated by laws and regulations. Once potential investors sign futures brokerage contracts with futures companies, we then assist those futures companies in verifying the customers’ qualifications and passing customers’ questions regarding account opening and trading to those futures companies. When those futures companies authorize us to provide futures trading software services customers will be able to receive updates and information of futures markets and could put trade orders which will be passed through to futures firms through our mobile APPs and the orders will be passed through to those futures companies. The futures companies, all of which are supervised by the CSRC and have membership qualifications at China’s three futures commodities exchanges, pass through our customers’ orders to the exchanges and also provide clearing services.

 

Pursuant to our introducing brokerage agreements with the futures firms, they would pay us commissions and fees based on their commission revenue generated by such customers and their related expenses incurred from the introducing brokerage cooperation.

 

Securities Services

 

Our securities services consist of securities advisory and information platform services, overseas securities brokerage services and asset management services, which provide medium and low risk products to our customers as compared to spot and futures commodities trading. We believe our securities services segment targets a wider range of customers and has demonstrated strong potential to grow.

 

In 2018, we generated net commissions and fees from securities services of RMB337.5 million (US$49.1 million), compared to RMB20.7 million in 2017.

 

Securities Advisory and Information Platform Services

 

On May 18, 2017, we entered into an agreement to acquire 94.29% of equity interest in Guangdong Bo Zhong Securities Investment Advisory Co., Ltd. (“Bo Zhong”), which holds a securities advisory license issued by CSRC. Through Bo Zhong, we offer subscription-based securities research and investment advisory services.

 

Our service offerings are used by and targeted at a broad range of individual investors in China. We offer a variety of services to our customers, including investment courses, trading strategy plans, abnormal fluctuation alerts, perspective of hot issues and stock analyses, and our customers are able to access our services via apps, wechat, text message and phone. Customers may choose to subscribe for different service packages and content provided by various investment advisors. All of the investment advisors on our platform of Bo Zhong are our employees and have relevant securities investment advisory qualifications.

 

On July 7, 2017, we entered into an agreement to form a financial software, information and services joint venture with SINA Corporation (NASDAQ: SINA) (“SINA”), a leading online media company serving China and the global Chinese communities. Pursuant to the Agreement, we and SINA took a 51.0% and 49.0% equity stake, respectively, in Sina Shi Jin (Shanghai) Information Technology Co., Ltd. (formerly known as SINA Cai Dao (Shanghai) Information Technology Co., Ltd., or the SINA Shi Jin) after completing a series of reorganization and capital increases, through which SINA Shi Jin’s paid-in capital was enlarged to RMB200.0 million.

 

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SINA Shi Jin focuses on providing financial information platform services to connect individual investors and professional investment advisors. The investment advisors registered on our platform are qualified financial practitioners. Through our platform, customers may subscribe for courses, Q&As, market views and trading plans of our investment advisors in order to acquire their valuable investment perspective on a variety of investment products, including stocks, funds and gold. The subscription fees are split in certain proportion between the investment advisors and us.

 

Overseas Securities Brokerage Services

 

In September 2017, we announced the acquisition of 100% equity interest in Forthright Securities Company Limited (“Forthright Securities”) from Mr. Ming Yan, our co-founder and director, and that we received approval from the SFC for the acquisition. The acquisition was completed in December 2017 for a total consideration of approximately RMB12.8 million.

 

As a licensed corporation permitted to carry on Type 1 (dealing in securities), and Type 4 (advising on securities) regulated activities from the SFC under the Securities and Futures Ordinance, Forthright Securities is regulated by the SFC and provides brokerage services to individual and institutional customers for a variety of securities and financial products traded on global capital markets, including stocks, bonds and ETFs.

 

By integrating Forthright Securities, we are now able to provide our customers with another important asset class to diversify their investment portfolio. With Forthright Securities’ proprietary mobile apps, customers are able to trade around the clock on global capital markets and enjoy customized one-on-one services.

 

Forthright Securities primarily generates revenues from trading commissions and interest of margin loans provided to customers.

 

Asset Management Services

 

We provide RMB asset management services through Shanghai Chun Da Asset Management Co., Ltd. (“Chun Da”), which completed the private investment fund manager registration with the Asset Management Association of China (“AMAC”). Chun Da develops and manages secondary market fund products, including both funds and funds of funds, targeting high net worth individuals in China.

 

Chun Da primarily generates revenues from recurring management fees and performance-based income from the fund products that it manages.

 

In 2018, we acquired OTS, a SFC registered asset management firm based in Hong Kong that focusing on fundamental and value investment strategies in the secondary market.

 

Established in 2015, OTS is a licensed corporation permitted to carry out Type 4 regulated activity (advising on securities) and Type 9 regulated activity (asset management) under the Securities and Futures Ordinance. OTS is regulated by the SFC and provides asset management services to individual and institutional customers for a variety of financial products traded on global capital markets, including stocks, bonds, ETFs and commodities. OTS generates revenues from recurring management fees and performance-based fees for the funds and products that it manages. OTS will provide a new and unique opportunity for us to offer investors access to a broad array of investment solutions, including a full spectrum of traditional and potentially cutting-edge innovative financial products and research and advice capabilities.

 

Our Business Model

 

Our business process can be generally divided into three stages: marketing, customer development and customer service, all of which are supported by our technology infrastructure. The following diagram illustrates this process:

 

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Marketing: We conduct brand promotion and precision marketing to attract potential customers through both online and traditional marketing channels. Interested persons who contact us and leave their contact information with us become our potential customers. We also promote our client software through various websites and app stores. The guest version of our software is free to download and use. Through simple online registration, people get free access to the user version of our client software and become our potential customers. We do not conduct cold calls. We also use popular interactive social media such as weibo and wechat to attract potential customers.

 

Customer development: Our customer representatives interact with potential customers through call, text message and instant messaging function in our client software. Our representatives begin building relationships with our potential customers in anticipation that they will open a trading account or subscribe to our service offering.

 

Customer service: A potential customer who opens and activates a trading account or subscribe to our service offering becomes our customer. We provide more services to customers compared with potential customers, including free usage of the customer version of the client software which has richer features, as well as access to more comprehensive research reports and technical analysis tools.

 

Sales and Marketing

 

Marketing

 

Our marketing activities include promoting our brand recognition, attracting new customers through targeted marketing and promoting our client software, to broaden the reach of users who might become our potential customers. We employ mainly online marketing channels. Our online marketing relies mainly on search engine marketing and displaying advertisements on third party portal websites and mobile applications. We also actively promote our client software through mobile application stores. In addition, we promote our brand and software through our accounts on popular interactive social media such as weibo and wechat.

 

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We focus on investing in cost-effective marketing initiatives and continuously evaluate the effectiveness of various marketing channels to optimize the allocation of our marketing spending. We incurred advertising expenses of RMB554.3 million, RMB424.9 million and RMB223.3 million (US$32.5 million) for the years ended December 31, 2016, 2017 and 2018, respectively, accounting for 20.4%,17.3% and 20.4% of total revenues for the same periods.

 

Customer Development

 

Our potential customers can initiate contact with us through call, text message and online instant message, as well as through software downloads and online registration. Our representatives generally follow up with potential customers and respond to their questions regarding relevant market, financial products and our software and services. Our representatives begin building relationships with our customers in anticipation that they will open trading accounts or subscribe to our services offering.

 

We use data mining to identify potential customers through an analysis of communications history and software usage records, thus improving the effectiveness of our customer development. For instance, based on our analysis, active users of our software are more likely to open a trading account with us than those who do not use our software. We have detailed internal rules regulating the conduct of our customer representatives. We also provide them with mandatory training to ensure the quality of their services. Our internal compliance team also uses our CRM system to monitor communications between our customer representatives and potential customers.

 

Our Services

 

We provide the following services to our customers.

 

Investor Education

 

We believe that investor education is critical in preparing potential customers for investment and trading. We have developed a set of educational programs designed to target customers with a variety of experience levels and investment preferences. Our education programs include basic rules and processes of online spot and futures commodities trading, overseas securities trading, fundamental analysis methods and technical analysis methods. We offer online lectures and live video programs we produce in-house which cover a variety of topics. Most of our educational resources are easily accessible through our client software. Certain more advanced investor education materials are provided exclusively to customers who have opened and activated accounts, or customers who have subscribed to our securities advisory services offering.

 

Market Information Provision

 

We provide comprehensive market information to our customers, including real-time price quotes from various exchanges and international markets, technical indicators, market news and macroeconomic data and news. Market information is accessible by our customers and potential customers through our client software.

 

Research

 

We have professional research teams at our in-house research institutes and our Yintech Innovations Labs in Boston and Shanghai, through which we provide fundamental and quantitative research support services to our customers. Our research staff members possess various professional qualifications in securities, futures and commodity trading. Our research services include research reports, online lectures, live market commentaries and quantitative analysis. Our research reports include daily, monthly and special event reports. Our research team also develops various quantitative analysis models and toolkits that can be used by our customers through our client software.

 

Live Discussion Boards

 

Our client software not only provides market information and investor education to users, but also provides live discussion boards for the users to communicate with our research personnel and among themselves, with respect to market trends, investment opportunities and other related topics.

 

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Customer Support

 

We are committed to providing high-quality customer support. Most of our services, including investor education, market information provision and research support services, are accessible through our client software, which we believe provides a positive experience for our customers due to its user-friendliness and easy access. Besides our client software, we have a dedicated team of customer service personnel that handles real-time customer inquiries about our software, market news and research reports, and other questions, via call, text message and online instant message. We request that all our customer representatives conduct customer communications via our communication system that is closely monitored by us. In addition, our Yintech Innovation Labs have developed an intelligent servicing tool that can understand and respond to customer inquiries in real time.

 

In addition, we receive customer complaints from time to time. To ensure that reasonable complaints made by each customer are adequately addressed and for risk management purposes, we have established a customer complaint department at our customer service center. For a complaint received, our customer compliant officer will first confirm details of the complaint with the customer and then verify the facts with the relevant department. Based on our verification results and our internal policy, we seek to resolve complaints through discussions with the customer. The complaint and our response are recorded in the CRM system, and feedback is also provided to relevant departments. We also report complaints to the compliance department, which will check for noncompliance and advise the relevant department to take rectification measures, if necessary.

 

Technology and Infrastructure

 

The client software and the CRM system comprise our core technology infrastructure and enable us to move each key phase of our business operation online. We received the “certified software enterprise and registered software products” qualification from the Shanghai Municipal Commission of Economy and Informatization in April 2013, and received ISO9001 certification for software development in June 2014, ISO20000 certification for IT service operation and maintenance in December 2014 and ISO27001 certification for information security management in December 2014. We made substantial investments in R&D. We received GB/T29490-2013 certification for enterprise intellectual property management system in April 2017. As of December 31, 2018, we had a software research and development and maintenance team of 451 employees.

 

Client Software

 

While many of our competitors use third-party software to deliver services, we have developed a range of proprietary client software to address our customers’ needs for the different markets we operate on. Through our client software, we provide customers with timely and comprehensive market information, investor education programs, research reports, live market commentary, quantitative analysis tools and interactive customer support functions. For spot and futures commodities trading and overseas securities trading, our customers can directly place trades and view their positions through our client software.

 

We believe that in-house development of our client software can shorten development cycles and improve usability of our software based on continuous customer feedback, and therefore differentiate us from our competitors.

 

CRM System

 

Our CRM system is the core IT system for customer development and customer services. Our CRM system allows us to centrally manage relationships with customers and potential customers, monitor and supervise customer communications conducted via calls, text messages and online instant messages, as well as collect and analyze customer data. We have utilized artificial intelligence technology to continuously enhance our CRM system and create more value in business areas such as marketing efficiency analysis, intelligent customer inquiry processing, 360-degree customer profiling, robo-advisor, intelligent customer services, intelligent quality monitoring and intelligent risk management. Our CRM system allows us to manage customer relationships in the following ways:

 

Customer communication platform. Our CRM system is integrated with our call center, online instant message and text message platform, which enables customer representatives to engage in dial-in and dial-out communications and online chats with our customers, and sends out personalized SMS for promotion and other notices.

