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SOHU » Topics » Risks Related to Chinas Regulation Environment

This excerpt taken from the SOHU 10-K filed Feb 26, 2009.

Risks Related to China’s Regulation Environment

STYLE="margin-top:6px;margin-bottom:0px">If our current ownership structure is found to be in violation of current or future PRC laws, rules or regulations regarding the legality of foreign investment in
the PRC Internet sector, we could be subject to severe penalties.

We conduct our Internet and value-added telecommunication operations solely in
the PRC through our indirect wholly owned subsidiaries, Sohu Era, Sohu Media, Sohu Software, Sogou Technology, Go2Map Software, AmazGame and New Software (or collectively PRC subsidiaries), and VIEs, High Century, Sohu Entertainment, Sohu Internet,
GoodFeel, Beijing Fire Fox, Tu Xing Tian Xia, Feng Yang Tian Lang, Sogou Information, 21 East Beijing, Gamease and New 21 East. We are a Delaware corporation, while Sohu Hong Kong, our indirect wholly owned subsidiary and the parent company of, Sohu
Era, Sohu Media and Sohu Software, and Changyou.com (Hong Kong) Limited, our indirect wholly owned subsidiary and the parent company of AmazGame, are both Hong Kong corporations and foreign persons under PRC law. In order to meet ownership
requirements under PRC law which restrict or prohibit wholly foreign owned enterprises, or WFOEs, from operating in certain industries such as Internet information, wireless, Internet access, and certain other industries, our VIEs are companies
incorporated in the PRC and owned by certain of our employees.

The PRC began several years ago to regulate its Internet sector by making pronouncements or
enacting regulations regarding the legality of foreign investment in the PRC Internet sector and the existence and enforcement of content restrictions on the Internet. We believe that our current ownership structure complies with all existing PRC
laws, rules and regulations. There are, however, substantial uncertainties regarding the interpretation of current PRC Internet laws and regulations. The PRC government may issue new interpretations of the regulations regarding supervision of the
Information industry from time to time. In July 2006, the MIIT issued a notice to strengthen management of foreign investment in and operation of value-added telecommunication services. The notice emphasizes that foreign investors who wish to engage
in value-added telecommunication services must strictly follow the relevant rules and regulations on foreign investment in telecommunication sectors. The notice also prohibits domestic telecommunication services providers from leasing, transferring
or selling telecommunications business operating licenses to any foreign investor in any form, or providing any resources, sites or facilities to any foreign investor for their illegal operation of a

 


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telecommunications business in China. According to the notice, either the holder of a value-added telecommunication service license or its shareholders must
directly own the domain names and trademarks used by such license holders in their provision of Value-added Telecommunication Services. The notice further requires each license holder to have the necessary facilities, including servers, for its
approved business operations and to maintain such facilities in the regions covered by its license. Value-added services license holders are required to evaluate the compliance with the requirements set forth in the notice. We are in the process of
transferring several of our domain names and trademarks to Sohu Internet, which licensed the same to Sohu Era and Sohu Media, and we may modify other certain aspects of our business structure in order to further comply with these requirements. In
addition, new PRC Internet and foreign exchange laws and regulations were recently adopted. Accordingly, it is possible that the PRC government may ultimately take a view contrary to ours.

STYLE="margin-top:12px;margin-bottom:0px">In addition, under the agreement reached in November 1999 between the PRC and the United States concerning the United States’ support of China’s entry into the
World Trade Organization (or WTO), regulation of foreign investment in PRC Internet services is to be liberalized to allow for 30% foreign ownership in key telecommunication services, including PRC Internet ventures, for the first year after
China’s entry into the WTO, 49% in the second year and 50% thereafter. China officially entered the WTO on December 11, 2001. However, the implementation of China’s WTO accession agreements is still subject to various conditions.

Accordingly, it is possible that the relevant PRC authorities could, at any time, assert that any portion or all of the Sohu PRC subsidiaries’ and
Sohu VIEs’ existing or future ownership structure and businesses violate existing or future PRC laws, regulations or policies. It is also possible that the new laws or regulations governing the PRC Internet sector that have been adopted or may
be adopted in the future will prohibit or restrict foreign investment in, or other aspects of, any of our PRC subsidiaries’ and VIEs’ current or proposed businesses and operations. In addition, any such new laws and regulations may be
retroactively applied to us and our PRC subsidiaries and VIEs.

