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INTELLECTUAL PROPERTY PROTECTION AS

ECONOMIC POLICY: WILL CHINA EVER

ENFORCE ITS IP LAWS?

ROUNDTABLE

BEFORE THE

CONGRESSIONAL-EXECUTIVE

COMMISSION ON CHINA

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

MAY 16, 2005

Printed for the use of the Congressional-Executive Commission on China

(

Available via the World Wide Web: http://www.cecc.gov

CONGRESSIONAL-EXECUTIVE COMMISSION ON CHINA

LEGISLATIVE BRANCH COMMISSIONERS

Senate House

CHUCK HAGEL, Nebraska, Chairman

SAM BROWNBACK, Kansas

GORDON SMITH, Oregon

JIM DEMINT, South Carolina

MEL MARTINEZ, Florida

MAX BAUCUS, Montana

CARL LEVIN, Michigan

DIANNE FEINSTEIN, California

BYRON DORGAN, North Dakota

JAMES A. LEACH, Iowa, C-Chairman

DAVID DREIER, California

FRANK R. WOLF, Virginia

JOSEPH R. PITTS, Pennsylvania

ROBERT B. ADERHOLT, Alabama

EXECUTIVE BRANCH COMMISSIONERS

STEPHEN J. LAW, Department of Labor

PAULA DOBRIANSKY, Department of State

DAVID DORMAN, Staff Director (Chairman)

JOHN FOARDE, Staff Director (Co-Chairman)

(II)

(III)

C O N T E N T S

Page

STATEMENTS

Chow, Daniel, C.K., Robert J. Nordstrom Designated Professor of Law, Ohio

State University, Michael E. Mortiz College of Law, Columbus, OH .............. 2

Smith, Eric H., president, International Intellectual Property Alliance, Washington, DC ............................................................................................................. 6

Zimmerman, James M., partner and chief representative, Beijing office,

Squire, Sanders & Dempsey, LLP, Beijing, China ............................................ 9

APPENDIX

PREPARED STATEMENTS

Chow, Daniel C.K. ................................................................................................... 31

Smith, Eric H. .......................................................................................................... 35

Zimmerman, James M. ............................................................................................ 72

(1)

INTELLECTUAL PROPERTY PROTECTION AS

ECONOMIC POLICY: WILL CHINA EVER ENFORCE ITS IP LAWS?

MONDAY, MAY 16, 2005

CONGRESSIONAL-EXECUTIVE

COMMISSION ON CHINA,

Washington, DC.

The Roundtable was convened, pursuant to notice, at 2 p.m., in

room 192, Dirksen Senate Office Building, John Foarde (staff director) presiding.

Also present: Demetrios Marantis, Office of Senator Max Baucus;

Susan Roosevelt Weld, general counsel; Keith Hand, senior counsel;

Adam Bobrow, counsel, commercial rule of law; and William A.

Farris, senior specialist on Internet and commercial rule of law.

Mr. FOARDE. Good afternoon, everyone. Let us get started. We

have developed a reputation, whether deserved or undeserved, for

both starting on time and ending on time, so we are going to try

to keep up our three and a half years of good record this afternoon.

I would like to welcome everyone on behalf of Chairman Chuck

Hagel and Co-Chairman Jim Leach of the Congressional-Executive

Commission on China, and also on behalf of the legislative and executive branch members of the Commission who have been named

so far.

This afternoon, our inquiry is about intellectual property and its

protection, or lack thereof, in the People’s Republic of China. All of

our members have been interested in our trade relationship for

many years, and all of them share an interest in the protection of

intellectual property [IP]. They recognize, as I am sure everyone

here recognizes, that America’s intellectual property industries,

which rely on IP protection for their revenues, significantly contribute to the U.S. economy and represent a growing proportion of

our gross domestic product [GDP]. This sector includes not only the

copyright industries, such as motion pictures, musical recordings,

and book publishing, but also industries that rely on the value of

their trademarked brands. It also includes patent industries, such

as the pharmaceutical industry and many manufacturing businesses.

The health of U.S. IP industries, as well as the development of

IP industries in China, may depend on whether China continues its

role as the largest producer of pirated products in the world or

joins the ranks of nations that protect IP.

So this afternoon we want to examine the current crisis resulting

from the lack of IP enforcement in China, and looking beyond the

2

simple question of how much piracy and counterfeiting occurs, we

hope to examine the policies that have created the current problems and assess whether they are likely to continue in the future.

Our panelists this afternoon will explain the scope of the problem, analyze its source, and assess which strategies can advance IP

protection in China. We are delighted to have three extremely distinguished and knowledgeable panelists this afternoon. I will introduce them in detail before they speak.

Our procedure is as we have operated for the last three and a

half years at these Issues Roundtables. Each panelist will get 10

minutes for an opening presentation. After about eight minutes, I

will tell you that you have a couple of minutes left, and then that

is your signal to wrap things up. Inevitably, you will not cover everything that you want to say in your initial presentation, but we

will be able, we hope—and that has certainly been our experience—to pick up anything that has been left unsaid during the

question and answer session, which will follow the opening presentations.

Each of the members of the staff panel here will get the opportunity to ask a question and hear the answer for about five minutes each, and then we will just continue to do rounds until 3:30

arrives, or we run out of steam or exhaust the subject, whichever

comes first. On a subject this interesting and complex, I doubt we

will get to the exhaustion-of-topic problem this afternoon.

So let me then recognize, with great pleasure, Mr. Daniel C.K.

Chow, Robert J. Nordstrom Designated Professor of Law at Ohio

State University’s Michael E. Mortiz College of Law. Mr. Chow

specializes in international trade law, international business transactions, international intellectual property, and legal issues concerning China. He has authored numerous books and articles,

including two well-known case books, but he is probably most wellknown as the author of this wonderful tome, ‘‘The Nutshell Series:

The Legal System of the People’s Republic of China,’’ and we have

all benefited from it. Mr. Chow is fluent in Mandarin Chinese and

reads and writes Chinese at a high level. He obtained his bachelor’s degree from Yale College and his J.D. from Yale Law School.

Welcome, Dan. Thank you for coming this afternoon.

STATEMENT OF DANIEL C.K. CHOW, ROBERT J. NORDSTROM

DESIGNATED PROFESSOR OF LAW, OHIO STATE UNIVERSITY, MICHAEL E. MORTIZ COLLEGE OF LAW, COLUMBUS, OH

Mr. CHOW. Thank you, Mr. Foarde. Does the staff panel have a

copy of the PowerPoint printout? Let me begin on page one.

My topic today is trademark counterfeiting, so I am going to

focus on the counterfeiting of trademarks, products, and brands. I

am not going to focus on patent infringement or on copyright piracy, but I am going to focus specifically on product counterfeiting.

Let me begin, nonetheless, by saying that the counterfeiting problem

in China is recognized by many as the most serious counterfeiting

problem in world history. The PRC Government itself estimates

that the counterfeit trade in China is between $19 and $24 billion

per year, and about 8 percent of its gross national product.

U.S. industries that do business in China estimate their losses

to be in the billions to tens of billions of dollars per year. In China,

3

15 to 20 percent of well-known brands of consumer products are

counterfeit. You can find them in every large city, in every street

market in China.

One thing about this that I want to emphasize is that no problem

of this size and scope could exist without the direct or indirect involvement of the government, and I want to detail how that occurs

in my talk. I also want to highlight an ominous development, which

is that exports from China of counterfeit products, which are already serious and which make this into a global problem, are

about, in my opinion, to increase significantly as a result of China’s

entry into the World Trade Organization [WTO]. I will discuss that

in detail.

If we could go to the second page, please.

What are the origins of such a problem? Well, first, let me say

that China is the world’s largest recipient of foreign direct investment. It surpassed the United States as a recipient of foreign direct

investment—I mean foreign capital—in the year 2002. But along

with capital, foreign direct investment is the best source of technology transfer in the world today. In fact, when you look at a company such as Coca-Cola, the value to Coca-Cola of its trademark in

China is worth much more to that company than the millions, tens

of millions, or hundreds of millions of dollars of capital investment

that Coca-Cola has put into China.

So, too, with trademarks of companies like Procter & Gamble,

Johnson & Johnson, Unilever. All of these marks, all of these intellectual property rights [IPRs], are actually far more valuable to the

company than the value of the capital that the company might put

into China. So because it is the world’s largest recipient of foreign

direct investment, China now has unprecedented access to the

world’s most valuable intellectual property.

The second cause of this problem, I think, is that although China

is the world’s largest recipient of foreign direct investment, China’s

legal system still has many gaps, it is still weak, and it is still developing. That, in combination with the value of the product or intellectual property that has gone into China, has led to one of the

world’s most serious counterfeiting problems.

I will also talk about issues of political and legal reform, but let

us go on now and I want to discuss the issue in detail, if we can

turn to the third page. I am going to talk now about the economics

of counterfeiting in China. If you look at the map here, you can divide counterfeiting really into two distinct segments. First, there is

the manufacturing end of it, and second, there is the distribution

end.

With respect to the manufacturing end, if you look at the map,

the shaded area of the map shows the southeast region of China,

Guangdong Province and Fujian Province, which were two of the

areas first open to foreign direct investment, and which is where

most of the manufacturing occurs. The manufacturing occurs in the

south, but let me emphasize here the role of criminal organizations

in counterfeiting, organized crime in Hong Kong and in Taiwan.

Most of the people in Hong Kong have their ancestral home in

Guangdong Province; most of the people in Taiwan have their ancestral home in Fujian Province. But criminal organizations involved in smuggling, prostitution, and narcotics have now moved

4

into the counterfeit trade because it is so lucrative. They supply the

capital and they supply the know-how by investing in factories in

Guangdong and in Fujian Province, and they use the international

borders of Taiwan and Hong Kong to elude law enforcement and

detection.

The second part of the counterfeiting industry that I want to

point out is the distribution end. Of course, as everyone knows, it

is no good just to have a counterfeit product, you must be able to

deliver it to the end-use consumer. So, distribution plays a vital

role in the counterfeit trade.

Here on the map are highlighted five different wholesale markets

throughout the central and northern region of China. Each of these

wholesale markets is located near a strategic urban location, large

and densely populated urban areas such as Shanghai in the east,

Beijing and Tianjin in the north, Guangzhou and Shenzhen in the

south. These wholesale markets, many of them open-air or partly

enclosed, serve the vital role of delivering the counterfeit product

to the end-use consumer, as retailers who will come to these wholesale markets will be able to buy counterfeit goods and then take

them back to street kiosks, street stalls, and small retail stores for

their purchase by consumers.

I want to focus for a moment on Yiwu, which is in Zhejiang Province, that you see on the map on the east here. If I had a screen,

I would point to it, but unfortunately I do not. If you see it, it is

on the east coast of China. This city is well-known as the counterfeiting capital of China.

The thing to understand about these distribution centers is that

many of these wholesale markets are established by local governments. Local governments, specifically the local Administrations of

Industry and Commerce [AIC], invest in and protect these local

markets.