 

Customer relationship management. Our CRM system also facilitates the categorization of customers and potential customers, the management of account opening procedures, account status, rebate arrangement, collection of customer complaints and advice, as well as other customer activities. Through our CRM system, our customer representatives can access customers’ communication history with us, their software usage records and trading records. Such background information can help them communicate in more effective ways with our customers and potential customers.

 

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Monitoring and auditing. All customer communications through our CRM system are recorded, including calls, text messages and online instant messages. Our compliance department conducts spot checks of our customer communications on a daily basis for any behavior that is noncompliant with our internal policies and for any irregularities. We also recently installed an automatic speech recognition system to monitor calls with customers and identify any noncompliance or irregularities. These recordings and narratives may also be used for training and quality control purposes.

 

Internal information distribution. Our CRM system distributes internally generated information, such as market information, research reports, new trading products, promotional information and compliance notices, to our customer representatives, which enables us to provide high-quality customer services and to maintain a consistent connection with our customers.

 

Human resource management. Our CRM system improves our efficiency by facilitating the allocation of existing and potential customers to our customer representatives. We can also monitor and evaluate the performance of each customer representative using data compiled by our CRM system such as the number of customers developed and the number of customer inquiries answered by each customer representative.

 

Our Focus on Utilizing Data Assets

 

We collect data through our client software and CRM system. Through our client software, we are able to collect data with regard to users’ usage history, including log-on/off time, duration of each log-on and users’ activities during each log-on session, such as watching investor education programs, reading market information or research reports and participating in the online discussion board. Through our CRM system, we can collect data about a customer’s or a potential customer’s communication history with us, including recorded calls between the customer and our customer representatives, duration and content of each call, text messages and online instant message records. We also obtain customers’ trading records from the exchanges. All of these collected data become our data assets. Our customer representatives can access most of this data through our CRM system. We also have a dedicated big data team to analyze this data.

 

We believe that collection and analysis of our data assets enhance our operational efficiency and improve our business in many ways. Our data assets enable us to accurately evaluate the effectiveness of different marketing channels and, consequently, to more efficiently allocate our marketing budget. Through analysis of data on software usage, individual information and communication records, we can more accurately identify potential customers who have a high interest in opening a trading account or subscribe to our services offering and thus improve the efficiency of our customer development activities. Through our CRM system, our customer representatives can access customer-specific data, including software usage history, communication history with us and trading records, which make it easier for us to provide informed services to individual customers and enhance their experience with us.

 

Reliability and Business Continuity

 

Our client software runs on reliable hardware and software technologies with primary and back-up facilities hosted at two separate geographic locations in Shanghai and Beijing, respectively. In addition, both servers are located in advanced outsourced data centers with full business continuity features, including redundancy for power, telecommunications connections and daily monitoring.

 

We also maintain formal business continuity policies and practices aimed at ensuring rapid recovery from any business or trade interruptions. We rank each of our services according to the risks associated with potential interruptions and have also established business recovery time objectives for our services. We regularly review and test our recovery plans and controls to ensure the effectiveness of such plans and controls in meeting our business needs.

 

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Risk Management

 

We have established rigorous risk management policies and practices as we believe that risk management is crucial to the success of our business. We mainly focus on three types of risks: trading-related risks, operational risks and information security risks.

 

Operational Risks

 

We are exposed to operational risks for various aspects of our business and we have formulated a series of internal procedures focusing on the risks of four key business areas. First, for advertisement, all promotion materials, webpages, information and media programs for public advertisement are reviewed by the compliance department before publication. Second, for customer development, we conduct spot checks on the audio recordings of customer development calls made by our customer representatives for any noncompliance or irregularities, and our automatic speech recognition system further facilitates such internal screening. Third, all our published research reports contain prominent disclaimers, and our research institute and compliance department will review all research reports before publication, in order to prevent the disclosure of any misleading or inaccurate information or other potential risks. Fourth, for customer service, we monitor the interactions of our customer representatives with customers through our automatic speech recognition system and through conducting spot checks on recorded conversations with customers for any noncompliance. All customer-facing employees receive compliance training upon joining us and we also provide ad hoc compliance trainings on various compliance matters to all employees. In addition, we have also established an internal whistleblower system for all employees to report any violation to the compliance department on an anonymous basis through various channels including e-mail, phone call and wechat account.

 

Information Security Risks

 

Secure access to our customers’ information and other confidential information is paramount to our business success and we are exposed to the risks that such information may be leaked or misused. We maintain strict internal practices, procedures and controls, such as providing different levels of access rights, which enable us to better protect our customers’ sensitive information (including ID card number, telephone number and other personal data). We deploy advanced firewall technologies to restrict inappropriate access to our hosting facilities. Access to our information systems is granted to our internal users on an as-needed basis. Our in-house information security team monitors our websites and critical servers 24/7. We use hardware security machines to encrypt sensitive customer information in our CRM system. We received ISO27001 certification issued by British Standards Institution, the world’s largest certification organization, in recognition of our information security system.

 

Competition

 

We provide investment and trading services to individual investors in China and we encounter intense competition in all of our business lines. There is a variety of financial institutions in the PRC that provide investment and trading services to individual investors. We compete primarily with PRC commercial banks, securities firms, trust companies, funds and emerging internet-based financial companies.

 

·                  Spot commodities trading: the Chinese government has made efforts to clean-up the spot commodities trading market in recent years. After the market has been regulated, leading trading service providers like us are better positioned with less competitors. In terms of the SGE, there are now approximately a dozen active trading service providers acting as agents of financial members. In addition, there are also over 25 commercial banks operating as financial members on the SGE, through which individual customers can open accounts and trade gold and other precious metals. However, we believe that in most cases, these banks only offer a trading channel to their existing customers as part of their overall banking package and do not provide specialized services for spot commodity trading.

 

·                  Futures commodities trading: the futures industry in China is highly competitive and we expect competition to continue to intensify. Currently, there are 149 futures firms in the PRC that are eligible to provide futures brokerage services. In addition, there are also many introducing brokers in the market, which are similar to us. We face competition mainly from these futures firms and introducing brokers.

 

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·                  Overseas securities trading: for our overseas securities trading business, we primarily compete with international banks and securities firms conducting business in Hong Kong, as well as certain internet securities firms. Currently, there are 1,350 companies that are licensed to engage in Type 1 regulated activities (dealing in securities), 357 companies that are licensed to engage in Type 2 regulated activities (dealing in futures contracts), 1,445 companies that are licensed to engage in Type 4 regulated activities (advising on securities), 162 companies that are licensed to engage in Type 5 regulated activities (advising on futures contracts).

 

·                  Securities advisory and information services: there are 84 companies eligible to provide investment advisory services in the PRC. In addition, there are also 131 securities firms allowed for providing investment advisory services.

 

·                  Asset management: the asset management industry in China and Hong Kong is undergoing rapid growth. We operate in an increasingly competitive environment and compete for clients on the basis of product choices, client services, reputation and brand names. Our principal competitors include commercial banks, trust companies, independent wealth management service providers, insurance companies, asset management service providers and internet financial service companies. Currently 24,380 asset management operators are registered with Asset Management Association of China and 1,643 companies that are licensed to engage in asset management business under the Securities and Futures Ordinance of Hong Kong.

 

Although some of our competitors may have greater financial resources or a larger customer bases than we do, we believe that our proprietary technology platform, our focus on premier customers, our comprehensive customer services and strong brand recognition in the industry, will enable us to compete effectively in providing investment and trading services to individual customers in China.

 

Intellectual Property

 

Our trademarks, copyrights, domain names, trade secrets and other intellectual property rights are important to us in distinguishing our brand and services from those of our competitors and contribute to our ability to compete in our target markets. We rely on a combination of copyright and trademark laws, trade secret protection and confidentiality agreements with our employees, business partners and selected third-party service providers to protect our business and intellectual property rights. We also enter into confidentiality and invention assignment agreements with all executive officers and key employees and rigorously control access to proprietary technology.

 

As of March 31, 2019, we have 19 patents, including 6 patents for invention and 13 for product design. We have 156 registered trademarks in the PRC and we have applied to register for an additional of 52 trademarks. We have 104 software copyright registrations and own 175 domain names that we use in our business operations. As our brand name gains more recognition among the general public, we will work to increase, maintain and enforce our trademark portfolio as well as software and domain name registration, the protection of which is important to our reputation and the continued growth of our business.

 

Regulation

 

This section summarizes the principal current PRC laws and regulations relevant to our business and operations.

 

Provisions on Foreign Investment

 

All limited liability companies and joint stock limited companies incorporated and operating in the PRC are governed by the Company Law of the People’s Republic of China , or the Company Law, which was amended and promulgated by the Standing Committee of the National People’s Congress on December 28, 2013 and came into effect on March 1, 2014. In the latest amendment, paid-in capital registration, minimum requirement of registered capital and timing requirements of capital contribution were abolished. Foreign invested enterprises must also comply with the Company Law, with exceptions as specified in foreign investment laws.

 

With respect to the establishment and operation of wholly foreign-owned enterprises, or WFOE, the MOFCOM, and the National Development and Reform Commission, or NDRC, promulgated the Catalogue of Industries for Guiding Foreign Investment, or the Catalogue, as amended on June 28, 2017, which came into effect on July 28, 2017. The Catalogue serves as the main basis for management and guidance for the MOFCOM to manage and supervise foreign investments. The Catalogue divides industries for foreign investment into three categories: encouraged, restricted and prohibited. Those industries not set out in the Catalogue shall be classified as industries permitted for foreign investment. According to the Catalogue, online spot commodity trading, technical development, technical consultation and technical services sectors are neither restricted nor prohibited.

 

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According to the Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises, which was amended and effective on July 30, 2017, promulgated by the MOFCOM, the establishment and change in basic information of investors or foreign-invested enterprises (including WFOEs) which are not subject to special administrative measures shall be filed with MOFCOM rather than approved.

 

On March 15, 2019, the Foreign Investment Law has been formally passed and will take effect on January 1, 2020. The Foreign Investment Law stipulates certain forms of foreign investment:

 

·                  foreign investors set up foreign-invested enterprises in China severally or jointly with other investors;

 

·                  foreign investors acquire shares, equity, properties or other similar interests in any domestic enterprise;

 

·                  foreign investors invest in new projects in China severally or jointly with other investors; and

 

·                  foreign investors invest through any other methods under laws, administrative regulations or provisions prescribed by the State Council.

 

The Foreign Investment Law stipulates that “negative list” is applied in certain industry sectors. The “negative list” set out in the Foreign Investment Law classifies the relevant prohibited and restricted industries into the Catalog of Prohibitions and the Catalog of Restrictions, respectively. Where any foreign investor directly or indirectly holds shares, equity, properties or other interests in any domestic enterprise, such domestic enterprise is not allowed to invest in any sector set out in the Catalog of Prohibitions. Foreign investors are allowed to invest in sectors set out in the Catalog of Restrictions, subject to certain conditions. Foreign investors are allowed to invest in any sector beyond the “negative list” and shall be managed on the same basis as domestic investments unless otherwise provided by laws and administrative regulations.

 

Provisions on Merger and Acquisition and Overseas Listing

 

According to the Provisions on Merger and Acquisition of a Domestic Enterprise by Foreign Investors , or the M&A Rules, promulgated jointly by the MOFCOM, the SASAC, the SAT, the SAMR (formerly known as “SAIC”), the CSRC and the SAFE, beginning on June 22, 2009, overseas special purpose vehicles which are established through the acquisition of domestic companies in the PRC and are controlled by Chinese companies or individuals for the purpose of overseas listing must obtain the approval of the CSRC before overseas listing. According to the M&A Rules, if any domestic company, enterprise or natural person intends to merge an affiliated domestic company into an overseas company legally incorporated or controlled by the aforesaid domestic company, enterprise or natural person, the proposed merger shall be subject to the approval of the MOFCOM, and the parties thereto shall not circumvent the above provision through any means, including domestic investment by foreign-invested enterprises, or the Related Party M&A Rules. As none of Mr. Wenbin Chen, Mr. Ming Yan and Ms. Ningfeng Chen is a PRC citizen, our PRC legal advisor is of the view that the onshore acquisitions during our reconstruction are not subject to the Related Party M&A Rules.