If we or any of our PRC subsidiaries and VIEs were found to be in violation of any existing
or future PRC laws or regulations, the relevant PRC authorities would have broad discretion in dealing with such violations, including, without limitation, the following:

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levying fines;

 







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confiscating our income;

 







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revoking our licenses;

 







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shutting down our servers and/or blocking our Websites;

 







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requiring us to restructure our ownership structure or operations; and

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requiring us to discontinue any portion or all of its Internet and value-added telecommunication businesses.

STYLE="margin-top:12px;margin-bottom:0px">We may be unable to collect long-term loans to officers and employees or exercise management influence associated with High Century, Sohu Entertainment, GoodFeel,
Sogou Information and Gamease.

As of December 31, 2008, Sohu had outstanding long-term loans of $11.9 million to Dr. Zhang, Sohu’s
Chief Executive Officer and a major Sohu shareholder, and certain of our employees, such as Tao Wang, the head of our online game business. The long-term loans are used to finance investments in High Century, which is owned 80% by Dr. Zhang and
20% by an employee; Sohu Entertainment, which is owned by two of our employees; GoodFeel, which is owned by two of our employees; Sogou Information, which is owned by two of our employees, and Gamease, which is owned by Tao Wang and one of our other
employees. High Century, Sohu Entertainment, GoodFeel, Sogou Information and Gamease are used to facilitate our participation in telecommunications, Internet content and certain other businesses in China where foreign ownership is either prohibited
or restricted.

The loan agreements contain provisions that, subject to PRC laws, (i) the loans can only be repaid to us by transferring the shares of
High Century, Sohu Entertainment, GoodFeel, Sogou Information or Gamease to us; (ii) the shares of High Century, Sohu Entertainment, GoodFeel, Sogou Information or Gamease cannot be transferred without our approval; and (iii) we have the
right to appoint all directors and senior management personnel of High Century, Sohu Entertainment, GoodFeel, Sogou Information and Gamease. In the loan agreements the borrowers have pledged all of their shares in High Century, Sohu Entertainment,
GoodFeel, Sogou Information and Gamease as collateral for the loans and the loans bear no interest and are due on demand after November 2003 in the case of High Century; after August 2006 in the case of Sogou Information; after October 2006 in the
case of GoodFeel; after November 2006 in the case of Sohu Entertainment; and after September 2008 in the case of Gamease and the earlier of a demand or, in any case, at such time as Dr. Zhang or the other employee borrowers, as the case
may be, is not an employee of Sohu. Sohu does not intend to request repayment of the loans as long as PRC regulations prohibit it from directly investing in businesses being undertaken by the VIEs.

STYLE="margin-top:12px;margin-bottom:0px">Because these loans can only be repaid by the borrowers’ transferring the shares of the various entities, our ability to ultimately realize the effective return of
the amounts advanced under these loans will depend on the profitability of High Century, Sohu Entertainment, GoodFeel, Sogou Information and Gamease is uncertain.

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Furthermore, because of uncertainties associated with the PRC law, ultimate enforcement of the loan agreements is
uncertain. Accordingly, we may never be able to collect these loans or exercise influence over High Century, Sohu Entertainment, GoodFeel, Sogou Information and Gamease.

FACE="Times New Roman" SIZE="2">We depend upon contractual arrangements with High Century, Sohu Entertainment, Sohu Internet, GoodFeel, Tu Xing Tian Xia, Feng Yang Tian Lang, Sogou Information and Gamease for the success of our business and
these arrangements may not be as effective in providing operational control as direct ownership of these businesses and may be difficult to enforce.

SIZE="2">Because we conduct our Internet operations only in the PRC, and are restricted or prohibited by the PRC government from owning Internet content or telecommunication operations in the PRC, we are dependent on High Century, Sohu
Entertainment, Sohu Internet, GoodFeel, Tu Xing Tian Xia, Feng Yang Tian Lang, Sogou Information and Gamease, in which we have no direct ownership interest, to provide those services through contractual agreements between the parties. These
arrangements may not be as effective in providing control over our Internet content or telecommunications operations as direct ownership of these businesses. For example, some of our subsidiaries and VIEs could fail to take actions required for our
business, such as entering into content development contracts with potential content suppliers or failing to maintain the necessary permit for the content servers. If High Century, Sohu Entertainment, Sohu Internet, GoodFeel, Tu Xing Tian Xia, Feng
Yang Tian Lang, Sogou Information and Gamease fail to perform its obligations under these agreements, we may have to rely on legal remedies under PRC law. We cannot assure you that such remedies under PRC law would be effective or sufficient.

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