In Yiwu, there are 100,000 different products, 200,000 visitors

per day who purchase 2,000 tons of goods. Between 80 and 90 percent of these goods are counterfeit and infringing goods. I know

this for a fact because I spent many weeks in Yiwu when I was

working in China and saw personally the scope of this problem.

In 1997, the China Small Commodities Market, the largest

wholesale market in Yiwu, grossed $2.4 billion in total revenue in

China. That is larger than Procter & Gamble, Nike, Unilever, and

Johnson & Johnson combined. That is larger than their total yearly

revenues.

The role of counterfeiting in Yiwu, it is no exaggeration to say,

supports the entire local economy and legitimate businesses, such

as restaurants, nightclubs, warehouses, transportation companies,

and hotels. All of them have grown up and they support the trade

in counterfeit goods. If you shut down the trade in counterfeit

goods in Yiwu, you will probably shut down the local economy. Because the government has invested in these wholesale markets,

they are heavily defended at the local level.

If you skip the chart on the next page, I know I am running out

of time already. I would like, now, to move to the chart on the

State Administration of Industry and Commerce [SAIC] on trademark enforcement activity.

5

I just want to highlight for you the nature of the enforcement

issue. I am just going to talk about this briefly and skip over most

of this subject, but it is detailed in my written statement.

In the year 2000, there were 22,000 enforcement cases which

were brought by the State Administration of Industry and Commerce. The average fine in those cases was $794. We are talking

about a multi-billion dollar industry, and the fine was $794. Perhaps even more startling, if you look at criminal prosecutions,

there were 45, total. That is 45 cases out of 22,000 enforcement actions that were then transferred over to the authorities for criminal

prosecution. The level of enforcement, I think, in China, does not

create deterrence.

Now, if we can go to the next page on exports. As I know my

time is running very low, I am going to now emphasize the most

significant point on this page, which is that in my opinion there is

going to be a significant increase of counterfeit products from

China, which already accounts for probably 80 percent of all of the

counterfeit items that are exported in the world today. There is

going to be a significant increase because, in 2004, China, in accordance with its WTO commitments, has eliminated the export

monopoly that had been enjoyed by state trading companies. Prior

to 2004, a counterfeiter had to get the cooperation and compliance

of a state trading company, which had a monopoly on export rights,

before they could export counterfeit product. Now, in 2004, that

monopoly has been eliminated. It means that any counterfeiter now

can export counterfeit product. As there are, in my view, no criminal penalties specifically directed at the exporter of counterfeit

goods, I think we are going to see a significant increase. In fact,

mid-year 2004 figures show a sharp jump in the amount of counterfeit product that is being seized by U.S. Customs.

Finally, if we can go to the last page, let me just talk now about

future trends. The issue, as I see it, in China is that, really, counterfeiting occurs at the local level. It supports local economies.

Shutting down counterfeiting will mean, in many instances, shutting down entire towns and municipalities which will cause problems of unemployment, dislocation, and social chaos, which is

something that the Chinese Government fears more than anything

else.

On the one hand, you have the tremendous cost of the shutdown

and crackdown on counterfeiting. On the other hand, you have

multinational companies in China which are very afraid of offending the Chinese Government and they do not want to do anything

that might jeopardize their business interests.

So I think right now there is no political will on the part of the

Chinese Government to crack down, because right now counterfeiting is not causing the Chinese Government pain. Until it does,

I do not think there is going to be a significant change in the situation.

Thank you very much.

Mr. FOARDE. Thank you very much, Dan, for a sobering and very

quick overview. We will come back to some of the issues that you

have raised in the question and answer session. I take it they did

not give you the key to the city for all the time you spent in Yiwu,

right?

6

Mr. CHOW. No. We stayed in the best hotel, though, I must say.

It was run by the counterfeiters.

[The prepared statement of Mr. Chow appears in the appendix.]

Mr. FOARDE. I would like, now, to recognize Eric Smith, who is

president of the International Intellectual Property Alliance [IIPA].

IIPA is a private sector coalition of six U.S. trade associations

which represents over 1,300 companies producing and distributing

materials protected by copyright laws throughout the world.

Mr. Smith serves as chairman of the ITAC–15, the executive

branch’s Trade Advisory Committee on Intellectual Property

Rights, and regularly advises the U.S. Government on negotiating

strategy in the trade and intellectual property rights arena. He was

formerly chairman of IFAC–3, the predecessor to ITAC–15, as well

as a member of IFAC–4, which formally advised the U.S. Government on e-commerce issues. He is a former trustee of the Copyright

Society of the United States, and former chairman of the D.C. Bar’s

Committee on Copyright. He has written numerous articles on communications and international copyright, and has lectured worldwide on many subjects related to both domestic and international

copyright law, U.S. trade policy, and intellectual property and new

technologies.

Eric hails from California, and holds a J.D. from the University

of California at Berkeley—Boalt Hall, 1967—and obtained his

bachelors degree with honors from Stanford.

Welcome, Eric Smith. Thank you for sharing your expertise with

us this afternoon.

STATEMENT OF ERIC H. SMITH, PRESIDENT, INTERNATIONAL

INTELLECTUAL PROPERTY ALLIANCE, WASHINGTON, DC

Mr. SMITH. Thank you, Mr. Foarde. I appreciate it. This is a terrific forum to highlight both the counterfeiting and piracy problems

in China, and I really appreciate the opportunity to talk to all of

you about it. Mr. Chow introduced the topic quite well. I am going

to speak about copyright piracy.

Our organization represents, as you mentioned, six trade associations, 1,300 companies that account for about 6 percent of the U.S.

GDP and about 4 percent of U.S. employment, and that has been

growing every year since we started doing the first study in 1990.

These industries employ workers at about three times the rate

of the economy as a whole. The situation globally for the copyright

industries is very difficult because of the ease of copying, but China

is a particular problem for us because the levels of piracy are the

highest in the world. For example, in each of our industries, piracy

runs about 90 percent of the market. That means 9 out of 10 copies

available in China are pirated. Given the global demand and the

demand in China for our products, for movies, for music, for software, these companies should be generating literally billions of dollars of revenue in the Chinese market. When you think about it,

how do you make money in a market where you are competing for

10 percent of the market?

But it should not be forgotten that an additional problem in

China is the lack of market access for each of these sectors. The

copyright sector is probably the most closed to doing effective business in China than any other U.S. business sector, partly because

7

of the sensitivity of many of these industries; the Chinese Government always viewed film as a major propaganda tool. But the combination of high levels of piracy and the inability to get legitimate

product into the market combines to create, in our case, a very conservative estimate of $2.5 billion in losses a year. Now that is just

measuring what the market is today. If you were to look at what

the market should be with market access and the ability to form

anti-piracy organizations like we have in every other country in the

world, and if piracy stayed at 90 percent, the losses would be many

times that.

I wanted to leave you with some key thoughts. I have given in

my written testimony, and I have handed you our rather comprehensive February 301 submission that we give to the Office of

the U.S. Trade Representative [USTR] every year, that goes into

detail about the problems in China from a copyright piracy standpoint.

The Chinese enforcement system relies almost entirely on thousands of people who run administrative raids against pirates and

counterfeiters. As Mr. Chow said, the fines are the cost of doing

business, basically. We did a survey in Beijing a little while ago

with respect to actions taken at the request of one of our industries, the motion picture industry, and looked at the fines that were

assessed in those cases. These were administrative cases brought

by the Beijing Copyright Bureau, in conjunction with the Ministry

of Culture and other agencies that worked together. We discovered

that the fines tended to average a little bit above the cost of buying

a blank tape. With this kind of penalty structure, as Mr. Chow

mentioned, there is simply no disincentive to continue in this business.

In the trademark area, we understand there have been some

criminal cases. I think Mr. Chow mentioned 40. In our area, we

have been able to count, over the last 10 years, maybe, to our

knowledge, 10 criminal cases. We know of only one criminal case

that involved foreign copyrighted works. This really gets to the

nubbin of the issue, I think. In every other country in which our

companies do business, and that is 100 countries, all use their

criminal law as a way of dealing with piracy.

The profits are so high in this business that if you are a CD factory owner—and there are now 83 factories in China, many of

which churn out pirated product on a regular basis—the money is

so high that, without criminal enforcement and the potential of jail

terms, there is going to be no possibility of ever getting a handle

on this problem. We have been, and the U.S. Government has been,

asking now for 15 years, really, for the Chinese to undertake an

enforcement program that has deterrent penalties, and we have yet

to really see it.

In the Joint Commission on Commerce and Trade [JCCT], which

convened last April when Vice Premier Wu Yi was here, the U.S.

Government and the Chinese delegation met, and the Chinese delegation committed—Wu Yi committed—to significantly reducing

piracy rates. A year later, during the USTR out-of-cycle review

process, the formal legal process that they use to evaluate what

China has been doing, there has only been a negligible change in

the piracy levels in China.

8

I think in the recording industry, piracy rates went down approximately 5 percent, from 90 percent to 85 percent. However, on

the other side of the equation, Internet piracy skyrocketed. We do

not have any way of really measuring Internet piracy yet, but

China is going online, and it is a very serious problem and the

legal infrastructure is not there yet.

So we have a situation where piracy rates have not been significantly reduced, and during the course of that one-year period, we

know of one copyright piracy case that involved the two Americans

who were arrested in Shanghai.

Let me just spend a couple of minutes on that case. That case

was initially prosecuted under Article 225 of the criminal law of

China. That is the part of the criminal law that says it is illegal

to engage in a business operation without the license allowing you

to do it. It is not a piracy offense, it is illegal business operations.

At the end of the day, when that case was finally decided, the prosecutor broke that down to an Article 217 case, which is, in fact, the

crime of piracy. There has not been much news about that. We

were happy that that happened, because it is the first time that

that has happened. The problem with criminal prosecutions under

Article 225, is it just sends the wrong message to Chinese society.

I would just leave you with this one fundamental point. Unless

China is willing to use its criminal law procedures to deal with

piracy, they are not going to be able to substantially change the situation. Now, China cannot continue to operate in the atmosphere

in which they are operating now. They have to move up the value

chain. They cannot continue to be a low-wage manufacturing country.

We have the examples of Korea, Taiwan, and other countries in

the Asian region that have driven down piracy rates from, in the

mid-1980s, 100 percent piracy in Taiwan and Korea, to—believe

me—piracy rates at the latter part of the 1990s that were down to

15 percent. How did they do it? Very simple. They put pirates in

jail. If it was not a jailable offense, they fined them at levels that

were deterrent. Until China makes the political commitment to do

that, it is not going to be able to deal with this problem.

In 1995–1996—and this goes to the point that Mr. Chow made

at the end of his presentation, and this is a point about incentives—the Chinese Government was facing $2 billion worth of retaliation if they did not close their CD factories. The Minister of

Propaganda finally ordered the closure of those factories. They

were in the provinces.

Mr. Chow is absolutely right, it is a local issue, too. But until the

Politburo and the central political leadership of China makes that

kind of a decision to say ‘‘enough’’ and announces it into the society, nothing is going to change in China. We are working now with

USTR, looking at the possibility of a WTO case. We are strongly

supportive of the JCCT commitment on both the market access and

the piracy side, and there is an IPR working group.