 

Provisions on Futures Introducing Business

 

Under current PRC laws and regulations, future introducing brokers are under the supervision of CSRC and its local authorities and the brokers are mainly subject to the administrative measures or self-discipline rules which have been issued by competent local securities regulatory authorities or local associations. It is worth mentioning that China Futures Association (which is a nationwide association for futures business) had issued the Measures for the Provision of Intermediary Introduction Business Commissioned by Futures Companies (Draft for comment), or the Draft, on March 14, 2016 to seek public comments. The Draft mainly governs and enhances supervision of the conduct of future introducing brokers in all material aspects including setting the qualifications for the introducing brokers, prohibiting individuals acting as introducing brokers, formulating guidance for introducing brokerage agreements and requiring the filing procedures and so on. The Draft further provides that one introducing broker is prohibited from providing introduction services to two or more future brokerage firms concurrently and introducing one client to several future brokerage firms.

 

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Provisions on Securities Investment Advisory Business

 

According to the Securities Law of the People’s Republic of China, which was amended and came into effect on August 31, 2014, promulgated by the Standing Committee of the National People’s Congress, an investment advisory institution engaging in any securities service business shall be subject to the approval of the CSRC or relevant administrative departments and obtain the securities advisory license. The requirements to apply for qualification of engagement in securities investment advisory business are stipulated in the Interim Procedures on Administration of Securities and Futures Investment Advisory, which was issued on December 25, 1997 and effective on April 1, 1998, approved by the State Council.

 

With respect to securities investment advisory business, CSRC issued the Interim Provisions on the Securities Investment Consulting Business on October 12, 2010 and implemented from January 1, 2011 in order to regulate the securities investment consulting business carried out by securities investment advisory institutions and supervise the behavior of securities investment advisory institutions and their personnel.

 

Provisions on Privately Offered Fund Management Services

 

According to the Securities Investment Fund Law of the People’s Republic of China, or the Fund Law, which was amended and effective on April 24, 2015, promulgated by the Standing Committee of the National People’s Congress, and the Interim Measures for the Supervision and Administration of Privately Offered Investment Funds , or Circular 105, which was issued and effective on August 21, 2014, promulgated by the CSRC, the CSRC and its local office shall oversee and regulate the business operations of privately offered funds, and the Asset Management Association of China, or the AMAC, shall conduct self-disciplinary management of the privately offered fund sector.

 

According to the Fund Law and Circular 105, a privately offered fund management institution shall submit the basic information and apply to the AMAC for registration in accordance with the provisions of the AMAC. Upon the completion of the offering of a privately offered fund, the privately offered fund management institution shall undergo the recordation procedure for the fund in accordance with the provisions of the AMAC.

 

On April 27, 2018, PBOC, CBIRC, CSRC and SAFE jointly released the Guidance Opinions on Regulating the Asset Management Business of Financial Institutions (“Asset Management Guidance Opinions”). The Asset Management Guidance Opinions requires that each regulator shall further promulgate detailed rules targeting specific segments of the wealth and asset management industries.

 

Operational Rules of the Shanghai Gold Exchange

 

We are an agent of a financial member of the SGE and we are required to comply with the operational rules of the SGE to engage in online spot commodity trading services business and the agent business on the SGE. Operational rules of the SGE are summarized as below:

 

Membership Administration

 

Pursuant to the Membership Management Measures of the SGE issued by the SGE on September 16, 2014, business entities or other economic organizations that meet the prescribed conditions of the SGE may apply to the exchange for membership and, upon approval, engage in spot commodity trading of precious metals products within the scope authorized by the exchange. There are two types of members in the SGE, ordinary members and special members. Furthermore, SGE divides the ordinary members into three categories according to their business scope: financial members, comprehensive members and proprietary members. The proprietary members are only allowed to conduct proprietary trading, while comprehensive members and financial members are allowed to conduct proprietary trading and agent business for institutional customers. In addition, financial members can also conduct agent business for individual customers.

 

Pursuant to the aforesaid Membership Management Measures of the Shanghai Gold Exchange, a member of the SGE is required to go through an annual inspection registration procedure with the SGE in order to renew its membership qualification.

 

To ensure compliance by the members of relevant rules and regulations, the SGE further promulgated several measures for the resolution of non-compliances and violations by the members and their customers, including daily examination, investigation initiation policies, resolution procedures and penalty provisions, as well as dispute resolution policies for any dispute between any member and individual customer. If a comprehensive member violates the relevant regulations of the SGE, the exchange may impose penalties on such member, including oral warning, written notification, compulsory training, suspension of membership qualification, revocation of membership qualification and payment of liquidated damages.

 

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Rules for Trading of Precious Metals Products

 

For the trading of gold, silver and platinum, the SGE also formulated and promulgated the Trading Rules for Spot Commodities Trading.

 

The above trading rules set out detailed provisions on product standard and quotation rules, trading methods, fee standards, cash settlement, delivery, risk control, information management and other aspects of spot trading of precious metals products, which collectively constitute the basic trading model of the SGE. Specifically, the SGE has the right to make adjustments on the trading rules based on different circumstances within a certain scope.

 

We are not required to comply with the trading rules of the SGE which specifically regulate the members. However, we are required to follow the trading and management rules, such as duly disclosing risks to the customers, based on the contract we entered into with a financial member of the SGE.

 

Risk Control

 

According to the Measures of the SGE for Risk Control Management issued by the SGE on September 16, 2014, the SGE has established the following rules for risk management of online spot commodity trading:

 

Position limit and major client reporting system. In order to manage risks, the SGE sets limits on the maximum single or aggregate position any individual customer can have, i.e., position limit for individual customers. Individual customers that have a position reaching the position limit may not initiate a new trade.

 

Risk alerting system and emergency measures. The SGE may take measures as they deem necessary to manage risks, including requesting members and investors to report irregular circumstances, sending reminders of risks, warnings or alerts. For unusual circumstances, the SGE will further take different emergency measures to eliminate and mitigate risks, such as adjusting trading hours, suspending trading, suspending adding good orders, setting a time limit on transfer, compulsory transfer, limiting cash withdrawal, increasing deposit ratio and compulsory decrease of trading orders.

 

Management and Settlement of Trading Funds

 

To manage trading funds, the SGE issued the Measures of the SGE for Management of Member Agency Trading Funds. Such trading management measures define the rights, obligations and liabilities of the parties involved in trading funds-related activities and set forth rules regulating the depository bank, bank account, customer trading account and member trading account.

 

In addition, to regulate the settlement procedures, the SGE included relevant rules in the Implementing Rules of the Shanghai Gold Exchange for Spot Trading Funds Settlement. However, as an agent of a financial member, we don’t participate in the management and settlement of the trading funds and the relevant rules of the SGE do not apply to us.

 

Regulation on the SGE

 

On October 10, 2001, the PBOC obtained the approval of the establishment of the SGE issued by the State Council. Later on October 31, 2001, the SGE was officially set up by the PBOC and was registered by the SAIC on February 6, 2002. On December 20, 2011, the PBOC, the Ministry of Public Security, the SAIC, the China Banking Regulatory Commission, or CBRC, and the CSRC jointly issued the Notice of Reinforcing the Management of Gold Exchanges and Platforms Which Conduct Gold Trading Business (Yin Fa [2011] No. 301) , which confirmed that the SGE is the only approved exchange for spot trading of gold and the Shanghai Futures Exchange is the only approved exchange for trading of gold futures and clarified that the SGE is under supervision of the State Council and the PBOC accordingly.

 

Regulations on Internet Financial Services

 

Due to the relatively short history of the Internet financial service industry in China, the PRC government has not adopted a clear regulatory framework governing it. There are ad hoc laws and regulations applicable to elements of Internet financial service-related businesses, such as laws and regulations governing payment related and value-added telecommunication services. On July 18, 2015 the PBOC together with nine other PRC regulatory agencies jointly issued a series of policy measures applicable to Internet financial services titled the Guidelines on Promoting the Healthy Development of Internet Finance (“Guidelines”). On April 12, 2016 the General Office of PRC State Council issued the Implementation Plan for Special Rectification of Internet Financial Risks (“Rectification Implementation Plan”). The Guidelines introduced formally for the first time the regulatory framework and basic principles for Internet financial services industry in China as “law-abiding regulation, appropriate regulation, classified regulation, collaborative regulation and innovative regulation.” The Guidelines further stated the definitions and basic principles for Internet financial services in the areas of Internet payment, Internet fund distribution and others. The Guidelines also specified several basic rules for Internet financial services industry administration, such as: (1) any organization or individual that intends to set up a website to provide Internet financial services shall, in addition to going through relevant financial regulatory procedures as required, also undergo website record-filing procedures with telecommunications authorities pursuant to the law; (2) unless otherwise specified, an industry player shall select qualified banking financial institutions as fund depository institutions to manage and oversee client funds, and achieve the management of client funds and its proprietary funds under separate accounts; and (3) basic rules of information disclosure, risk reminder and qualified investors, information security and anti-money-laundering. The Rectification Implementation Plan further provides that: (1) the regulators will adopt the see-through way of supervision; and (2) the non-financial institutions, or the enterprises which do not carry out financial business, shall not use the wordings, such as “exchange,” “finance,” “asset management,” “wealth management,” “fund,” “fund management,” “investment management,” “equity investment fund,” “online lending,” “peer-to-peer,” “equity crowd-funding,” “Internet insurance,” “payment” and the like, as their enterprise name or registered business. If the enterprise chooses to use the aforementioned word/words, the Administration of Industry and Commerce will inform the financial regulators. The Notice on Further Rectification of Asset Management Business through Internet and Carrying Out Inspection issued on March 28, 2018 (“Inspection Notice”) clarifies that the Internet asset management business is licensed business and shall operate under the supervision of competent financial regulators. Internet financial activities shall be licensed. For example, to carry out the online fund/asset management plans distribution, the platform shall be licensed with the distribution qualification. The competent regulators will carry out inspection on online platforms and require that any unlicensed business cease such operation and clear any inventory before June 30, 2018. Any online platform not complying with the Inspection Notice shall be penalized.

 

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Labor and Personnel

 

The PRC Labor Contract Law was amended by the Standing Committee of the National People’s Congress on December 28, 2012 and came into force on July 1, 2013. In the amended PRC Labor Contract Law, more stringent provisions are adopted specifically for labor dispatch, including more qualifications for labor dispatch, reinforced principle of equal pay for equal work and defined restrictions on positions to which labor dispatch is applicable. The above-mentioned provisions are further elaborated in the Interim Provisions on Labor Dispatch (“Interim Provisions”) that were promulgated by the Ministry of Human Resources and Social Security on January 24, 2014 and came into force on March 1, 2014. It specifies that an employer shall strictly control the number of dispatched workers so that it shall not exceed 10% of the total number of its workers. The Interim Provisions also specify that if, before the Interim Provisions come into force, the number of dispatched workers in an employer exceeds 10% of the total number of its workers, the employer shall adjust its employment plan and reduce the proportion to the required proportion before March 1, 2016. The employer may not employ new dispatched workers unless the number of dispatched workers is reduced to the required proportion. However, if any labor dispatch agreement executed prior to, but expiring within two years of, the promulgation of the amended PRC Labor Contract Law (amended in 2018), such agreements may continue to be performed until their expiry dates thereof. In addition, the employment of dispatched workers by an employer pursuant to labor dispatch arrangement shall be governed by the Interim Provisions.

 

According to the Interim Provisions, the labor dispatch entity shall pay social insurance premiums and follow relevant social insurance procedures for the dispatched workers as required by law and as agreed upon in the labor dispatch agreements. The Social Insurance Law of the People’s Republic of China (amended in 2018)that was promulgated by the Standing Committee of the National People’s Congress on December 29, 2018 and came into force on December 29, 2018 and the Interim Regulations on the Collection and Payment of Social Insurance Premiums that was promulgated by the State Council on and came into force on January 22, 1999, require employers to pay basic endowment insurance, unemployment insurance, basic medical insurance, employment injury insurance, maternity insurance and other social insurance for its employees. Where an employer fails to fully pay social insurance premiums, the relevant social insurance collection agency shall order it to make up for any shortfall within a prescribed time limit, and may impose a late payment fee at the rate of 0.2% per day of the outstanding amount from the due date. If such employer still fails to make up for the shortfalls within the prescribed time limit, the relevant administrative authorities shall impose a fine of one to three times the outstanding amount upon such employer.

 

According to the Regulations on the Administration of Housing Accumulation Funds that was promulgated by the State Council on and came into force on April 3, 1999 and was amended on March 24, 2002, all employers shall deposit housing accumulation funds on behalf of their employees. Where an employer fails to make deposit registration of housing accumulation funds or fails to open housing accumulation fund accounts for its employees, it shall be ordered by the housing accumulation fund management center to complete the procedures within a prescribed time limit, and if it still fails to complete the procedures within such time limit, a fine of RMB10,000 to RMB50,000 shall be imposed thereupon. Where an employer fails to deposit or underpays the housing accumulation funds within the time limit, it shall be ordered by the housing accumulation fund management center to deposit the funds in full within such time limit.

 

Our PRC operating entities incorporated in various locations in China have not made adequate employee benefit payments. Further, we had historically engaged certain third party employment agencies to dispatch contract workers to work for us, and the third party employment agencies had a shortfall in making contributions of the social insurance and housing fund for the dispatched workers. For further information regarding this issue, please refer to “Risk Factors—Risks Related to Doing Business in China—Failure to make adequate contributions to various employee benefit plans as required by PRC regulations may subject us to penalties.”

 

Intellectual Property Rights

 

According to the Regulations on Computer Software Protection that was amended and promulgated by the State Council on January 30, 2013 and came into force on March 1, 2013, PRC citizens, legal entities or other organizations enjoy the copyright in the software that they have developed, whether published or not. A software copyright owner shall enjoy the rights of divulgation, developer-ship, alteration, reproduction, distribution, rental, communication through information network, translation and other rights. The term of software copyrights owned by a legal entity or an organization shall be fifty years, expiring on December 31 of the fiftieth year since the first publication of such software.

 

According to the Patent Law of the People’s Republic of China that was amended and promulgated by the Standing Committee of the National People’s Congress on December 27, 2008 and came into force on October 1, 2009, the inventor or designer of any invention-creation (including inventions, utility models and designs) could apply for the patent right for such invention-creation. An invention or utility model for which patents may be granted shall have novelty, creativity and practical applicability. A patent right for inventions shall remain in force and valid for twenty years and a patent right for utility models and designs shall remain valid for ten years, both commencing from the filing date of such patent right. The patent owner shall pay an annual fee for such patent right commencing the year in which the patent right was granted. In the event that a prescribed annual fee is not paid, the patent right will terminate before the expiration of its validity period.

 

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According to the Trademark Law of the People’s Republic of China that was amended and promulgated by the Standing Committee of the National People’s Congress on August 30, 2013 and came into force on May 1, 2014, the term for a registered trademark shall be ten years, commencing from the date of registration approval. A trademark registrant intending to continue to use the registered trademark upon expiry of the validity term thereof shall complete relevant renewal procedures within twelve (12) months preceding the expiry date, failing which the trademark registrant may be granted a six-month grace period. The term of each renewal shall be ten years, commencing from the day immediately after the expiry date of the previous term thereof. If the renewal procedures are not completed within the grace period, the trademark shall be deregistered. The Administration of Industry and Commerce above county level shall have the authority to duly investigate and impose punishment upon any infringement of trademark rights, and any suspected criminal infringement shall be promptly transferred to judicial authorities for further handling according to the law.

 

According to the Measures for the Administration of Internet Domain Names of China that were amended by the Ministry of Industry & Information Technology on August 24, 2017 and came into force on November 1, 2017, the principle of “first come, first serve” was adopted for the domain name registration procedure.

 

Foreign Exchange Administration

 

Conversion of Registered Capital

 

The principal law governing foreign currency exchange in the PRC is the Foreign Exchange Administration Regulations, which was enacted by the State Council on January 29, 1996 and amended on August 5, 2008. According to the Foreign Exchange Administration Regulations, international payments in and transfer of foreign currencies under current account items shall not be restricted. Foreign currency transactions under capital accounts, such as direct investment and loans, are still subject to limitations and require approvals from, or registration with, the State Administration of Foreign Exchange, or SAFE, and other relevant PRC governmental authorities.

 

On August 29, 2008, the SAFE promulgated the Notice of the General Affairs Department of the SAFE on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-invested Enterprises (HuiZongFa [2008] No. 142), or the SAFE Circular 142, to regulate the conversion by a foreign-invested enterprise of its foreign currency registered capital into RMB. The SAFE Circular 142 provides that the registered capita l converted into RMB from foreign currency of a foreign-invested enterprise may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC. The use of such RMB fund may not be altered without approval, and such RMB fund may not in any case be used to repay any RMB loans if the proceeds of such loans have not been utilized. Violations of the SAFE Circular 142 could result in severe monetary penalties.

 

In 2015, the SAFE has published the Circular of the State Administration of Foreign Exchange on Reforming the Management Approach regarding the Settlement of Foreign Exchange Capital of Foreign-invested Enterprises, or Circular 19, which has come into effect since June 1, 2015, and the SAFE Circular 142 was repealed simultaneously. According to Circular 19, foreign invested enterprises are now allowed to convert their registered capital from foreign exchange to RMB and apply such funds to equity investment within the PRC, conditioned upon the investment target’s duly registration with local bank of such reinvestment and open a corresponding special account pending for foreign exchange settlement payment. Further, such conversion will be handled at the bank level and does not need to be approved by SAFE.

 

SAFE Circular 37

 

The SAFE promulgated the Circular of the State Administration of Foreign Exchange on Issues Concerning Foreign Exchange Administration over the Overseas Investment and Financing and Round-Trip Investment by Domestic Residents through Special Purpose Vehicles (HuiFa [2014] No. 37), or the SAFE Circular 37, on July 4, 2014. Circular 37 requires PRC residents, including PRC individuals, institutions and foreign individuals who have a habitual residence in the PRC due to economic interests, to register with SAFE or its local branches in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests. Such PRC residents must update their foreign exchange registrations with SAFE when the offshore entity, referred to as an offshore special purpose vehicle, undergoes material events relating to any change of basic information, increases or decreases in investment amount, share transfers or exchanges, or mergers or divisions.

 

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If any shareholder holding interest in an offshore special purpose vehicle, who is a PRC resident as determined by Circular 37, fails to complete relevant SAFE registration, the PRC subsidiaries of that offshore special purpose vehicle may be prohibited from distributing their profits and dividends to their offshore parent company, contributing additional capital to its PRC subsidiaries, or carrying out other subsequent cross-border foreign exchange activities. Moreover, failure to comply with the SAFE registration described above could result in liability under PRC laws.

 

Historically, our ultimate individual beneficial owners were unable to complete the aforesaid SAFE registration. For further information on this, please refer to “Risk Factors—Risks Related to Our Corporate Structure—We may be subject to penalties, including restriction on our ability to inject capital into our PRC subsidiaries and our PRC subsidiaries’ ability to distribute profits to us, if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange regulations.”

 

SAFE Circular 7

 

On February 15, 2012, SAFE promulgated the Circular of the State Administration of Foreign Exchange on Issues Concerning the Foreign Exchange Administration of Domestic Individuals’ Participation in Equity Incentive Plans of Overseas Listed Companies (HuiFa [2012] No. 7), or the Circular 7. Pursuant to Circular 7, all PRC residents who participate in an employee stock incentive plan or stock option plan of an overseas listed company are required, through the PRC subsidiary of such overseas listed company that they are employed by, to jointly entrust a PRC agent to handle foreign exchange registration with SAFE or its local branches and complete certain procedures relating to the share incentive schemes such as opening account and capital transfer. PRC residents include PRC nationals or foreign citizens who have been consecutively residing in PRC for not less than one year, acting as directors, supervisors, senior management personnel or other employees of PRC companies affiliated with such offshore listed company. A PRC agent could be a PRC subsidiary of such overseas listed company participating in the share incentive scheme or another PRC institution qualified for asset trusteeship as designated by the PRC subsidiary and in accordance with PRC laws. The PRC agent is required to amend the SAFE registration with respect to the stock incentive plan if there is any material change to the stock incentive plan, the PRC agent or the overseas entrusted institution or other material changes. The foreign exchange proceeds received by the PRC residents from the sale of shares under share incentive plans granted by the overseas publicly listed company must be remitted to bank accounts in the PRC opened by the PRC agents.

 

SAFE Circular 3

 

In 2017, the SAFE published the Circular of the State Administration of Foreign Exchange on Further Advancing the Reform of Foreign Exchange Administration and Improving Examination of Authenticity and Compliance (HuiFa [2017] No. 3), or Circular 3, which came into effect since January 26, 2017, and in case of any consistency between previous provisions and Circular 3, Circular 3 shall prevail. According to Circular 3, transferring of funds under onshore guarantee for offshore loans for domestic use is permitted now. A debtor may directly or indirectly transfer funds under the guarantee for domestic use by domestic lending, equity investment or otherwise. However, Circular 3 continues to implement and improve the policy for outward remittance of foreign exchange profit generated from direct investment. To be detailed, when conducting outward remittance of a sum equivalent to more than US$50, 000 for a domestic institution, the bank shall, under the principle of genuine transaction, check the profit distribution resolution made by the board of directors (or profit distribution resolution made by partners), original of tax filing form and audited financial statements, and stamp with the outward remittance sum and date on the original of tax filing form. In addition, the domestic institution shall make up its losses of previous years according to law.

 

PBOC Circular 3

 

In 2018, the PBOC has published the Circular of the People’s Bank of China on Further Improving Cross-Border RMB Service Policies to Promote Trade and Investment Facilitation (YinFa [2018] No.3), or PBOC Circular 3. PBOC Circular 3 further facilitates direct investment in RMB of overseas investors. Where the RMB capital and overseas loans of a foreign-invested enterprise are used for wages, travel expenses, and minor purchase and other expenditures, such expenditures to the enterprise’s payment order could be handled directly by the bank on the basis of the three principles for business development. Profits, dividends, and other investment returns legally obtained within China by overseas investors could be settled and freely remitted out of China after examining the relevant supporting materials as required by banks.

 

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Tax

 

EIT

 

According to the EIT Law that was promulgated by the National People’s Congress on March 16, 2007 and amended and newly effective on February 24, 2017, the enterprise income tax rate for both domestic enterprises and foreign-invested enterprises is 25% (except for certain eligible foreign invested enterprises). On December 6, 2007, the State Council promulgated the Regulations on the Implementation of the Enterprise Income Tax Law of the People’s Republic of China, or the EIT Implementation Regulations, which came into force on January 1, 2008.

 

According to the EIT Law and the EIT Implementation Regulations, both resident and non-resident enterprises that earn income within the territory of China are subject to enterprise income tax at the rate of 25%. A non-resident enterprise without a permanent establishment in the PRC or a non-resident enterprise with a permanent establishment in the PRC whose earning income is not connected with such permanent establishment will only be subject to tax on its PRC-sourced income. The income for such enterprise will be taxed at a reduced rate of 10%, subject to the provisions of any applicable tax treaties.

 

According to the EIT Law and the EIT Implementation Regulations, income from equity investment between qualified resident enterprises such as dividends and bonuses, which refers to investment income derived by a resident enterprise from its direct investment in another resident enterprise, is tax-exempt income.