Madam Ma is going to be in town next week. So this hearing,

in particular, is very timely and we hope that the Chinese delegation gets the kinds of messages from the U.S. Congress that they

need to get in order to solve this problem. Thank you very much.

[The prepared statement of Mr. Smith appears in the appendix.]

9

Mr. FOARDE. Thank you very much, Eric Smith, for another rich

presentation. We will pick up some of those issues as well in the

question and answer session.

I would like to go on now and recognize an old friend, Jim Zimmerman, partner and chief representative of the Beijing office of

Squire, Sanders & Dempsey, LLP. Jim concentrates his practice on

foreign investment matters in China and represents multinational

clients in a broad range of industries with respect to their joint

venture investments, manufacturing investments, liquidation and

dissolution of investments, mergers and acquisitions, regulatory

compliance, customs and trade matters, and dispute resolution. Jim

is the author of several books, chapters, and articles concerning

Chinese law, customs regulations, and trade policy related issues,

including ‘‘The China Law Deskbook,’’ which is a publication of the

American Bar Association. He is a governor and vice chair of the

Board of Governors of the American Chamber of Commerce in

China [AmCham], and chair of the Legal Committee for that

Chamber. He is also chair emeritus of the China Law Committee

of the ABA’s International Law Section. He is on the panel of mediators for the U.S.-China Business Mediation Center, jointly operated by the CPR Institute of Dispute Resolution and the China

Council for the Promotion of International Trade. Jim is also on the

panel of arbitrators for the International Court of Arbitration of the

International Chamber of Commerce [ICC] and has served as an

arbitrator in ICC cases.

Welcome, Jim Zimmerman. It is great to have you here in Washington.

STATEMENT OF JAMES M. ZIMMERMAN, PARTNER AND CHIEF

REPRESENTATIVE, BEIJING OFFICE, SQUIRE, SANDERS &

DEMPSEY, LLP, BEIJING, CHINA

Mr. ZIMMERMAN. Thank you, Mr. Foarde. It is a pleasure to be

here.

My comments will be on behalf of not just myself and my firm,

but also on behalf of the American Chamber of Commerce in

China. We are here in town this week as part of the Chamber’s annual Washington Doorknock Program. I have prepared a written

statement and I will send that by e-mail to you later today. If anyone would like a copy of that, they can ask me or send me an

e-mail.

Basically, my perspective is a little different. I come from the

perspective of being on the ground in China and spending a lot of

time meeting with government officials, meeting with court officials, and to get their insights on IP enforcement.

But let me start by saying this. In January of this year the U.S.

Ambassador to China held an IPR roundtable and I provided the

comments on behalf of the U.S. industry. I made the following comment: ‘‘Since its accession to the World Trade Organization in

December 2001, China has made significant improvements to its

written laws governing intellectual property rights. However, there

has been minimal progress in establishing a system of effective enforcement.’’ My comments were picked up by the press in the

United States and by the press in China. The press in China, in

the China Daily, focused on the comment that ‘‘significant improveVerDate 11-MAY-2000 16:38 Jun 23, 2005 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 21813.TXT China1 PsN: China1
10

ments have been made.’’ The press in the United States focused on

the comment of ‘‘minimal progress in establishing a system of effective enforcement.’’ Therein lies the problem, which is a perception issue. Some people in the United States believe China has done nothing, and I do

not believe that is true, as I will go into some detail later. At the

same time, China believes that it has made significant improvements, not just to their written laws, but with respect to enforcement. That is not true, either. Much, much, much more work needs

to be done in a lot of different areas, and China does need to be

strongly encouraged to make some progress, and progress this year.

The progress that they have made is that they have spent a

great deal of time re-writing their laws and amending regulations,

adopting rules and standards. They have improved the court systems. They have gone from a situation where they were without a

legal system 25 years ago, to one where they have an environment,

at least to some degree, in which the rule of law is followed.

The IP court, specifically in Beijing and Shanghai, at least, has

highly trained judges. They have retired most of the military officials, most of the Party officials, and have put in place qualified

judges, for the most part.

Now, the situation in the courts right now is that there is a significant amount of litigation, but that has been filed mostly by domestic companies. At least 90 percent of the litigation in the courts

is between domestic parties, and less than 10 percent may involve

a foreign party. Somebody is taking advantage of the court system

in China. It is not the foreigners, but the domestic companies because the issue of IPR enforcement strongly affects domestic companies. I agree 100 percent with Dan and Eric on their observations, but a big impact is on the domestic companies as well and

their ability to get the benefit of their IP rights.

But progress needs to be made. Leadership needs to be shown in

a number of areas. I do agree with what Eric is saying and Dan

is saying about criminal prosecution. The PRC Government needs

to demonstrate the political will to put people in jail and to enforce

the laws.

In a meeting with the Supreme People’s Court in February, the

AmCham leadership discussed the judicial interpretation on IPR

criminal penalties that came out in January 2004. On its face, the

judicial interpretation lacks specificity. It is not detailed enough.

There is much that needs to be clarified, specifically with respect

to the liability of organizational end users with software, with respect to the liability of exporters, and also with respect to infringement that may be a health and safety issue.

One question we posed to the Supreme People’s Court was,

‘‘Well, what if you are below the threshold? ’’ Hence, you have a situation where you do not reach that threshold for criminal liability,

but someone dies as a result of a tainted drug? The Supreme People’s Court did say that a crime would be committed in that instance, but not under the judicial interpretation, but some other

law. The Supreme People’s Court, in no uncertain terms, told us

that they will use their leadership to strongly enforce the judicial

interpretation. So, it is left for observation what they will actually

do. At the end of the day, what really needs to take place is that

11

they need to bring prosecutions. That is something that we are encouraging them to do.

Second, what needs to take place is that China must dedicate

more resources to IP-related issues. As an example, the Trademark

Office is significantly understaffed. In this regard, I have seen situations where we have applied or petitioned on behalf of clients to

invalidate infringing trademarks and we have been told by the

Trademark Office staff that they have over 20,000 cases, and they

are still dealing with cases that were filed in 1999. This is the

Trademark Office telling us that they are understaffed. It is unheard of that a Chinese Government official would make that kind

of statement, but it is true. They are under-staffed. It is almost like

a cry for help, that they need more resources. Now, one of the

things that we are stressing—the American Chamber of Commerce—is that the government needs to add resources to get that

backlog of cases taken care of.

Bear in mind that the 20,000 case backlog also involves domestic

companies. The case that we are waiting for specifically is a U.S.

company versus a Singapore company, foreigner versus foreigner.

There is no political risk here. There is no political issue. The

Trademark Office will not be protecting some domestic enterprise.

It is a case, from our view, that should be quickly decided, but they

are backlogged. So, the dedication of additional resources must be

encouraged. It is very important. In addition, the Chinese Government agencies responsible for trademark and patent registration

are behind because they do not have the resources.

Third, they need better agency coordination. One of the things

that we have been pressing for is better communication and coordination of cases between IPR-related agencies. In China, it is common for China Customs to be doing one thing, and the SAIC doing

another thing, and they do not coordinate with one another. They

do not even pass files to one another. That is a real practical and

logistical problem. There is also no agency coordination between

province to province, from city to city.

How do you get the message to them on these issues? I do believe

that one forum is the JCCT, which will be meeting this summer.

Now, we do not want to be in the same position we were last year

where we came up with a list of bullet points and then they do not

make progress. We do need to get the message to the Chinese that

they must make progress on these issues.

So on the criminal side, at the end of the day they have got to

throw violators in jail. They have got to enforce their laws. We

need to see statistics on that. We need transparency. We need to

see that people are being prosecuted. They need better inter-agency

coordination, and then they also need to dedicate more resources.

Another issue is—and this is a role that the American Chamber

and other organizations can play—is to encourage China to believe

that if they protect intellectual property and do away with the companies that are making billions on counterfeit goods, there is a tremendous potential tax revenue that they are losing out on.

The IPR Roundtable raised that issue to the Chinese Government. Can you imagine the PRC Government’s tax revenue if all

companies were making legitimate products and they put the counterfeiters out of business? Because the counterfeiters are out of the

12

system, they are likely not paying taxes. They are not in the system, they are out of the system. As Dan mentioned, a lot of the

counterfeiters are criminal organizations. They are not paying

taxes in China. Those people should be paying taxes. The same

thing is true with legitimate foreign companies that want to sell

their goods in China and demand market access. If they are legitimately selling their goods, that potentially is tax revenue that the

PRC Government can tap into.

So, those are things that the Chinese Government needs to be

told, and not just, ‘‘you are going to be subject to a Section 301 investigation,’’ but to be told some of the positive side on this.

Those are my comments for now. I would be happy to answer any

questions that you might have on this issue.

[The prepared statement of Mr. Zimmerman appears in the appendix.]

Mr. FOARDE. Jim, thank you very much also for some useful and

timely information.

I would like to let our panelists rest their voices for a moment

while I make an announcement or two. I would like everyone to

also attend next week’s Issues Roundtable, which will be on unofficial religions in China. We will be looking at the religious groups

that are not so-called ‘‘patriotic’’ religious groups. That roundtable

will be on Monday, May 23, at 2 p.m. in room 2255 of the Rayburn

House Office Building, so we hope to see you on the other side of

the Capitol next week.

Also, the statements, and eventually the transcript, of today’s

roundtable, will be up on our Web site at www.cecc.gov. You will

also find the transcripts and statements from all of our earlier

hearings and roundtables. If you are not already signed up for our

master mailing list, you can do that on the Web site and then you

will get all of the announcements about hearings, roundtables, and

other activities.

So, now let us go on to the question and answer session. As I

said before, we will let each of the staff panel up here question either one individual panelist, or all of you, for about five minutes

each. If the question is directed at just one panelist but the other

two have comments, by all means, we would like to hear those responses, because the whole purpose of the exercise, from our point

of view, is to hear your ideas and get those on the record.

I am particularly pleased this afternoon to exercise the prerogative of the chair and waive my own first set of questions to recognize my colleague, Demetrios Marantis, who has just joined

Senator Max Baucus’ trade staff. Senator Baucus was our first

chairman and Demetrios is now working for him. Max Baucus

spends a lot of time thinking about our issues and is in touch with

us frequently. So, Demetrios, over to you, and welcome.

Mr. MARANTIS. Thank you very much for that kind introduction.

I would like to thank the panelists. That was extremely useful.

Given the recent release of USTR’s Special 301 report, this roundtable is rather timely. I have one question that I would like to address to Eric, but I would be curious as well as to what the rest

of the panelists think. The issue that has been of concern to Senator Baucus, as well as to the whole Finance Committee, relates to

IPR enforcement in China.

13

As you probably know, all 20 Senators of the Finance Committee

sent a letter on April 30, urging the Administration to step up its

enforcement of the Trade-Related Aspects of Intellectual Propety

Rights [TRIPS] commitments in China, with a view to a potential

WTO dispute settlement case. My boss, Senator Baucus, was a bit

disappointed that USTR’s out-of-cycle review did not include the

initiation of a WTO dispute settlement case against China, given

that we have been hearing from the Administration that piracy in

China is at ‘‘epidemic’’ levels and the losses, Eric, that you mentioned that the copyright industries are facing on a yearly basis,

are pretty staggering.

So I just would like to get your thoughts as to what you all think

the utility of WTO dispute settlement against China is, particularly

on the copyright and trademark side of things, and why we are

where we are in terms of not being in a place where we can initiate

a dispute settlement case against China, and whether or not WTO

dispute settlement is the way to go to address some of these issues,

or if you have other thoughts as to what would be a more effective

use of the Administration’s resources. Thank you.

Mr. SMITH. Thank you, Demetrios. As you may know, the enforcement text of the TRIPS agreement is a part of the agreement

that is not a bastion of clarity. To bring a case under Articles 41

and 61 against a country that has piracy at the levels of China, the

first thing you would say is, how, possibly, could a country such as

China be in compliance with any kind of enforcement obligation

when you are running a 90 percent piracy rate? But in the WTO,

you have to prove your case absolutely. And you are quite right.

We asked for the commencement of WTO consultations. USTR decided not to do that. They decided to move forward with a process

of using Article 63 of the TRIPS agreement to get more statistics

from the Chinese Government about the exact nature of what is

going on there, because as you know, China’s system is wholly nontransparent. It is very, very difficult to find out what is going on,

particularly when you are talking about cases brought and results

obtained in cases.

We are working very closely with USTR right now in moving

along that line. We understand what USTR did. It would not have

been our first choice, but they made the decision to move forward

in a deliberate way. They have invited us to go along with them.

We are in the process of preparing what is going to be, or what will

possibly be, a very large and extremely important case.

We wish that the language in those two sections of the TRIPS

agreement were clearer and that we could use them with less risk

of losing a case. We think we can win the case, but we have a ways

to go to develop the evidence to get there.

Mr. FOARDE. Do either of the other panelists want to address

that? You can have a minute or two, if you would like.

Mr. ZIMMERMAN. A quick comment on that. I agree with Eric.

The language in the TRIPS agreement on enforcement is uncertain.

To bring an action would be time-consuming. I think that the

choice of remedies that the USTR has taken will probably move

China faster. If they do not make progress, then there is the option

of pursuing a formal enforcement action under TRIPS. I think,

right now, the strategy is a smart strategy. With the various orgaVerDate 11-MAY-2000 16:38 Jun 23, 2005 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 21813.TXT China1 PsN: China1
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nizations pressuring, or working with USTR to pressure, China, we

are hopeful that action will be taken this year. I do believe China

knows that this year, 2005, the United States is very serious and

wants action, and wants to see accomplishments this year.

Mr. CHOW. Let me just say, from the trademark perspective, I

think many companies with trademarks in China are very reluctant to confront China. The whole idea of bringing a WTO dispute

settlement action, or worse, much worse, a Special 301, is something that many of the companies on the ground are very reluctant

to do because they do not want to do anything that is going to offend the Chinese Government. That is part of the issue here, that

the multinational companies that are in China now have to decide

how far they are willing to go. Many of them scream all the time

at the U.S. Government, but they do not want to do anything to

offend the Chinese Government. That includes Special 301, that includes WTO dispute settlement. So I think industry, on the trademark side, big companies, part of the Quality Brands Protection

Committee that is the multinational companies in China that are

lobbying the Chinese industry, they are very conflicted on this

issue. They are not sending clear signals to the U.S. Government.

USTR, of course, is going to listen to its constituency. There is a

lot of reluctance to confront China.

Mr. FOARDE. Thanks, all three of you, for that response.

Let me recognize Susan Roosevelt Weld, who is the general counsel of the Commission. Susan.

Ms. WELD. Thank you very much, John. Thank you for all of your

remarks. I am interested in whether you three think that bilateral

cooperative efforts by the United States can do anything to help

cure this problem. I guess I will start with you, Mr. Smith.

Mr. SMITH. This is a very frustrating topic. Some of my colleagues who I work with right now used to be in the U.S. Government, and they were engaged bilaterally with China. I have been

engaged, the U.S. Government has been engaged, for 15 years now.

With respect to this topic, enforcement, there really has been very

little progress. Over the last year, following Wu Yi’s commitment

about substantially reducing IPR infringements, that has not happened. Is it going to happen in the next year? With Jim Zimmerman, we really hope so. But absent that progress and without the

incentives that Mr. Chow is talking about, one begins to question

whether or not the Chinese have the incentive to do this.

Over the long term, they must. They cannot continue to live as

a counterfeit culture. The question is when? In the case of the copyright companies, unlike the trademark companies—I should not

draw this distinction too harshly—our companies do not really even

have market access. Many of the companies in the trademark area

are doing business in China and making money. They are getting

hurt by counterfeiting. Many of our companies are not making anything in China. So we have a slightly different perspective on this

question, as we did in 1995 and 1996 when the trademark community did not join in the 301 action, which was basically a copyright

industry driven action.

But now we are in a WTO world. A 301 bilateral world is much

more difficult now. So, we really have to look, first, at multilateral

15

remedies. That is where you come up against Articles 41, 61, and

the TRIPS agreement.

Mr. FOARDE. Does anyone else want to address that? Please, Jim.

If you have a comment, go ahead.

Mr. ZIMMERMAN. I was going to add that this is the first step.

The bilateral negotiation is the first step, and I do think it is a

helpful step. We will just have to see how it plays out.

I am optimistic. We have to remain optimistic. Part of that optimism is based on some of the assurances that we received from

Chinese Government officials, how they are serious about it, and

they do want to improve. They want the relationship with the

United States to improve, so they have an incentive to really make

progress.

And when I say 2005 is the year, it is because we also understand that the U.S. Congress is under pressure from a lot of different quarters from people who are not happy, but at the same

time, I think that China realizes that and understands that they

are going to have to listen this time. It is just like in 1995, when

they had the Section 301 hanging over their heads. Right now, they

have got these negotiations that are hanging over their heads.

Mr. CHOW. Well, just going back to this whole issue of bilateral

negotiations, I think that the United States is going to take its lead

from industry. I can tell you that when I worked in China for a

multinational company, we met with the U.S. Government. What

we said to the U.S. Government was, ‘‘well, we would like you to

talk to the Chinese Government, but please do not use our name

and please do not make them angry.’’ That is what we said, because that was essentially the attitude of the companies. So I think

that the companies themselves have to make a decision: how far

are they willing to push this, or is this really a situation that is

more or less the status quo?

Mr. FOARDE. Thank you, all, very much.

Putting on these Issues Roundtables, although they may seem

quite seamless, requires a great deal of organization and hard

work. So we give the privilege of asking questions at each roundtable to the one staff member who has done the most heavy lifting

to organize it. In this case, it is our friend and colleague, Adam

Bobrow, our senior counsel for commercial rule of law. Adam, over

to you for some questions.

Mr. BOBROW. Thank you, John. And thank you very much to the

panelists. This has been very informative and we have heard a lot

of very good testimony so far.

I would like to switch gears a little bit. We think of this sometimes as a simple situation in which you have people who want to

see DVD movies or want to buy trademark products and other

things, and some sort of a culture of willingness to let this stuff get

made under the table without enforcement. The Chinese Government believes nobody is getting hurt, so what is the big deal, and

that it is that simple.

But I would like to look a little bit behind that and see whether

or not the panelists have any feeling about whether or not some

of the policy decisions that the Chinese Government makes in other

areas have led to this situation where there is no real incentive for

enforcement against infringers.

16

Let me give a particular example. It is probably a bit outside

your specific expertise, so you do not necessarily have to address

the specific example. But in the case of China’s 3–G standard that

they are developing domestically, it is known as TD–SCMA. CDMA

is a U.S.-company owned, IP-protected, patent-protected standard

for cell phone communications. TD–SCMA obviously is going to be

built—you can tell from the name—on top of that.

The Chinese Government has recently issued draft regulations

that would seem to indicate that, in the situation under which

there would be patents or other IP-protecting and underlying technology that is announced in the standard, they would issue a compulsory license for that technology without using the term. This is

where I think the rubber hits the road.

Regarding IP domestically, the Chinese Government has decided

who, what, where, when, and how it will generate a Chinese-owned

IP system that will move their manufacturing economy up the

value chain.

At the same time, enforcement of IP rights owned by innovators,

whether they be foreign or domestic, have never really received the

same sort of policy attention by the policymakers in the central

government. Therefore, as Dan outlined, with the local enforcement

authorities, and because those authorities unfortunately are tied

up in a web with the illegal counterfeiters, there is perhaps too little incentive to get actual enforcement on the ground.

The first part of my question is, I guess, to what extent do you

think that I am making this much too complicated? The second

part of the question is how do you actually generate that will at

the political or policy level in the central government to get the enforcement to occur at the local level? I will open it up to any of the

panelists who would like to answer that.

Mr. SMITH. Maybe I could start. I think it is wrong to say that

local Chinese rights owners are not being damaged by what is

going on China. I think, in the trademark area, we have heard

about whole cities being devoted to counterfeiting. But just the examples in our area, if you are a Chinese filmmaker, or you are a

Chinese performer, or you are a music composer, or you are a software developer, you are in big trouble. You cannot make a return

on your investment. Now, we know that these people complain all

the time in the only way that they can, politically, to the Chinese

Government about this problem, and they are not getting any recompense and it is very sad.

If you look at what has happened with other governments, governments have started to listen and realize that they are hurting

themselves worse than they are hurting U.S. companies. So, maybe

that is more specific to the copyright area than it is to other areas.

On the other hand, I think your general observation is probably

close to correct. I think there are a lot of policymakers in China

that have looked at this as, ‘‘how do we build into our system a 10

percent growth rate, because that is what we need to stay even,

and rule of the law be damned. The fact that we have laws on the

books and we are not enforcing them, we are letting them just go,

we think that is what we need to grow.’’

I think Jim made the point that the growth rate from legal businesses is going to be, in our judgment, and we think the economic

17

literature supports this point, the growth rate from encouraging

legal businesses is greater than encouraging businesses based on

naked copying. China is going to have to realize that very soon. We

hope Jim is right, that they realize it in 2005, because we are dying

and we cannot wait too much longer.

Mr. ZIMMERMAN. A couple of comments. On the standards issue,

there is a big debate going on in China as to whether or not the

inclusion of patents and standards should be a voluntary process

or a compulsory process. There were some draft regulations from

the Standard Administrations of China released for public comment last September, and then there was a big uproar about that

because it was basically a compulsory process. The Chinese Government backed off. Two things to China’s credit on that: one, they

did allow for public comment; second, it was a relatively transparent process.

Now the issue has not been resolved, but I can tell you this:

there are some elements in China that believe the inclusion of

foreign patents and standards could be characterized as foreign

domination, given the history of foreign domination and foreign

intervention in China. So there are a lot of people that do not like

that idea. They do not like foreign standards being imposed on

China, they want to create their own.

Unfortunately, that does not encourage innovation. The debate,

I think, is a healthy debate going on in China right now, because

they are trying to break away from being viewed as the low-valued

knock-off economy. They want to move toward something where

their homegrown IP has value, because as we have mentioned, that

is where the true economic development lies—in China getting

away from being a knock-off culture to one based on innovation,

and we have to encourage China to move in that direction.