 

Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion on income, a PRC resident enterprise which distributes dividends to its Hong Kong shareholders must pay income tax according to PRC law. However, if the beneficial owner of the dividends is a Hong Kong resident enterprise that directly holds no less than 25% equity interests of the aforesaid enterprise (i.e., the dividend distributor), the distributed dividends may be subject to a reduced tax rate of 5%. If the beneficial owner is a Hong Kong resident enterprise, which directly holds less than 25% equity interests of the aforesaid enterprise, the tax levied will be 10% of the distributed dividends.

 

In addition, pursuant to the Circular of the SAT on Relevant Issues Relating to the implementation of Dividend Clauses in Tax Treaty issued by the SAT on February 20, 2009, all of the following requirements shall be satisfied for a non-PRC tax resident enterprise to be entitled to the benefits of any applicable tax treaty for the dividends received from PRC resident companies: (1) such non-PRC resident enterprise should be a company as provided in the tax treaty; (2) such non-PRC resident enterprise must directly own a specified percentage of the equity interests and voting shares of the PRC resident company; and (3) the capital ratio of the PRC resident company directly owned by such non-PRC resident enterprise must reach a certain specified percentage in the applicable tax treaty at any time within 12 months prior to the receipt of the dividends.

 

Pursuant to the Announcement of the State Administration of Taxation on Promulgating the Administrative Measures for Tax Convention Treatment for Non-resident Taxpayers (Announcement of the State Administration of Taxation [2015] No. 60) which came into effect on November 1, 2015, non-resident taxpayers which satisfy the criteria for entitlement to tax treaty benefits may, at the time of tax declaration or withholding declaration through a withholding agent, enjoy the tax treaty benefits, and be subject to follow-up administration by the tax authorities. Such taxpayers who make their own declaration shall self-assess whether they are entitled to tax treaty benefits, make truthful declaration and submit the relevant reports, statements and materials required by the relevant tax authorities.

 

On February 3, 2015, SAT issued the Announcement of the State Administration of Taxation on Several Issues concerning the Enterprise Income Tax on the Indirect Transfers of Properties by Non-Resident Enterprises, or the SAT Announcement 7. Pursuant to SAT Announcement 7, if a non-resident enterprise, or a transferor, transfers its equity in an offshore enterprise which directly or indirectly owns PRC taxable assets, including ownership interest in PRC resident company, or referred as the Taxable Properties, without a reasonable commercial purpose, such transfer shall be deemed a direct transfer of Taxable Properties. The payer, or the transferee, in the equity transfer shall be the withholding agent, and is thus obligated to withhold and remit enterprise income tax accordingly to the relevant PRC tax authorities. Factors that may be taken into consideration when determining whether there is a “reasonable commercial purpose” include components of the transferred equity, offshore tax situation of the transaction, the economic essence and duration of the offshore structure, trading fungibility and other factors. Specifically, when an equity transfer satisfies all the following requirements, such transaction will be considered an arrangement with “reasonable commercial purpose”:

 

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(i)             Transaction parties’ equity relationship falls into one of the following situations:

 

(1)         Equity transfer or directly or indirectly holds more than 80% of the transferee’s equity;

 

(2)         Equity transferee directly or indirectly holds more than 80% of the transferor’s equity;

 

(3)         A third party directly or indirectly holds more than 80% equity interest in both equity transferor and transferee.

 

If more than 50% (not inclusive) of a non-resident enterprise’s equity directly or indirectly derives from real estate within the PRC, the required equity holding proportions shall be 100% instead of 80%. Indirectly held equity should be calculated as the product of the equity proportion held by each enterprise within the equity holding chain.

 

(ii)   If another indirect transfer transaction, or referred as a “contemplated transaction”, is to be executed after such transaction is consummated, the related PRC income tax burden will be no less than the PRC income tax burden associated with a transaction similar to the contemplated transaction without the consummation of such transaction.

 

(iii)  Equity transferee pays the entire transfer consideration with its own shares or shares of other enterprises controlled by the transferee (excluding shares of listed enterprise).

 

VAT

 

According to the Circular on Printing and Distributing the Pilot Proposals for the Collection of Value-Added Tax in Lieu of Business Tax (CaiShui [2011] No. 110) promulgated by SAT and the Ministry of Finance on November 16, 2011 and the Circular on Comprehensively Promoting the Pilot Program of the Collection of Value-added Tax in Lieu of Business Tax (CaiShui [2016] No. 36), which was promulgated on March 23, 2016 and became effective from  May 1, 2016, entities and individuals that sell services, intangible assets or immovable properties within the territory of the PRC shall pay VAT instead of business tax.

 

According to the Interim Regulations of the People’s Republic of China on Value Added Tax that was latest amended by the State Council and came into force on November 19, 2017, the Rules for Implementation of the Interim Regulations of the People’s Republic of China on Value Added Tax that was amended by the Ministry of Finance on October 28, 2011 and came into force on November 1, 2011, and recent tax reforms, entities and individuals that engage in the sale of commodities, provision of processing, repair and replacement services or tangible movable property leasing services or tangible movable property leasing services and import of goods within the PRC are subject to VAT at the rate of 16%, or 10% for taxpayers selling transportation, postal, basic telecommunications, construction, or immovable leasing services, selling immovable, transferring the rights to use land, and selling or importing certain kinds of specific commodities, or 6% for taxpayers selling services or intangible assets, except as otherwise specified before.

 

Preferential Tax Treatment for Software Enterprise

 

According to the Circular of the State Council on Printing and Issuing the Policies for Encouraging the Development of the Software Industry and the Integrated Circuit Industry (GuoFa [2000] No. 18) promulgated by the State Council on June 24, 2000, eligible software enterprises shall enjoy preferential treatments in tax, investment and financing, research and development input, import and export and other relevant aspects.

 

On January 28, 2011, the State Council promulgated the Circular of the State Council on Printing and Issuing the Policies for Further Encouraging the Development of the Software Industry and the Integrated Circuit Industry (GuoFa [2011] No. 4), specifying that qualified software enterprises shall be exempt from business tax.

 

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On October 13, 2011, the Ministry of Finance and the SAT promulgated the Circular on the Policies for Value Added Tax of Software Products (CaiShui [2011] No. 100), specifying that if a general VAT taxpayer sells self-developed and self-produced software products, the refund-upon-collection policy shall be applied to the portion of actual VAT burden in excess of 3% after VAT has been collected at a tax rate of 16%.

 

The Ministry of Finance and the SAT promulgated the Circular on the Enterprise Income Policies for Further Encouraging the Development of the Software Industry and the Integrated Circuit Industry (CaiShui [2012] No. 27), or the Circular 27, on April 20, 2012. According to Circular 27, an eligible software enterprise shall, upon recognition, be exempted from the enterprise income tax for the first two years and pay the enterprise income tax at a reduced rate of half of the statutory rate of 25% from the third year to the fifth year until expiry of the preferential period.

 

As of the date of this annual report, three of our PRC subsidiaries enjoy the preferential income tax treatment as follows: (i) Yin Sai, was granted the “High-tech Enterprises” qualification extension in 2019 which retroactively entitles Yin Sai to a preferential tax rate of 15% from 2018 to 2020; (ii) Yin He You, received the “certified software enterprise” and “certified software products” qualifications in April 2016 and April 2015, respectively and is eligible for an income tax exemption for the first two years from the year in which it starts making profit and is entitled to a 50% reduction of income tax for the third year to the fifth year, rendering its actual income tax rate 0% in 2015 and 2016 and 12.5% from 2017 to 2019; and (3) Gold Master Technology, received the “certified software enterprise” and “certified software products” qualifications in December 2016 and October 2016, respectively and is eligible for an income tax exemption for the first two years from the year in which it starts making profit and is entitled to a 50% reduction of income tax for the third year to the fifth year, rendering its actual income tax rate 0% in 2016 and 2017 and 12.5% from 2018 to 2020.

 

C.            ORGANIZATIONAL STRUCTURE

 

The following diagram illustrates our corporate structure, including our major subsidiaries and VIE Entities as of March 31, 2019.

 

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D.            PROPERTY, PLANT AND EQUIPMENT

 

Our principal executive offices are located on leased premises comprising approximately 25,415 square meters in Shanghai, China. In addition to Shanghai, we also have leased properties principally used as office premises for our operations in Beijing, Guangzhou, Shenzhen, Hong Kong and Boston, totaling approximately 6,709 square meters. We lease our premises from unrelated third parties under operating lease agreements. The lease for our principal executive offices will expire in 2019. We believe that we will be able to obtain adequate facilities, principally through leasing, to accommodate our future expansion plans.

 

Item 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

Item 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following discussion of our financial condition and results of operations is based upon, and should be read in conjunction with, our audited consolidated financial statements and the related notes included in this annual report on Form 20-F. This report contains forward-looking statements. See “Forward-Looking Information.” In evaluating our business, you should carefully consider the information provided under the caption “Item 3. Key Information—D. Risk Factors” in this annual report on Form 20-F. We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.

 

A.                                    OPERATING RESULTS

 

Key Components of Results of Operations

 

Revenue

 

Our revenues consist of net commissions and fees, net trading gains and losses, interest and investment income and other revenues.

 

Net Commissions and Fees

 

Net Commissions and fees are the largest component of our revenues and represent 93.7%, 89.8% and 86.0% of our total revenues for the years ended December 31, 2016, 2017 and 2018, respectively. The components of our net commissions and fees are set out below.

 

Commodities services: Commodities services segment comprises of commissions and fees earned from customer trading of spot and futures commodities contracts.

 

Securities services: Securities services segment comprises of commissions and fees earned from providing securities advisory and information platform services, overseas securities brokerage services and asset management services.

 

Our net commissions and fees largely depend on our customers’ trading volume, which is the aggregate notional value of their transactions. Our customers’ trading volume is directly influenced by individual investors’ demand for trading of commodities and securities, which is affected by the general social, economic and market conditions, as well as individual investors’ preferences on investment products. In addition, customers’ trading activities are to some extent influenced by the trading price volatility of the relevant financial products. The periods of increased fluctuations of trading prices of relevant financial product often coincide with higher levels of trading volumes by our customers.

 

Our net commissions and fees are also affected by the fee rate we charge our customers for our commodities, overseas brokerage services and our asset management business. A higher fee rate would generate more net commissions and fees for us. Our fee rate is primarily influenced by the standard fee rates stipulated by the exchanges we operate on, as well as the rebates we offer to our customers.

 

In addition, we offer a verity of on-line investment courses lectured by talented and experienced securities advisors and licensed practitioners. The tuition fees we generate from those on-line courses are closely affected by the quality of the courses we offer and the overall performance of the relevant capital market, as well as general economic conditions. In good years, investors tend to trade more actively and invest more in subscribing courses. Conversely, tuition income will probably be negatively impacted in bad years because investors tend to be much more cautious with investments.

 

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The following table sets forth our customer trading volume, active accounts, net commissions and fees and effective fee rate for the periods indicated.

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

(except active accounts and effective fee rate)

 

(unaudited)

 

Customer trading volume (in millions)

 

 

 

 

 

 

 

 

 

Commodities services

 

2,978,329

 

3,841,069

 

1,717,493

 

249,799

 

Securities services

 

 

 

13,190

 

1,918

 

Total

 

2,978,329

 

3,841,069

 

1,730,683

 

251,717

 

Commissions and fees, net (in thousands)

 

 

 

 

 

 

 

 

 

Commodities services

 

2,547,043

 

2,177,871

 

604,375

 

87,903

 

Securities services

 

 

20,704

 

337,493

 

49,086

 

Total

 

2,547,043

 

2,198,575

 

941,868

 

136,989

 

Active Accounts

 

73,078

 

121,410

 

40,240

 

Average effective fee rate(1) 

 

0.086%

 

0.057%

 

0.035%

 

 


(1)         Represents the net commissions and fees from commodities services as a percentage of the total customer trading volume.

 

Net Trading Gains/Losses

 

We recorded net trading gains, representing 0.5%, 1.7% and 3.1% of our revenues for the years ended December 31, 2016, 2017 and 2018. The following table sets forth the breakdown of our net trading gains for the periods indicated:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

(in thousands)

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Spot commodity contracts

 

296,809

 

(133,116

)

 

 

Risk and return transfer arrangement

 

(296,678

)

134,678

 

 

 

Commodity futures contracts

 

(1,780

)

753

 

 

 

Trading of physical commodities

 

2,840

 

(152

)

 

 

Income from short-term investments

 

11,372

 

38,391

 

34,103

 

4,961

 

Income from equity method investment

 

 

 

230

 

33

 

Total

 

12,563

 

40,554

 

34,333

 

4,994

 

 

Trading gains / (losses) consist of realized and unrealized gains and losses from exchange-traded spot commodity contracts, commodity futures contracts and risk and return transfer agreements, the realized gains from trading of physical commodities, realized and unrealized gains from equity securities investments pursuant to the adoption of ASU 2016-01, and realized gains and losses from the sale of AFS investments prior to the adoption of ASU 2016-01, all presented on a net basis. Changes in fair value in relation to spot commodity contracts, commodity futures contracts and risk and return transfer agreements are recorded in trading gains / (losses), net on a daily basis as disclosed in the accounting policy of derivative financial instruments. Trading gains / (losses) on physical commodities are recognized when title passes and measured by the difference between the acquisition cost of the commodity and the cash received or receivable.

 

Pursuant to the risk and return transfer agreements, our gains/losses arising from exchange-traded spot commodity contracts with customers were transferred to, and absorbed by the third party fund during the contract periods. Fair value movements on the risk and reward transfer agreement were recognized as trading gains/losses. Settlements were made on a monthly basis.

 

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Interest and Investment Income

 

Our interest and investment income consists of interest income from our cash deposits and available-for-sale investments, most of which are money market funds.

 

Other Revenues

 

Our other revenues include gain on disposal of subsidiaries, VAT refund, revenue from sales of application services and sales of silver products, awards from the exchanges, government grants and others. The following table sets forth the breakdown of other revenues for the periods indicated:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

(in thousands)

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Gain on disposal of subsidiaries

 

 

87,217

 

5,754

 

837

 

VAT refund

 

45,313

 

33,523

 

4,635

 

674

 

Sales of silver products

 

4,973

 

13,546

 

15

 

2

 

Sales of application services

 

28

 

6,475

 

55,513

 

8,074

 

Government grants and others

 

14,728

 

63,650

 

34,498

 

5,018

 

Awards from the exchanges

 

90,528

 

 

 

 

Total

 

155,570

 

204,411

 

100,415

 

14,605

 

 

Government grants and others primarily consist of financial subsidies granted by provincial and local governments. The government grants are non-recurring in nature and there is no assurance that we will continue to receive such government grants in the future.

 

During the year ended December 31, 2016, we recognized awards of RMB90.53 million, from the Exchanges based on customer trading volume of us. Awards from the Exchanges are recognized when there is reasonable assurance that they will be received and amounts can be reasonably estimated. Given the termination of trading in Guangdong and Tianjin Exchange in 2017, there is no award from the exchanges recognized in 2017 and 2018.

 

During the years ended December 31, 2016, 2017 and 2018, we recognized VAT refund of RMB45.31 million, RMB33.52 million and RMB4.64 million (US$0.67 million), respectively, based on the VAT preferential policy issued by the State Administration of Tax. VAT refund is recoginized when there is reasonable assurance that they will be received and amounts can be reasonably estimated. VAT refund is first recorded to offset the corresponding cost recognized by us, any excess refund is recognized in other revenue. The outstanding VAT refund receivable is RMB43.22 million, RMB7.69 million and RMB11.77 million (US$1.71 million) as at December 31, 2016, 2017 and 2018, respectively.

 

During the years ended December 31, 2016, 2017 and 2018, we recognized application service revenue of RMB0.03 million, RMB6.48 million and RMB55.51 million (US$8.07 million), respectively. In 2018, we began to focus on expanding its business operation into software development, which leads to a substantial increase in application service revenue. Such type of revenues are amortized over the prescribed contract period.

 

In 2017, we disposed eight subsidiaries, including Sheng Ding, Da Xiang Ping Tai, Tian Jin Da Xiang, Da Xiang Shun Yi, Rong Jin Hui Yin, Jin Xiang Yin Rui, Yin Ru Yi and Yin Tian Xia Products, to third-parties. We realized a disposal gain of RMB87.22 million in total.

 

In 2018, we disposed one subsidiary, Tianxi, to a former management personnel of us. We realized a disposal gain of RMB5.75 million (US$0.84 million). As at December 31, 2018, the outstanding receivables related to this disposal is RMB9.60 million (US$1.40 million).

 

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Expenses

 

The following table sets forth the breakdown of our expenses for the periods indicated:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

(in thousands)

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Commission expense

 

 

 

(2,012

)

(293

)

Employee compensation and benefits

 

(839,024

)

(1,066,553

)

(808,292

)

(117,561

)

Advertising and promotion

 

(554,291

)

(424,865

)

(223,265

)

(32,473

)

Information technology and communications

 

(40,905

)

(41,170

)

(32,421

)

(4,715

)

Occupancy and equipment rental

 

(76,594

)

(123,680

)

(115,810

)

(16,844

)

Taxes and surcharges

 

(30,748

)

(21,080

)

(6,455

)

(939

)

Intangible assets amortization

 

(19,081

)

(56,547

)

(56,515

)

(8,220

)

Impairment of goodwill and intangible assets

 

 

 

(639,000

)

(92,939

)

Other expenses

 

(107,766

)

(78,509

)

(83,334

)

(12,120

)

Total

 

(1,668,409

)

(1,812,404

)

(1,967,104

)

(286,104

)

 

Employee Compensation and Benefits

 

Employee compensation and benefits include (i) salaries, wages, bonuses and other benefits, (ii) training and employee activities expenses, (iii) contributions to defined employee contribution plans, and (iv) share-based compensation expenses for our employees. Employee compensation and benefits represented 30.9%, 43.6% and 73.8% of our revenues for the years ended December 31, 2016, 2017 and 2018, respectively.

 

Advertising and Promotion

 

Our advertising and promotion expenses consist of advertising expenses and sales agent expenses.

 

Our advertising expenses represent expenses for placing advertisements on television, radio and newspaper, as well as on Internet websites, search engines and application stores. Our advertising expenses represented 18.8%, 13.0% and 18.2% of our revenues for the years ended December 31, 2016, 2017 and 2018, respectively.

 

Currently, we work with certain external sales agent companies to develop customers on the SGE and the Futures Commodity Exchanges. Our sales agent expenses represent 1.6%, 4.4% and 2.2% of our revenues for the years ended December 31, 2016, 2017 and 2018, respectively.

 

The following table sets forth the breakdown of our advertising and sales agent expenses for the periods indicated:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

(in thousands)

 

 

 

(unaudited)

 

Advertising expenses

 

510,031

 

317,843

 

199,368

 

28,997

 

Sales agent expenses

 

44,260

 

107,022

 

23,897

 

3,476

 

Total

 

554,291

 

424,865

 

223,265

 

32,473

 

 

Information Technology and Communications

 

Our information technology and communication expenses are primarily related to the expenses we paid for telecommunication network, servers and bandwidth, as well as data center services for hosting our servers.

 

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Occupancy and Equipment Rental

 

Our occupancy and equipment rental fees primarily consists of office rental fees and server rental fees.

 

Taxes and Surcharges

 

Taxes and surcharges consist primarily of business tax and surcharges on business tax and VAT.

 

Impairment of Goodwill and Intangible Assets

 

In 2018, we recognized an impairment loss amounting to RMB639 million which consists of an impairment of goodwill of RMB505 million (US$73.45 million) and an impairment of intangible assets of RMB134 million (US$19.49 million) respectively.

 

Impairment of goodwill: In the fourth quarter of 2018, we tested goodwill for impairment at the reporting unit level. We historically and presently operates with one segment. For the Gold Master reporting unit, we first qualitatively assessed whether it was more likely than not that the fair values of the reporting segments were less than their carrying amounts and concluded that further impairment testing is necessary. We then performed the first step of the two-step impairment testing, where the fair value of the reporting unit of Gold Master was compared with its carrying amount. Gold Master estimated the fair values using the income approach considering factors that included expected future cash flows, growth rates and discount rates. In the fourth quarter of 2018, We recognized a RMB 505 million impairment loss for goodwill relating to the acquisition of Gold Master, primarily due to (i) the operational performance of Gold Master has failed to meet its earnings forecast and the profit outlook being uncertain; (2) less fluctuation on gold price and the deterioration of the macro market environment, based on which management determined that, these conditions had a material adverse impact on Gold Master’s ability to generate revenues and net income from trading commissions. For the other reporting units, management performed qualitative assessments and concluded that it was not more-likely-than-not the fair value of these reporting units were less than its carrying amount, and further impairment testing on goodwill were unnecessary as of December 31, 2018.

 

Impairment of intangible assets: Gold Master’s revenues for 2018 did not meet management’s expectations, which indicated that the carrying value of customer list and trademark that were recognized in the acquisition of Gold Master may not be fully recoverable. As such, we performed an impairment test and recognized RMB 78 million impairment loss on customer list and RMB 56 million impairment loss on trademark related to the acquisition of Gold Master in 2018.

 

Other Expenses

 

Our other expenses consist of other miscellaneous expenses, which include consultant fees, travel and meeting expenses and other expenses.

 

Income Tax

 

Cayman Islands and BVI

 

Under the current laws of the Cayman Islands and BVI, the Group is not subject to tax on income or capital gains. Additionally, upon payments of dividends by Yintech to its shareholders, neither Cayman Islands nor BVI withholding tax will be imposed.

 

Hong Kong

 

Our wholly-owned Hong Kong subsidiaries are subject to Hong Kong profit tax on their activities conducted in Hong Kong. Dividends from our Hong Kong subsidiaries to us are exempt from Hong Kong withholding tax.

 

PRC

 

The subsidiaries incorporated in PRC file separate tax returns in the PRC. The PRC statutory income tax rate is 25% according to the Corporate Income Tax Law (“CIT Law”). Under the CIT Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to dividends payable by a resident enterprise to investors that are non-resident enterprises, to the extent such dividends are derived from sources within the PRC, subject to any reduction set forth in applicable tax treaties. Substantially all the pretax income of us is derived from sources within the PRC.

 

As of the date of this annual report, three of our PRC subsidiaries enjoy the preferential income tax treatment as follows: (i) Yin Sai was granted the “qualified software enterprise” status in 2013 and is eligible and is entitled to a 50 percent reduction of income tax rate for the years ended December 31, 2016 to 2017. Yin Sai was granted the qualification of an “eligible high-tech enterprise” in 2019 which retroactively entitles Yin Sai to a preferential tax rate of 15% for years from January 1, 2018 to December 31,2020; (ii) Yin He You, received the “certified software enterprise” and “certified software products” qualifications in April 2016 and April 2015, respectively and is eligible for an income tax exemption for the first two years from the year in which it starts making profit and is entitled to a 50% reduction of income tax for the third year to the fifth year, rendering its actual income tax rate 0% in 2015 and 2016 and 12.5% from 2017 to 2019; and (iii) Gold Master Technology, received the “certified software enterprise” and “certified software products” qualifications in December 2016 and October 2016, respectively and is eligible for an income tax exemption for the first two years from the year in which it starts making profit and is entitled to a 50% reduction of income tax for the third year to the fifth year, rendering its actual income tax rate 0% in 2016 and 2017 and 12.5% from 2018 to 2020. Our other PRC subsidiaries are subject to an income tax rate of 25%.

 

United States and New Zealand

 

The Company’s subsidiaries incorporated in the United States and New Zealand are subject to income tax charges calculated on the basis of the tax laws enacted.