Many foreign companies are encouraging innovation because

they are setting up R&D operations and hiring local engineers, hiring creative people in China, and showing them how to develop

new technology that will be homegrown. China needs to protect

that homegrown technology and to protect the foreign technology as

well, give them equal status. But if they move in a direction where

they are going to have a lack of incentives and force patent holders

to be part of standards without any compensation, that will only

perpetuate the problem.

The other question as to whether there is a government policy

in general of supporting infringement? I do not think so. I think

you give China too much credit when you suggest that they are developing a policy which encourages infringement. I think it is more

a lack of resources, lack of coordination of agencies, lack of political

will, and those are things that they need to correct.

Mr. CHOW. Just turning to the patent issue and the compulsory

license issue, as far as I can see, this is really a different type of

dispute. As far as I can see, I think this is a legitimate trade issue.

I am not even convinced that what China is trying to do here is

wrong.

I think every country wants to acquire advanced technology and

that they want to implement policies that will allow them to do so.

That is very different from counterfeiting, which is organized criminal activity. These are illegal factories that are not registered.

18

These are not state-owned enterprises that are registered, and that

have a fixed permanent location, that have a legal identity, that

have a business license. We are talking about illegal, underground

factories financed by criminal organizations. There is no dispute

about that, but that is completely wrong. Nobody in China argues

that that should be in any way supported.

The other thing I want to mention also is I agree with Jim that

I do not think there is a policy supporting infringement in China.

I do not think that there is any coordinated view in the central government or any attempt, conscious or unconscious. I think that this

process has begun because, very simply, counterfeiting and piracy

are extremely lucrative economic crimes. There is so much money

to be made, that criminal elements and other loose elements of society are just naturally drawn to it.

Mr. FOARDE. Let me now recognize Keith Hand, who is senior

counsel with the Commission staff. Keith.

Mr. HAND. Thanks, John. Thank you for the presentations. They

have been very interesting.

I would be interested in talking a bit more about the domestic

pressures for enforcement. We have been touching on that issue

here and there through the course of our discussion, and I was very

interested in Jim’s point that 80 percent of the infringement cases

are brought by domestic entities for domestic infringement.

Are there domestic trade associations analogous to yours that are

bringing pressure for greater enforcement or is advocacy in China

more dispersed, an individual company with influence raising this

issue with the Chinese Government?

On the issue of the infringement cases, is there a significant difference in plaintiff success rates and enforcement rates in domestic

versus domestic cases as opposed foreign versus domestic cases?

Mr. ZIMMERMAN. First, the question on whether or not there is

support by domestic associations. I do know with respect to DVD

manufacturers, the Chinese organization that was responsible for

managing that issue was leading the negotiations for the various

Chinese DVD manufacturers to encourage them to negotiate with

what was called the 3-C and 6-C group of patent holders—which

are the foreign companies that hold the IP rights to the DVD technology. That association—and I cannot remember the name off the

top of my head—encouraged its member companies to negotiate

royalty-related agreements with the various foreign technology

holders. They had mixed success. They were able to negotiate arrangements on behalf of several companies, but there was still

room for improvement in terms of the negotiations. But the point

is that there are some associations that are taking the lead. Now,

I am not aware of what the film or the music industry is doing,

but there are more and more domestic companies and more and

more domestic organizations that realize the value of IP and realize that their members are losing out. So I think that if you were

to look at some of the organizations that have been behind those

issues, I think you’ll find that they are keen to push the question,

but I do not have the answer right now on that.

In terms of the success in litigation, it is a mixed bag for both

domestic and foreign companies. I think that foreign companies are

more successful in the courts in the major cities—and that is not

19

just IP, that is with regard to any kind of dispute. If you bring an

action in a local court or provincial court there is a risk that the

foreign litigant may experience local protectionism or that the local

Party might be politically influential and impact the case. So, the

foreigners will do much better in the larger cities. The courts are

treating cases in Beijing and Shanghai professionally. But I do not

have statistics in terms of the success rate, because sometimes success is measured in various ways; hence, even though a company

might lose, the result might be fair. We find, in terms of arbitration cases before, like the China International Economic & Trade

Arbitration Commission [CIETAC], CIETAC claims that in 75 percent of their cases involving foreigners, the foreign party prevails.

My statement to CIETAC was to give themselves some credit because even though a foreign party may lose, the result may be fair.

I have actually had cases where we have lost but the results were

very fair. For example, I had a matter where the amount at issue

was $20 million, but we lost and the amount that was actually

awarded was $50,000. So, given the results, we actually won. Thus,

it does not matter if you win or lose, it is whether or not the result

is fair and whether or not the court or the arbitrators followed the

law and parties’ contracts.

Mr. SMITH. If I might respond to that question. I agree with Jim.

The civil court system, and the IPR courts, and the intermediate

courts in China have improved significantly. Unfortunately, civil

litigation is not a way to get at criminal enterprises engaged in

counterfeiting and piracy. It just is not deterrent. Certainly from

our industry’s standpoint, it is not the way to go for us. No one is

making money, and you would make even less if you spent it on

lawyers engaged in civil litigation because it would not really be

deterrent.

That being said, the recording industry brought, over the last

three or four years, maybe well over 100 civil cases against licensed

CD and DVD factories. These were not underground plants, because you cannot bring a civil case against an underground plant

if you do not know where it is. You can only bring a criminal case

with the help of the government, and we are not getting criminal

cases. Those cases were mostly settled for damages that had an impact, but it is simply not the way ultimately that you are going to

deal with the problem of piracy, though it is very important to

China to work on the rule of law and make their civil courts work.

It just is not relevant in our area.

The second thing you asked is about trade associations. Yes,

there are trade associations: China Audio-Video Association and

Computer Software Association of China. First of all, many of these

trade associations comprise primarily state-owned enterprises. How

aggressive is that trade association going to be against its own government? You hear lots of talk in the background, but they are not

going to be out there screaming like a private sector trade association in the United States might scream.

An exception to that is probably the Computer Software Association, which has a number of private company members. But even

there, the politics within China—look, the Chinese are masters of

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erybody is scared to death of saying anything negative about China

for fear of retaliation. There is no question about that.

The last point I wanted to make, in response to you, Adam, is

the Chinese invented the pirate format in Asia, the VCD. They invented it. About a year ago, or a year and a half ago, we heard

news that they were going to ‘‘invent’’ or innovate a new DVD format, but this format would not have any protection on it. It would

be a completely in-the-clear format. Of course, the motion picture

industry was absolutely apoplectic about this possibility, and it has

not happened.

Third, the Chinese Government has just recently announced— and there was a hearing in the House Government Reform Committee yesterday on this subject—a procurement regulation that,

according to the Business Software Resellers Alliance [BSRA]

member, would probably kill any ability of a foreign software company to sell software in China, because that procurement regulation would require state-owned enterprises, et cetera, to purchase

only Chinese software.

So I do not subscribe to the view, and I do not think our members subscribe to the view, that there is any sort of great conspiracy here behind the scenes. I think there is just a combination

of a lot of different things going on, a lot of lack of cooperation, and

some agencies that have specific missions that are probably very

anti-foreign. The combination of all of those elements gives you

what we have today, which is a horrendous situation for IP owners.

Mr. CHOW. Civil litigation is for legitimate business disputes

when you have a plaintiff and a defendant who are willing to show

up in court. That is all right, and the local companies that are

bringing these cases they have legitimate business disputes. But

civil litigation does not preserve the element of surprise. When you

deal with counterfeiters, you have to surprise them, because they

are not there if you do not surprise them. So what most people in

China do is they bring an administrative action, an enforcement action that is an ex parte action, where you show up and 15 minutes

later the AIC or the PSB go with you and you raid the factory and

then you seize all the goods. Then what happens is that there are

penalties that do not create a deterrent. So, I think civil litigation

certainly is important for China’s long-term progress, but it is not

the answer for counterfeiting.

Mr. FOARDE. Thank you all again for those answers.

I would like now to recognize my friend and colleague, William

Farris, who is our senior specialist for the Internet, and has also

taken over duties as our press director. William.

Mr. FARRIS. Thank you. One of the areas I look at is censorship

in China. It seems like we were talking earlier about issues of political will and capacity. It seems like when it comes to censorship,

China has a great deal of political will and a great deal of capacity.

Mr. Smith, I believe you mentioned, perhaps indirectly, that China’s method of handling cultural imports is affecting the ability of

copyright holders to make money in China. You also mentioned

that the two foreigners arrested in Shanghai were initially charged

under Article 225, which, as I understand it, is the law on which

the Supreme People’s Court also has issued an interpretation that

says that illegal publications would be prosecuted under that law.

21

I am wondering if you, or perhaps the rest of the panelists, might

be able to further comment specifically on why they were arrested

under Article 225, and why the charge was eventually changed to

a charge under Article 217 of the criminal law, and also any issues

relating to how China’s censorship regime affects the ability of U.S.

copyright or other intellectual property holders to make money in

China. Thank you.

Mr. SMITH. Well, I think our industries face censorship in almost

every developing country in the world, so we are used to having our

movies and our music censored. You build around that. You can adjust to it. One of the difficulties in China, is that pirates do not go

through censorship and, in the case of the music industry, for example, local music companies do not go through censorship. So,

that is sort of a national treatment violation, right there.

The Internet is another example. I will just give you an example.

I think I mentioned it in my testimony. There are something like

200,000 Internet cafes in China, with 100 to 300 seats each. Most

of them are devoted to game playing. These Internet cafes are intensely regulated, but there is no regulation that says they cannot

pirate, and in fact, they all do. They download off the Internet,

they get pirated games. It is just a real big problem.

So the control that the Chinese Government has over its own society to prevent social misbehavior, to prevent pornography, many

of these 225 actions that have been commenced over the last 10

years were really actions against pornographers. Now, there was

pirated product seized in the raid, but the real gravamen, we think,

of a lot of these criminal actions was to get at the pornographers,

because that they view as a really serious problem that they need

to stop, and we just would like to see them to make the judgment

that piracy is like that.

Mr. FOARDE. Would any other panelist want to make a comment?

Please, go ahead. Go ahead.

Mr. ZIMMERMAN. One of the concerns with Chinese law in general, and including the IPR judicial interpretation, is that it is very

vague, very generally worded. It gives the government as much

wiggle room as possible, and, unfortunately, much enforcement is

in the hands of those who are interpreting the law.

Subjective enforcement is a concern because, without specificity,

we have to guess how they are going to interpret or implement the

law and regulations. That wiggle room creates problems because

there is too much discretion in the hands of the PRC agencies.

Such discretion is why some enforcement activities are politically

motivated and the politics have to be played to encourage somebody to prosecute or to seize goods.