 

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In addition, the EIT Law treats enterprises established outside of China that have “de facto management bodies” located in China as a PRC resident enterprise for tax purposes. A “de facto management body” is defined as a management body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and treasury, and acquisition and disposition of properties and other assets of an enterprise. We currently do not believe that we or our Hong Kong subsidiaries are PRC resident enterprises but there is no assurance in this regard. If we are considered a “PRC resident enterprise” for PRC tax purposes, we would be subject to the PRC enterprise income tax on our global income. See “Risk Factors—Risks Related to Doing Business in China—We may be deemed to be a PRC resident enterprise under the EIT Law and be subject to PRC tax on our worldwide income, which may significantly increase our income tax expenses and materially decrease our profitability or otherwise adversely affect the value of your investment” and “Risk Factors—Risks Related to Doing Business in China—You may be subject to PRC income tax on dividends from us or on any gain realized on the transfer of our ADSs.”

 

Pursuant to the EIT law and its implementation rules, dividends paid to non-PRC resident enterprise investors that are considered PRC-source are subject to a 10% withholding tax. Under the Arrangement between Mainland China and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion on Income, a qualified Hong Kong tax resident which is determined by the competent PRC tax authority to have satisfied relevant requirements under the Arrangement between Mainland China and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion on Income and other applicable PRC laws is entitled to a reduced withholding tax rate of 5%.

 

Critical Accounting Policies and Estimates

 

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates.

 

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe that the following accounting policies involve a higher degree of judgment and complexity in their application and require us to make significant accounting estimates. The following description of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this annual report.

 

Revenue Recognition

 

On January 1, 2018, we adopted ASC 606 “Revenue from Contracts with Customers” (“ASC 606”) and applied the cumulative effect method. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts were not adjusted and reported under the accounting standards in effect for the periods presented.

 

According to ASC 606, revenues are recognized when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expects to be entitled to in exchange for those goods or services. We determines revenue recognition through the following steps:

 

·                  Identification of the contract, or contracts, with a customer;

·                  Identification of the performance obligation in the contract;

·                  Determination of the transaction price, including the constraint on variable consideration;

·                  Allocation of the transaction price to the performance obligation in the contracts; and

·                  Recognition of revenue when (or as) we satisfies a performance obligation.

 

(i) Commissions and Fees

 

We earn trading commissions, spread fees and overnight fees from operation on Tianjin and Guangdong Exchanges, which are settled on a daily basis. We earn trading commissions from operation on Shanghai Exchange and the Futures Commodity Exchanges, which are settled on a monthly basis. Cash rebates on trading commissions and overnight fees offered by us to its customers are recorded as a reduction of revenue.

 

We earn securities brokerage fees from brokerage service for customers for executing and/or clearing transactions. Securities brokerage fees are recognized on a transactional basis.

 

We earn asset management fees from fund management services. Management fees are computed as a percentage of the fund net asset value, calculated daily. Revenue is recognized on a daily basis over the contract term.

 

We provide securities advisory services, offering various types of training programs to individuals. Such programs normally last for several months. The revenues are recognized during the programs period on a straight-line, time-elapsed basis.

 

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(ii) Trading Gains/Losses

 

Trading gains/(losses) consist of realized and unrealized gains and losses from exchange-traded spot commodity contracts, commodity futures contracts and risk and return transfer agreements, the realized gains from trading of physical commodities, realized and unrealized gains from equity securities investments pursuant to the adoption of ASU 2016-01, and realized gains and losses from the sale of AFS investments prior to the adoption of ASU 2016-01, all presented on a net basis. Changes in fair value in relation to spot commodity contracts, commodity futures contracts and risk and return transfer agreements are recorded in trading gains/(losses), net on a daily basis as disclosed in the accounting policy of derivative financial instruments. Trading gains/(losses) on physical commodities are recognized when title passes and measured by the difference between the acquisition cost of the commodity and the cash received or receivable.

 

(iii) Interest and Investment Income

 

Interest income is recognized at the effective interest rate. Investment income is recognized when earned.

 

(iv) Other Revenues

 

Other revenues primarily consist of gain on disposal of subsidiaries, income from sales of application services, sales of silver products, government grants, awards from the Exchanges and VAT refund.

 

Gain on disposal of subsidiaries are recognized when the substantive control over the subsidiaries are transferred and the disposal consideration is received or there is a reasonable assurance that they will be received.

 

Sales of application services comprise the sales of a license subscription bundled with customer support service during the license period. Revenue from sales of application services are recognized ratably over the term of the arrangement which is generally 1 year. During the period of the arrangement, the customer does not have the contractual right to take possession of the software at any time.

 

Sales of silver products are recognized when goods are delivered at the customers’ premises which are taken to be the point in time when the customer has accepted the goods and the related risks and rewards of ownership. Revenue excludes value added tax.

 

Government grants are recognized when there is reasonable assurance that they will be received and that we will comply with the conditions attaching to them. Grants that compensate us for expenses incurred are deducted in reporting the related expenses on a systematic basis in the same periods in which the expenses are incurred.

 

Awards from the Exchanges and VAT refund are recognized when earned and there is reasonable assurance that they will be received and amounts can be reasonably estimated.

 

Derivative Financial Instrument

 

We recognize all derivative instruments as either assets or liabilities in the balance sheet at their respective fair values.

 

In the normal course of business and as a comprehensive member of the exchanges, we enter into transactions in derivative financial instruments with customers. As a comprehensive member on the Guangdong Precious Metals Exchange, we are required to serve as the counterparty of the customer trading of precious metals through exchange-traded spot commodity contracts. The two exchanges quote trading prices of the spot commodity contracts with reference to the prices from relevant international and domestic spot commodities markets. We do not apply hedge accounting, as all derivative financial instruments are held for trading purposes and therefore recorded at fair value with changes reflected in earnings. Contracts with customers are traded either as long or short positions and the notional amount and fair values of the contracts in a loss position are not offset against notional amount and the fair value of contracts in a gain position. Gains and losses (realized and unrealized) on all derivative financial instruments are shown as a component of trading gains/losses), net.

 

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In accordance with the exchanges’ requirements, our customers must meet, at a minimum, the deposit requirements established by the exchanges at which the spot commodity contracts are traded. Therefore, exchange traded spot commodity contracts generally do not give rise to significant counterparty exposure due to the cash settlement procedures for daily market movements, or the variation margin, and the deposit requirements of the exchanges. The variation margin payments represent the daily settlement of the outstanding exposure of the derivative contract. Likewise, as the counterparty to the customer trades, we are also required to place deposits with custodian banks of the exchanges to meet the minimum deposit requirements. Such amount placed at banks to meet the deposit requirements is included in deposits with clearing organizations and restricted from withdrawal.

 

In 2016 and 2017, we traded commodity futures contracts on the Shanghai Futures Exchange to manage its exposure on spot commodity contracts and physical trading of raw silver. Commodity futures contracts are recorded at fair value with changes reflected in earnings. Gains and losses from these contracts are recorded in trading gains / (losses), net. At the end of December 31, 2017 and 2018, we have no commodity futures contracts outstanding.

 

In 2015, we entered into risk and return transfer agreements with a third party fund. Gains and losses from the risk and return transfer agreements are recorded in trading gains / (losses), net.

 

In 2016, under the New Mechanism of Tianjin Exchange, we only take the broker role in customer deals and does not take positions any more. As a result, we started to only earn trading commissions in Tianjin Exchange. By December 31, 2016, the New Mechanism has fully replaced the old mechanism and no trading gains / (losses) from Tianjin Exchange will be recorded from then on.

 

In 2017, with the termination of trading on the Guangdong and the suspension of trading on the Tianjin Exchange, there will be no more gains or losses arising from spot commodity contracts or the risk and return transfer agreements.

 

Goodwill and Intangible Assets

 

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. Indefinite-lived intangible assets are assets that are not amortized as there is no foreseeable limit to cash flows generated from them. Intangible assets with finite useful lives are amortized over their estimated useful lives in the method that reflect the pattern in which the economic benefits of the intangible assets are consumed.

 

Impairment of Goodwill

 

We assess goodwill for impairment at the reporting unit level at least annually and more frequently upon the occurrence of certain events.

 

We have the option to assess qualitative factors first to determine whether it is necessary to perform the two-step test. If we believe, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of the reporting unit is less than its carrying amount, the two-step quantitative impairment test described above is required. Otherwise, no further testing is required. In the qualitative assessment, we consider primary factors such as industry and market considerations, overall financial performance of the reporting unit, and other specific information related to the operations. In performing the two-step quantitative impairment test, the first step compares the carrying amount of the reporting unit to the fair value of the reporting unit based on either quoted market prices of the ordinary shares or estimated fair value using a combination of the income approach and the market approach. If the fair value of the reporting unit exceeds the carrying value of the reporting unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. The fair value of the reporting unit is allocated to its assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the reporting unit goodwill. If the carrying amount of the goodwill is greater than its implied fair value, the excess is recognized as an impairment loss.

 

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Treasury Stock

 

Our accounts for treasury stock using the cost method. Under this method, the cost incurred to purchase the shares is recorded in the treasury stock account on the consolidated balance sheets. At retirement, the ordinary shares account is charged only for the aggregate par value of the shares. The excess of the acquisition cost of treasury stocks over the aggregate par value is allocated between additional paid-in capital (up to the amount credited to the additional paid-in capital upon original issuance of the shares) and retained earnings.

 

Income Tax

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided to reduce the carrying amount of deferred tax assets to the amount considered more likely than not to be realized. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50 percent likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We present any interest or penalties related to an underpayment of income taxes as part of its income tax expense

 

Share-based Compensation

 

Win Yin Financial granted stock options and restricted share units on its shares to its employees pursuant to its 2013 Share Option Scheme, 2014 Share Option Scheme and Pre-IPO Restricted Share Unit Scheme, or the Share Incentive Plans. Pursuant to our reorganization completed on November 18, 2015, our Company became the holding company of us and the majority of the operating PRC subsidiaries under Win Yin Financial became our wholly-owned PRC subsidiaries. In connection with the reorganization, we assumed the Share Incentive Plans from Win Yin Financial and adopted the Share Incentive Plans. We issued stock options and RSUs to our employees to replace the stock options and RSUs issued by Win Yin Financial. The terms and conditions of the stock options and RSUs with respect to vesting and exercisability remain the same.

 

We apply ASC 718 to account for our employee share-based payments. In accordance with ASC 718, we determine whether an award should be classified and accounted for as a liability award or equity award. All grants of share-based awards to employees classified as equity awards are recognized in the financial statements based on their fair value on the grant dates. We have elected to recognize compensation expense using a straight-line method for all employee equity awards granted with graded vesting based on service conditions provided that the amount of compensation cost recognized at any date is at least equal to the portion of the grant-date value of the equity awards that are vested at that date. To the extent the required vesting conditions are not met resulting in the forfeiture of the share-based awards, previously recognized compensation expense relating to those awards are reversed. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent period if actual forfeitures differ from initial estimates.

 

Forfeiture rates are estimated based on historical and future expectations of employee turnover rates and are adjusted to reflect future changes in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those share-based awards that are expected to vest. To the extent we revise these estimates in the future, the share-based payments could be materially impacted in the period of revision, as well as in following periods. We, with the assistance of an independent third party valuation firm, determined the fair value of the stock options and RSUs granted to employees.

 

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The fair value of options and RSUs granted to employees and nonemployees is determined based on a number of factors including valuations. In determining the fair value of our equity instruments, we referred to valuation reports prepared by an independent third-party appraisal firm, based on data we provided. The valuation reports provided us with guidelines in determining the fair value of the equity instruments, but we are ultimately responsible for the determination of all amounts related to share-based compensation recorded in the financial statements.

 

The binomial option pricing model was applied in determining the estimated fair value of the options granted to employees. The Black-Scholes option pricing model was applied in determining the estimated fair value of the RSUs granted to employees. A change in any of the terms or conditions of the stock options or RS Us is accounted for as a modification of the plan. Incremental compensation cost is measured as the excess, if any, of the fair value of the modified option over the fair value of the original option or RSU immediately before its terms are modified, measured based on the fair value of the ordinary shares and other pertinent factors at the modification date. For vested stock options or RSUs, we recognize incremental compensation cost in the period the modification occurs. For unvested stock options or RSUs, we recognize over the remaining requisite service period, the sum of the incremental compensation cost and the remaining unrecognized compensation cost for the original award on the modification date. If the fair value of the modified option or RSU is lower than the fair value of the original option or RSU immediately before modification, the minimum compensation cost we recognize is the cost of the original award.