That is a problem with Chinese law, in general. It is very general, the way it is worded, and leaves a tremendous amount of discretion on the part of the agencies or the court with respect to the

judicial interpretation. Unfortunately, we have to anticipate how

the law is going to be applied and we have to have some faith that

they will, because of outside pressure, move forward with criminal

prosecution. That is the key thing here, is that at the end of the

day, at the end of the year, we are going to count the success of

achieving benchmarks, and we are going to find out if they put people in jail. It is not just the guy on the street that is selling the

22

DVDs that has no political power, no political strength, but it is the

factory owners and the government officials protecting them. Those

are the people that have to go to jail, and that is what we are looking for.

Mr. CHOW. We have talked a lot about the difficulty in obtaining

enforcement, and we have not gone into a great deal of detail, but

it is just really incredible how many obstacles there are to effective

enforcement. I will just give you a very simple example. When I

was working in China, we went to the Public Security Bureau

[PSB], and we said, ‘‘Well, we know of a counterfeiter, and what

we want you to do is to arrest them.’’ What the PSB said to us was, ‘‘Well, will you give us a reward? ’’ I said, ‘‘What do you mean? ’’ ‘‘Well, we want 50,000 RMB per arrest.’’ That is not that much.

That is about $6,000 U.S. dollars. But the U.S. corporation has to

worry about the Foreign Corrupt Practices Act, and of course we

said no. But they would not do it unless you paid them a case fee,

50,000 RMB per head. So, that is just to give you an idea.

There are so many others, and I can go into detail about evidentiary issues and what counts as evidence and what does not.

There are just so many issues and so many obstacles, it is very difficult to get that type of enforcement.

Mr. ZIMMERMAN. It is not a user-friendly system.

Mr. FOARDE. Let the record show that the comment was that it

is not a user-friendly system. Let me pick up on the questions now.

One for Dan Chow. I was struck by your comment on trading

rights eventually or suddenly being able to be acquired by counterfeiting companies, domestic counterfeiting companies in China,

which I take it was not the case before. How much relationship, if

any, does this have with the trading rights commitments that the

Chinese Government made in the WTO accession process?

Mr. CHOW. When China joined the WTO, China committed to

further liberalize its economy and its legal system so that it could

foster legitimate trade. Part of the same liberalizations which help

legitimate trade also help the illegal trade in counterfeit goods.

Specifically, what I mentioned was that, under China’s pre-WTO

system, only state trading companies had the privilege of exporting

products from China. This is an example of the lifting of a restriction that is going to help both legitimate and illegitimate trade. So,

for example, the reason why China has to eliminate the export monopoly that state trading companies have is to facilitate legitimate

businesses who do not then have to go through the process of hiring a state trading company to export their products.

Well, if you eliminate the monopoly rights that state trading

companies have on exports, that means anybody, including counterfeiters, can export without the help of a state trading company.

What has happened today is that counterfeiters find a cooperative state trading company that is willing to export counterfeit

goods, but that involves work, that involves payments, and that is

something of a barrier. But by lifting that export monopoly and by

giving a general right to every company, except with respect to certain types of goods, such as cotton, which are restricted, now any

company can export.

Now, if you are a counterfeiter and you can export to Eastern

Europe where there is no legitimate product, so they cannot tell,

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and where it appears that there is no specific criminal law directed

at exports, what is going to happen is you are going to see an explosion in the amount of exported products from China. I believe,

in the first half of 2004, there has been a sharp increase in the

number of seizures by U.S. Customs. So the same measures that

will liberalize trade in China and help legitimate trade will also,

in the short term, I think, lead to an increase in commercial piracy.

Mr. FOARDE. I would be happy to have either one of you address

that.

Mr. ZIMMERMAN. Just for clarification on that, there is a distinction between the trading rights and the distribution rights. To China’s credit, last summer they did provide for wholly foreign-owned

enterprises to have trading rights, and that was in the amended

foreign trade law. That was six months before their WTO obligation kicked in. But on distribution rights, it is still something that

we are waiting for. The new notice that came out two weeks ago,

is still unclear on the process of obtaining distribution rights.

Now, the impact of all of that on IP issues is that because things

are relaxing, I think you are going to find more and more counterfeits in the export market. So, with meeting the WTO obligations

on trading rights, distribution, or whatever, it is going to make it

worse because now they are exporting everywhere.

Mr. SMITH. We are actually a little bit more concerned on the import side, again, as part of the market access problem, getting legitimate product into China. Basically, the export of CD product,

after the 1996 closures, went down to a trickle. Now it is back up.

It is an interesting comment, because most of the exporting was

not done before, and it was smuggled out. So, that has not made

much difference.

But what we were really hoping for was to be able to import directly to the Chinese consumer without going through China Film

or the China monopoly importer for the record industry, or the

CMPIEC for book publishing. For those industries, all that is still

in place right now. We still have to go through those monopoly organizations, in part because the trading rights did not apply in the

film industry. In the publishing industry, we are trying to figure

out now why publishers are importing through the monopoly. They

should have full trading rights. They should be able to go directly

to the consumer. So, these are things that need to be worked on

and resolved.

I just want to say that what they did in the judicial interpretations is that they did kind of a back-handed thing. For somebody

who exports or imports, it is not a direct offense. You are an accomplice to some other offense. I do not know quite how that is going

to work. But they just did not go the whole way. To give you another example of this, there was an internal Supreme Court research study done before the judicial interpretations were issued,

and that study recommended, I believe, that the threshold be

measured by the of the value of the legitimate product, not of the

pirated product. You can imagine, if you are selling a DVD for 60

cents, you have to have a heck of a lot of DVDs before you meet,

for a major crime, the $54,000 threshold at 60 cents. That is a lot

of product. It was recommended that they get rid of that. In the

political processes, they worked through the JIs, or the judicial inVerDate 11-MAY-2000 16:38 Jun 23, 2005 Jkt 000000 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 21813.TXT China1 PsN: China1
24

terpretations, and that did not happen. In part, it was to maintain

this kind of discretion that Jim was talking about. They did not

want to have a hard-and-fast rule that said this is going to be a

crime, this is not going to be a crime. They wanted to be able to

make sure that they could play with it.

Mr. FOARDE. Our shadows are getting long this afternoon, but I

think I would like to take the privilege to ask the last question for

the afternoon and just pick up on a theme that I think both Jim

touched on, and Eric as well, in your opening presentations, on how

China compares with the sort of counterfeiting history of Taiwan,

Hong Kong, and South Korea. If you could help us a little bit to

understand your views about where China is on that continuum

and get into that a little bit more deeply in the couple of minutes

we have remaining, I think it will be very useful for us.

Mr. SMITH. I can say that it is a little difficult to talk about Taiwan in this context, because what happened was, from 1989

through 1998, they had an enforcement campaign that drove audio

and video piracy rates, as I say, down to like 12 and 15 percent.

We crowed about Taiwan as our success story. Then what happened, is the Taiwan government let the OD factories, the optical

disk factories, go. They kind of relaxed and the pressure went off.

All of a sudden, there were 60 factories. Organized crime took over

and they were investing on the mainland, they were investing in

Hong Kong, they were investing in Thailand and Malaysia, and it

went out of control and piracy went back up to 50 percent. So, it

is now back down. It is going back down again. I would say you

could cite Taiwan as an example of a country very much like the

mainland, but much smaller, where the political will was there.

Korea is another example. Within a period of maybe five years,

they went from 90 percent piracy rates down to 15 percent piracy

rates. So, again, a smaller country, a country that at the time had

a government that was not as democratically oriented as it is now,

and the piracy situation in Korea is not quite as good. It is a whole

new thing. The Internet is in Korea now. It is the most wired country in the world and piracy is out of control. But back in the days

before the Internet, piracy was under control.

So, our message is, China could do this. This is not impossible.

You do not have to take every person on the street and make them

a cop to stop piracy. It is called smart enforcement, deterrent enforcement, not just throwing bodies at it. The SAICs have 100,000

employees and they are doing trademark enforcement. I do not

work much with the SAICs, but there are a lot of people. It does

not necessarily take a lot of people. It takes smart enforcement, not

bodies.

Mr. FOARDE. If either of you would like to comment on that in

the minute or so we have remaining, please.

Mr. ZIMMERMAN. I think there is a pattern between Taiwan,

South Korea, and China here, and also, with Mexico and Latin

America, where you have countries that have underdeveloped legal

systems and where their focus is on low-cost manufacturing. They

are going to find a way to make money and make money off counterfeiting. I remember in the early 1970s in Mexico, there were

knock-off eight-track tapes and cassettes that were readily available on the streets. I am not sure if you will find those today. I

25

think Mexico has made progress on IPR issues. But there is a pattern. China is, of course, a bigger country.

I do agree with what Eric is saying. What is required is smart

enforcement. It is coordination of resources, dedicating more resources, and then having the political will to go after those criminal

organizations and to shut them down. But we have also got to keep

reminding China that there is a tremendous benefit for their own

industry, for their own tax revenues to make this a priority. We

cannot keep saying to them, ‘‘Hey, this is to protect foreign companies,’’ or ‘‘this is to protect foreign IP holders.’’ That is part of the

equation.

The other part of the equation is that you have to protect your

own industry, and, most importantly, to protect themselves and

their reputation internationally. China has a lot to gain by being

an international player. They have a lot to lose by being labeled as

a hub for knock-off manufacturing. That reputation is not something that China wants or needs.

Mr. CHOW. I know that many people draw comparisons between

Taiwan, South Korea, and China. But Taiwan and South Korea felt

the pain of counterfeiting, and that has not happened to China. I

am not sure if it is going to happen to China.

The other thing is that there is this basic assumption that we

have that no nation can achieve a high level of industrial and economic development without respect for IP laws. But I am not sure

that that historical lesson is going to apply to China. I mean, I

think we may be seeing the emergence of a new type of economy,

one in which piracy rates remain permanently higher than anything we have ever seen before, and the economy continues to

grow. That is what is going on. The economy continues to grow at

rates which are the envy of the world. China continues to be the

largest recipient of foreign direct investment in the world, consumer wealth and spending continue to increase, all this against a

background of a commercial piracy problem that has no parallels

in world history. So, I do not know that the historical lesson is

going to apply to China, and I think that China may test that. We

may be seeing something new.

Mr. FOARDE. I take it from what we have heard before, particularly from Eric, that there is not universal agreement on that

point, but I am glad that we heard a diverse set of views on this

question.

Our time for this afternoon is up, unfortunately, so we are going

to have to leave it there. I would like to thank, on behalf of Senator

Chuck Hagel, our Chairman, and Congressman Jim Leach, our CoChairman, our three panelists, Eric Smith, Jim Zimmerman, Daniel Chow, and also all of you who came to listen this afternoon.

We hope you will join us again next week on Monday afternoon

at 2 p.m. over in 2255 Rayburn for a roundtable on unofficial religions in China.

So we will call this one closed for today. Thank you all.

[Whereupon, at 3:34 p.m. the roundtable was concluded.]

(27)

A P P E N D I X

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PREPARED STATEMENTS

PREPARED STATEMENT OF DANIEL C.K. CHOW

MAY 16, 2005

COUNTERFEITING IN CHINA

I. INTRODUCTION

In terms of size, scope, and magnitude, counterfeiting in China is considered by

many to the most serious counterfeiting problem in world history. (As used here,

counterfeiting refers to the unauthorized use of trademarks owned by another on

identical or similar goods.) A recent study by the PRC State Council Research and

Development Center reported that in 2001 the PRC economy was flooded with between $19–$24 billion worth of counterfeit goods. Brand owners in China estimate

that 15 to 20 percent of all well-known brands in China are counterfeit and estimate

their losses to be in the tens of billions of dollars. Counterfeiting is estimated to now

account for approximately 8 percent of China’s gross domestic product.

China is also a leading exporter of counterfeit products to other countries in Asia, Europe, and the United States. In 2003, China accounted for 66 percent or over $62

million of the $94 million of all counterfeit and infringing goods seized by the U.S.

Customs Service at ports of entry into the United States. Mid-year figures in 2004

indicate that seizures are sharply higher with $64 million seized in the first half

of 2004 alone. An ominous development is that beginning in 2004, exports of counterfeits from China to the United States and other parts of the world may begin

to increase significantly for the foreseeable future.

II. ORIGINS AND CAUSES OF COUNTERFEITING

There are several explanations for the unprecedented size and scope of counterfeiting in China:

(1) Foreign Direct Investment and Advanced Technology. China’s economic growth

through the decade of the 1990s has been fueled in large part by foreign direct investment (FDI) from multi-national enterprises (MNEs). In the 1990s, China

emerged as the world’s second largest recipient of foreign direct investment behind

only the United States and in 2002, China surpassed the United States to become

the world’s largest recipient of foreign direct investment with $50 billion of foreign

capital inflows. FDI is the best means in the world today for the transfer of advanced technology, intellectual property, and other forms of valuable information. In

many cases today the intellectual property component of a FDI in the form of patents, copyrights, and trademarks is the most important component of the foreign investment. For example, the value of the Coca-Cola trademark in China is worth

more many more times to that company than the millions of dollars in capital that

it has invested in China. The same is true for the patents and copyrights owned

by pharmaceutical companies and software companies doing business in China

today. However, while MNEs are creating a transfer of technology through FDI that

is being absorbed into China’s legitimate economy through joint ventures and wholly

foreign owned enterprises some of this intellectual property is also being diverted

into China’s illegitimate economy as pirates steal this technology to engage in counterfeiting and other forms of commercial piracy. It is no coincidence that China, the

world’s largest recipient of FDI, advanced technology, and intellectual property also

has the world’s most serious commercial piracy problem.

(2) State Support of Counterfeiting and Local Protectionism. No problem of this

size and scope could exist without the direct or indirect involvement of the state.

In China, the national government in Beijing appears to be sincere in its recognition

of the importance of protecting intellectual property rights, but national level authorities are policy and law-making bodies whereas enforcement occurs on the

ground at the local level. At this level, local governments are either directly or indirectly involved in supporting the trade in counterfeit goods and are often reluctant

to punish counterfeiters.

(3) Ineffective Legal Enforcement and Lack of Deterrence. China has a developing

legal system that is weak in many respects by comparison to legal systems in advanced industrialized countries such as the United States. While China’s intellectual property laws are now considered by most observers to be in compliance with

the standards set by TRIPS, enforcement of these laws remains inadequate and fails

to create sufficient deterrence of counterfeiting.

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The combination of these factors—the world’s largest influx of foreign direct investment and widespread access to advanced technology, direct or indirect government involvement and support of the counterfeit trade, and a weak legal system

that does not create sufficient deterrence for counterfeiters in a very lucrative

trade—has resulted in a counterfeiting and commercial piracy problem that is unprecedented in world history.

III. OVERVIEW OF COUNTERFEITING IN CHINA

The illegal trade in counterfeit goods in China can be divided into two components: manufacture and distribution:

(1) Manufacture: The manufacture of counterfeit products tends to be concentrated in China’s southeast region in coastal areas near Taiwan and Hong Kong.

Criminal organizations in Hong Kong and Taiwan involved in smuggling, prostitution, and narcotics have now branched out into counterfeiting because of its lucrative nature. These criminal organizations supply the capital and startup costs and

use the borders between China and their headquarters in Taiwan and Hong Kong

to frustrate and elude law enforcement.

(2) Distribution: Distribution of counterfeit products occurs through a series of

large open air or partially enclosed wholesale markets. These wholesale markets are

found in strategic locations around the country and are positioned to serve large

densely populated urban areas. These wholesale markets are established and regulated by the local Administration of Industry and Commerce (AIC), a branch of the

local government responsible for promoting, regulating, and policing commercial activity. Based on the experience of the author, every wholesale market in China traffics in counterfeit goods. As AICs are also one of the primary government entities

in China charged with enforcement against counterfeiting, AICs are faced with a

conflict of interest as they are charged with policing and enforcing the very markets

in which AICs and the local government have a substantial investment and financial interest. Shutting down these wholesale markets would not only result in a direct loss of revenue to the AIC but would also have many repercussions as many

retail businesses, hotels, restaurants, and nightclubs are all supported by the trade

in counterfeit goods.

IV. BARRIERS TO EFFECTIVE ENFORCEMENT AGAINST COUNTERFEITING

(1) Local Protectionism: While it appears that central level leaders understand the

importance of protecting intellectual property for promoting China’s long-term economic development, central level authorities are legislative and policymaking bodies. Actual implementation and enforcement of the law occurs at the local level

where there continue to be questionable commitments to suppressing counterfeiting,

copyright piracy, and other forms of economic crimes. Local areas benefit directly

and indirectly from counterfeiting. In some areas, counterfeiting provides jobs and

generates revenue that are essential to support the local economy. In some cases,

counterfeiters voluntarily pay substantial taxes to local authorities. In other cases,

legitimate businesses such as hotels, restaurants, nightclubs, storage and transportation companies have been created to support the trade in counterfeit goods. The

payment of taxes and the creation of lawful supporting businesses has integrated

counterfeiting into the legitimate local economy. It is no exaggeration to say that

some local areas in China are entirely supported by the trade in counterfeit goods

and that local residents are ready to use any means necessary to protect their illegal

trade. A crackdown on counterfeiting would result in shutdown of the local economy

with all of the attendant costs of unemployment, dislocation, social turmoil, and

chaos. Because the costs of a crackdown at the local level can be so severe, counterfeiting is heavily defended at local levels.

(2) Inadequate Punishment: Local protectionism and a weak legal system contribute to the lack of adequate enforcement against counterfeiting. The result is that

the Chinese enforcement system does not create deterrence. To be sure there is no

lack of enforcement activity. To the contrary, it is relatively easy to obtain an administrative action in the form of a raid and seizure action against suspected counterfeiters. The problem is that once the enforcement action is completed the level

of fines and criminal prosecutions are so low that whatever sanctions are meted out

do not create deterrence. For example, the average fine imposed on the counterfeiter

or infringer in 2000 was $794, a figure that is so low as to be considered a cost of

doing business in a very lucrative trade. The amount of compensation awarded to

brand owners in 2000 stands at $19, a negligible amount. Damages awarded by

AICs seek to award the brand owner the profits earned by the counterfeiter after

deducting all expenses (as represented by the counterfeiter) and are not based upon

economic losses suffered. As for criminal prosecutions, in 2000 only about 1 in 500

30

cases were referred to judicial authorities for criminal prosecutions. Enforcement in

China does not create fear in counterfeiters or deterrence.

V. EXPORTS FROM CHINA

Recent changes indicate an ominous development: exports from China are likely

to increase dramatically beginning in 2004.

(1) Exports to the United States: In 2003, U.S. Customs seized a total of $94 million of counterfeit and infringing goods in ports of entry at the United States. Of

this total, products originating in China accounted for 66 percent of the total and

$62 million of the total. The 2003 figures for China represent a significant increase

over comparable 2002 figures when China account for 49 percent of all counterfeiting and infringing products and $48 million of the total $98 million of illegal

product seized by U.S. Customs. Counterfeits from China and Hong Kong (through

which many counterfeits produced in China are transshipped) accounted for $80

million or 75 percent of the total. No other country accounted for more than 3 percent of counterfeit products. As many counterfeit products, such as auto parts, that

originate in China are transshipped through other countries, such as those in South

America and through Canada, before ultimately entering the United States, China

likely accounts for a significantly higher percentage than the 66 percent set forth

the 2003 U.S. Customs statistics. It is possible that China accounts for as much as

80 percent or more of the counterfeits goods that enter the United States. Note that

the $94 million figure represents only the value of the products that are seized by

U.S. Customs in 2003, which can only be a tiny fraction of what enters the U.S.

market. If the total value of the products seized represents 1 percent of the counterfeiting and infringing product that enters the U.S. market then the total value of

counterfeits that entered the U.S. market in 2003 is approximately $10 billion with

China accounting for between $6 and $8 billion of that total. It is possible that the

actual figures are much higher.

(2) WTO Commitments: There is likely to be a significant increase in the amount

of counterfeit products exported from China to the United States beginning in 2004

and for the foreseeable future for several reasons. In accordance with its WTO obligations, China has amended its foreign trade laws in December 2003 to eliminate

the monopoly on export rights that had been limited to state trading companies.

Under prior law, only certain designated state trading companies were permitted to

lawfully export products from China to other countries. This restriction meant that

counterfeiters had to find a compliant state trading company that was willing to

work together with the counterfeiter in exporting the illegal goods overseas. To be

sure, there was no shortage of export companies willing to work with counterfeiters

in exporting counterfeit and infringing products, but this requirement nevertheless

created an additional obstacle and costs that have now been removed. The effect of

the elimination of the monopoly on exports rights means that anyone can now lawfully export products from China. As counterfeiters are likely to take full advantage

of the elimination of this restriction, exports of counterfeits from China to the

United States are likely to surge for the foreseeable future. U.S. Customs mid-year

seizure figures for 2004 indicate that there is a sharp increase in seizure activity:

$64 million in counterfeit goods were seized by mid-year 2004 compared to $38 million by mid-year 2003.

(3) Lack of Criminal Laws: China does not appear to have any current criminal

laws that specifically apply to the export of counterfeit products. As the earlier discussion indicated, China has criminal laws against commercial scale counterfeiting

within China, although the effective enforcement of these laws is impeded by various obstacles. In the area of exports, however, it is arguable that there are no applicable criminal laws at all, and that counterfeiters can export with impunity from

both civil and criminal liability. As pressure mounts on China to obtain better enforcement results within China, it is likely that counterfeiters will turn increasingly

to exports as a source of revenue.

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PREPARED STATEMENT OF ERIC H. SMITH

MAY 16, 2005

Mr. Chairman, Members of the Commission and Commission Staff, IIPA and its

members thank you for the opportunity to appear today to review China’s record

on enforcement of its copyright law against widespread piracy and China’s compliance with its WTO-TRIPS obligations. IIPA represents the U.S. copyright industries. Its six member trade associations consist of over 1,300 U.S. companies,

accounting for millions of U.S. jobs. The copyright industries, in 2002, contributed

over $625 billion to the GDP, or 6 percent of the U.S. economy and almost 5.5 million jobs or 4 percent of U.S. employment. These companies and the individual creators that work with them are critically dependent on having strong copyright laws

in place around the world and having those laws effectively enforced. On average,

the copyright industries generate over 50 percent of their revenue from outside the

United States, contributing over $89 billion in exports and foreign sales to the U.S.

economy. Given the overwhelming global demand for the products of America’s creative industries, all these numbers would be significantly higher if those trading

partners, including China, that continue to allow piracy to flourish in their own

economies were to significantly reduce piracy rates by enforcing their copyright law

vigorously.