 

The following table presents the assumptions used to estimate the fair values of the share options and RSUs granted in the periods presented:

 

 

 

2016

 

2017

 

2018

 

Expected volatility

 

48.44%

 

47.23%

 

48.19%

 

Option life

 

5.97-8.00

 

5.64-9.32

 

5.53-6.53

 

Expected dividends

 

0-1.8%

 

4.3%

 

4.27%

 

Risk-free interest rate

 

1.43%-1.94%

 

1.78%-2.10%

 

2.81%-2.85%

 

 

If any of the assumptions used in the binomial option pricing model or Black-Scholes option pricing model changes significantly, share-based compensation expense for future awards may differ materially compared with the awards granted previously.

 

The following table sets forth the options and RSUs granted under the share option plans from 2013 to the date of March 31, 2019.

 

 

 

Type of Awards

 

Underlying
Ordinary Shares
of Awards

 

Exercise Price

 

Fair Value of
Underlying
Ordinary Shares

 

 

 

 

 

 

 

US$

 

US$

 

Grant Date

 

 

 

 

 

 

 

 

 

December 3, 2013

 

Options

 

36,771,900

 

0.163

 

0.106

 

December 15, 2014

 

Options

 

46,524,100

 

0.163

 

0.325

 

January 15, 2015

 

RSUs

 

12,665,000

 

 

0.325

 

January 13, 2016

 

Options

 

13,741,271

 

0.163

 

0.406

 

January 13, 2016

 

RSUs

 

4,075,435

 

 

0.406

 

April 27, 2016

 

Options

 

50,000,000

 

0.500

 

0.675

 

November 16, 2016

 

RSUs

 

27,937,360

 

 

0.820

 

June 29, 2017

 

RSUs

 

2,962,740

 

 

0.483

 

September 6, 2017, Batch 1

 

Options

 

8,000,000

 

0.500

 

0.157

 

September 6, 2017, Batch 2

 

Options

 

2,000,000

 

0.500

 

0.168

 

December 5, 2017, Batch 1

 

RSUs

 

27,358,720

 

 

0.359

 

December 5, 2017, Batch 2

 

RSUs

 

7,556,240

 

 

0.379

 

June 21, 2018, Batch 1

 

Options

 

1,800,000

 

0.500

 

0.010

 

August 8, 2018

 

RSUs

 

323,580

 

 

0.369

 

November 2, 2018

 

RSUs

 

140,000

 

 

0.314

 

January 1, 2019

 

RSUs

 

2,618,380

 

 

0.296

 

March 1, 2019

 

RSUs

 

6,380,400

 

 

0.327

 

March 18, 2019

 

RSUs

 

144,000

 

 

0.304

 

 

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Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (‘‘FASB’’) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which outlines a comprehensive new revenue recognition model designed to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14 to defer the effective date to annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017. We adopted ASC 606 beginning January 1, 2018 and assessed its contracts with customers under the new standard. Results for reporting periods prior to January 1, 2018 were not adjusted and are presented in accordance with the accounting standards in effect for those periods. The adoption of ASC 606 had no material impact on the consolidated financial statements, and there was no adjustment to beginning retained earnings on January 1, 2018.

 

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). The main objective of this update is to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. ASU 2016-01 changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. The guidance also changes certain disclosure requirements and other aspects of current U.S. GAAP. Further, in March 2018, the FASB issued “Technical Corrections and Improvements to Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which provides further guidance on adjustments for observable transaction for equity securities without a readily determinable fair value and clarification on fair value option for liabilities instruments. ASU 2016-01 is effective for annual reporting periods, and interim periods within those years beginning after December 15, 2017. Early adoption by public entities is permitted only for certain provisions. We have adopted ASU 2016-01 with a cumulative effect adjustment recorded to opening retained earnings for all existing outstanding instruments on January 1, 2018. The unrealized losses, net of tax, on the equity securities of RMB 800 thousands were reclassified from accumulated other comprehensive income to retained earnings as of January 1, 2018.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize most leases on the balance sheet. This ASU requires lessees to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Lessees are permitted to make an accounting policy election to not recognize the asset and liability for leases with a term of twelve months or less. The ASU does not significantly change the lessees’ recognition, measurement and presentation of expenses and cash flows from the previous accounting standard. Lessors’ accounting under the ASC is largely unchanged from the previous accounting standard. In addition, the ASU expands the disclosure requirements of lease arrangements. Lessees and lessors will use a modified retrospective transition approach, which includes a number of practical expedients. In July 2018, the FASB issued ASU 2018-11, which provides another transition method in addition to the existing transition method by allowing entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption consistent with preparers’ requests. The amendments in this Update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for public entities. We will adopt this new guidance for the year ended December 31, 2019 and interim periods in the year ended December 31, 2019. We estimates approximately RMB 104.7 million would be recognized as total right-of-use assets and total lease liabilities on our consolidated balance sheet as of January 1, 2019. Other than disclosed, we do not expect the new standard to have a material impact on its remaining consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This ASU requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This ASU eliminates the probable initial recognition threshold in current principal and, instead, reflects an entity’s current estimate of all expected credit losses. The amendments in this ASU are effective for us for our fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We will apply the adoption through a cumulative-effect adjustment to opening retained earnings as at the beginning of the first reporting period in which the ASU 2016-13 is effective. We are in the process of evaluating the impact of ASU 2016-13 on the consolidated financial statements.

 

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In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” (“ASU 2016-16”). This ASU requires the recognition of the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, which consequently eliminates the exception for an intra-entity transfer of an asset other than inventory to the recognition of current and deferred income taxes. Deferred tax assets recognized as a result of this ASU shall be assessed for realizability. This ASU should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. ASU 2016-16 is effective for public companies for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. We have adopted ASU 2016-16 on January 1, 2018 and the adoption had no material impact on the retained earnings as of January 1, 2018. The adoption of ASU 2016-16 has resulted in a decrease in net income of RMB 13.9 million for the year end December 31, 2018.

 

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows: Restricted Cash” (“ASU 2016-18”). This ASU affects all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows under Topic 230. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This update will become effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, and early adoption is permitted in any interim or annual period. We adopted ASU 2016-18 retrospectively on January 1, 2018, and as a result, the consolidated statements of cash flows now present restricted cash in the beginning and ending balances of cash and restricted cash.

 

In January 2017, the FASB issued No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”), which is effective for the annual reporting period beginning after December 15, 2017, and interim period within that period. This update clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of business. We have adopted ASU 2017-01 and the adoption had no material impact on the consolidated financial statements.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which requires an entity to no longer perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, impairment will be measured using the difference between the carrying amount and the fair value of the reporting unit. The changes are effective for public business entities that are SEC filers, for annual and interim periods in fiscal years beginning after December 15, 2019. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, “Compensation — Stock Compensation (Topic 708) Scope of Modification Accounting”(“ASU 2017-09”) which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. Adoption of the Standard is required for annual and interim periods beginning after December 15, 2017 with the amendments in the update applied prospectively to an award modified on or after the adoption date. We have adopted ASU 2017-09 in the current year and the adoption had no material impact on the consolidated financial statements.

 

In June 2018, the FASB issued ASU No. 2018-07, “Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting” (“ASU 2018-07”), to simplify the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. Under the guidance, the measurement of equity-classified nonemployee awards will be fixed at the grant date, which may lower their cost and reduce volatility in the income statement. The guidance is effective for public business entities in annual periods beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted, including in an interim period. We have evaluated the impact of this new standard and expected no material effect on the consolidated financial statements.

 

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”), which eliminates, adds and modifies certain disclosure requirements for fair value measurement. Under the guidance, public companies will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The guidance is effective for all entities for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years, but entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. We are in the process of evaluating the impact of ASU 2018-13 on the consolidated financial statements.

 

In November 2018, the FASB issued ASU 2018-18,“Collaborative Arrangements (Topic 808), which clarifies the interaction between Topic 808 and Topic 606 by (1) clarifying that certain transactions between collaborative arrangement participants should be accounted for under Topic 606, (2) adding unit-of-account guidance in Topic 808 to align with the guidance in Topic 606, and (3) clarifying presentation guidance for transactions with a collaborative arrangement participant that are not accounted for under Topic 606. The guidance is effective for all entities for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years. Early adoption is permitted, including in an interim period. We are in the process of evaluating the impact of ASU 2018-18 on the consolidated financial statements.

 

In addition to those described above, the FASB has issued other accounting standards, none of which are expected to have a material impact on the our consolidated financial statements when adopted.

 

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Results of Operations

 

The following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report. Our limited operating history makes it difficult to predict our future operating results. We believe that the period-to-period comparison of operating results should not be relied upon as being indicative of our future performance.

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

 

 

(unaudited)

 

 

 

(in thousands, except per share data)

 

Revenues

 

 

 

 

 

 

 

 

 

Commissions and fees, net

 

2,547,043

 

2,198,575

 

941,868

 

136,989

 

Trading gains/(losses), net

 

12,563

 

40,554

 

34,333

 

4,994

 

Interest and investment income

 

4,365

 

5,406

 

18,128

 

2,637

 

Other revenues

 

155,570

 

204,411

 

100,415

 

14,605

 

Total revenues

 

2,719,541

 

2,448,946

 

1,094,744

 

159,225

 

Expenses

 

 

 

 

 

 

 

 

 

Commission expense

 

 

 

(2,012

)

(293

)

Employee compensation and benefits

 

(839,024

)

(1,066,553

)

(808,292

)

(117,561

)

Advertising and promotion

 

(554,291

)

(424,865

)

(223,265

)

(32,473

)

Information technology and communications

 

(40,905

)

(41,170

)

(32,421

)

(4,715

)

Occupancy and equipment rental

 

(76,594

)

(123,680

)

(115,810

)

(16,844

)

Taxes and surcharges

 

(30,748

)

(21,080

)

(6,455

)

(939

)

Intangible assets amortization

 

(19,081

)

(56,547

)

(56,515

)

(8,220

)

Impairment of goodwill and intangible assets

 

 

 

(639,000

)

(92,939

)

Other expenses

 

(107,766

)

(78,509

)

(83,334

)

(12,120

)

Total expenses

 

(1,668,409

)

(1,812,404

)

(1,967,104

)

(286,104

)

Income/(loss) before income taxes

 

1,051,132

 

636,542

 

(872,360

)

(126,879

)

Income tax expense

 

(125,430

)

(169,556

)

(1,028

)

(150

)

Net income/(loss)

 

925,702

 

466,986

 

(873,388

)

(127,029

)

Less: Net loss attributable to non-controlling interests

 

(4,966

)

(13,678

)

(10,350

)

(1,505

)

Net income/(loss) attributable to Yintech

 

930,668

 

480,664

 

(863,038

)

(125,524

)

Earnings/(loss) per share

 

 

 

 

 

 

 

 

 

Basic

 

0.79

 

0.34

 

(0.60

)

(0.09

)

Diluted

 

0.75

 

0.33

 

(0.60

)

(0.09

)

Other comprehensive income/(loss)

 

 

 

 

 

 

 

 

 

Unrealized gains/(Loss) on available-for-sale investments, net of tax

 

 

(800

)

 

 

Foreign currency translation adjustment

 

42,696

 

(18,714

)

22,538

 

3,279

 

Comprehensive income/(loss)

 

968,398

 

447,472

 

(850,850

)

(123,750

)

Comprehensive loss attributable to non-controlling interests

 

(4,966

)

(13,678

)

(10,350

)

(1,505

)

Comprehensive income/(loss) attributable to Yintech

 

973,364

 

461,150

 

(840,500

)

(122,245

)

 

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Revenues

 

Our revenues decreased by 55.3% from RMB2,448.9 million in 2017 to RMB1,094.7 million (US$159.2 million) in 2018, primarily due to a decrease in our net commissions and fees.

 

Net Commissions and Fees

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

RMB

 

RMB

 

RMB

 

US$