Before turning to the important topic of this Roundtable, I want to provide you

with a brief update to IIPA’s comprehensive February 2005 Special 301 submission

on China to the U.S. Trade Representative. In that submission we called for entering into a new, multilateral dialogue in the WTO with the Chinese government as

a way to persuade it to take aggressive action—as promised in the Joint Commission on Commerce and Trade Meetings over one year ago—to significantly reduce

the rate of piracy in all IPR sectors including the copyright sector. We then provided

a summary review of what had happened in China over the last year to redeem that

commitment. Our conclusion: China has failed to comply with its commitment made

over one year ago in the JCCT to significantly reduce piracy rates. While some modest reductions have occurred in some sectors, by no measure have piracy rates been

significantly reduced. In fact little has changed in the marketplace for our members

and their companies, despite reports of increased raiding activity and seizures of

many pirate products. For the record, I am submitting a copy of that Special 301

submission which tells the story of the failure of an enforcement system to deter

rampant piracy in the potentially largest market in the world.

On April 29, 2005, USTR issued its decision resulting from the out-of-cycle review

of China’s enforcement practices announced on May 3, 2004. USTR reflected in this

decision its deep concern over China’s lack of progress in the enforcement area by

elevating China to the Priority Watch List. It also announced a number of other initiatives, one of which was to work closely with our industries with an eye on utilizing WTO procedures to bring China into compliance with its WTO obligations.

Since that time we have met with USTR to begin this process and will work intensively with USTR toward the mutual goal of bringing China into compliance with

its WTO TRIPS obligations, its bilateral obligations to the United States in the 1995

and 1996 IPR agreement and action plan, and its commitments made to our government in the JCCT process.

This process has now commenced in earnest. USTR will also be seeking information from the Chinese government under the transparency provisions of the TRIPS

agreement, and is committed to using the JCCT process to encourage the Chinese

government to implement key reforms on both the enforcement and the all-important market access front.

Mr. Chairman, our industries are deeply frustrated by the lack of real progress

by China in taking effective action to deter piracy and to open up its market to legitimate cultural and high technology copyright products. China remains one of the

most closed markets in the world for the U.S. copyright industries. Onerous market

access restrictions affect all our industries. Notwithstanding Premier Wen’s pledge

to address the $162 billion trade imbalance between the United States and China

by increasing China’s imports from the United States, China is retaining—and, in

some sectors, augmenting—market access restrictions for creative and high-tech

products that represent America’s comparative advantage.

Copyright piracy represents perhaps the largest barrier to effective market access

in China. An average (and truly staggering) 90 percent piracy rate has persisted for

years despite repeated ‘‘strike hard’’ enforcement campaigns, steamroller campaigns,

and public statements from many high level government officials supporting stronger enforcement. While our Special 301 submission highlights the current situation

in China, I wanted to give you a brief flavor of what copyright companies confront

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in trying to do business in China in face of these trade barriers and these inexcusably high piracy levels.

Taking the business software industry first—one of our nation’s most productive

and important creative sectors: The software industry faces piracy rates in China

of 90 percent, one of the highest in the world for that industry. China leads the

world in the production and export of counterfeit software—software packages that

are purposely designed to replicate the original legitimate product. Losses to U.S.

software publishers were estimated by the Business Software Alliance (BSA) at

$1.47 billion in 2004. China was the 6th largest market in the world for personal

computers and ranked 26th in legitimate software sales. This increasing disparity

not only damages the U.S. industry but hurts Chinese software developers as well.

China has failed to criminalize the most damaging type of piracy to the business

software industry—the unauthorized use of software within businesses and government institutions. This is a violation of the TRIPS Agreement. Combined with the

total absence of a criminal remedy is the absence of all but a few administrative

actions against this type of piracy with woefully low and non-deterrent fines. As a

consequence, piracy rates continue to remain at staggering levels.

To make matters worse, China is on the verge of shutting down access for U.S.

and other foreign companies to the largest purchaser of software in China: the Chinese government. It would accomplish this by adopting draft government procurement regulations that would expressly favor Chinese software only. In short, the

situation for this critical copyright sector is truly dire in China with no significant

improvement in sight.

The U.S. motion picture industry is facing a 95 percent piracy rate in China (the

highest in the Asia Pacific region, and among the highest in the world) which represents a worsening of the situation from the previous year. Losses to just the motion picture industry, from 1998 through 2004, are estimated at over $1 billion (not

including losses from Internet piracy, which are growing alarmingly). While raids

and seizures have increased somewhat following Vice Premier Wu Yi’s 2004 enforcement campaign, administrative fines remain far too low to deter pirate activity and,

as I will describe later, criminal cases have been extremely rare despite Chinese

promises to use this TRIPS-required remedy. According to a recent newspaper report, the legitimate home video market in China represents about 5 percent of the

estimated total market of $1.3 billion (which is itself a very conservative estimate).

Of the 83 optical disc factories licensed by the government (and an unknown number of ‘‘underground’’ unlicensed plants), many continue to churn out pirate DVDs.

The export of pirated home video product, which had slowed to a trickle after the

U.S. Section 301 action (and threatened retaliation) in 1995–96, has resumed and

is growing. The total optical disk plant production capacity, a significant amount of

which is devoted to producing pirate product, is now close to 2.7 billion units annually. Optical disks sourced in China and containing pirated films have been seized

in over 25 countries around the world. The massive quantity of pirated movie product available in China is evidenced by the fact that pirate prices start around $0.60

per unit the lowest price in Asia. As with the other copyright industries, any enforcement that occurs is conducted by administrative agencies, with overlapping jurisdiction and often little coordination, and fines imposed are a mere ‘‘cost of doing

business.’’ A recent anecdotal study, conducted by IIPA member, the Motion Picture

Association (MPA), revealed that the average fine imposed per pirate home video

product (DVD, VCD) seized in raids resulting from MPA complaints is only slightly

higher than the cost of purchasing a blank disk—clearly of no deterrent value. The

lack of deterrent administrative penalties is a key reason, in addition to the almost

complete lack of criminal enforcement that piracy rates persist at 90 percent of the

market and above.

Accompanying and reinforcing this piracy situation are onerous market access restrictions, including a Government-owned, monopoly importer, very limited competition in distribution, and a quota of 20 theatrical films allowed into China annually

on commercial terms. The pirates capture 100 percent of the market for films not

permitted legally in China. Even those films permitted theatrical release suffer piracy rates of 70–75 percent, because of the long delays before most American films

are given screen time. Another consequence of the lack of competition in importation

and distribution is the non-competitive pricing in the Chinese market. Cumbersome

licensing requirements burdens the retail sale of legal home entertainment product,

holding down revenue potential and helping keep the market in the hands of the

pirates. These barriers and those to all our industries must be removed in the JCCT

process.

The entertainment software industry, one of the fastest growing copyright-based

industries, faces similar high piracy rates and estimates the value of pirated video

games in the market at $510 million in 2004. Demand for entertainment software

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products is growing rapidly but is being soaked up primarily by the pirates. This

demand is exemplified by the exploding popularity of ‘‘massively multiplayer online

roleplaying games’’ (MMORPGs) where literally thousands of players can compete

against one another simultaneously. Demand for MMORPGs in China grew at 40– 45 percent over expectations in 2004. This increasing demand has fueled, in part,

the growth of Internet cafe ́s in China. (It is estimated that there are close to

200,000 Internet cafe ́s in the country, with a seating capacity of between 100–300

seats, of which 60 percent are involved in game play.) While U.S. game publishers,

represented by IIPA member, the Entertainment Software Association (ESA), have

engaged in some licensing of the cafe ́s, the vast majority of the product used is pirated, either available at the cafe ́ or downloadable from the Internet. This dire situation has been all the more exasperating since the Chinese government extensively

regulates the activities of these Internet cafe ́s and often and vigorously revokes licenses for actions the government deems inappropriate. However, as far as we

know, the government has never sought to include in this extensive regulatory

scheme prohibitions against the widespread and blatant piracy at these cafe ́s in its

business licenses (which are otherwise very thorough). Moreover, no copyright enforcement of any kind has occurred. The legal infrastructure governing the Internet

still is not helpful to copyright enforcement. Takedown of pirate sites is negligible;

penalties non-existent.

Cartridge-based handheld games are also hard hit by the pirates with manufacturing and assembly operations throughout China with exports throughout Asia,

Latin America, the Middle East and Europe. Enforcement attempts have been relatively successful in terms of raids and seizures but, like with other industries,

administrative fines are non-deterrent and criminal enforcement action very rarely

undertaken, even against factories generating millions of dollars in illicit profits.

Entertainment software products are also subject to a protracted content review

process, by two separate agencies contributing to market entry delays. Given the immediate nature of the demand and lifecycle of best selling games, this leaves the

pirates virtually uncontested in the market prior to the official release of a new

title. There are also Internet and investment restrictions that must be significantly

eased or abolished.

The U.S. book publishing industry, represented by IIPA member, the Association

of American Publishers (AAP), faces both significant offset printing of pirated books,

primarily in translated editions, and massive commercial photocopying of textbooks

and reference books on and near University campuses. There are 580 licensed stateowned publishers in China, 50 of which are considered major. There are only a few

privately owned publishers but they must buy publishing rights from the stateowned publishers. U.S. publishers issued 4500 translation licenses in 2004, a significant number but far below China’s potential. All the best selling books are then

virtually immediately pirated by outlaw ‘‘printers’’ and made available through independent bookstores, stalls and street vendors. To give an example, the famous selfhelp bestseller ‘‘Who Moved My Cheese’’ sold over 3 million copies in China. It is

estimated, however, that the pirates sold another 6 million copies. The Harry Potter

books, and other best sellers like Hilary and Bill Clinton’s books ‘‘Living History’’

and ‘‘My Life,’’ John Grisham’s books and others all face a similar fate from the pirates. Former General Electric President, Jack Welch’s biography, ‘‘Winning,’’ has

sold over 800,000 copies but with an equal number of pirate copies available in the

market. English language textbooks are also heavily photocopied in their entirety

and there are six known websites which make available entire copies of textbooks

that are downloaded and then photocopied. Enforcement against this vast piracy is

spotty and all done administratively through the local and national copyright bureaus. Any resulting administrative fines are non-deterrent. We know of no criminal

enforcement. The book publishing industry also faces market access barriers—U.S.

publishers are not permitted to publish, sign authors, or print their books in China.

The recording industry, represented by IIPA member, the Recording Industry Association of America (RIAA) did experience a minor reduction in the piracy rate for

sound recordings, from 90 percent in 2003 to 85 percent in 2004 in ‘‘hard goods’’

piracy, but with significant increases in Internet piracy. Losses remain in excess of

$200 million per year from continued optical disk manufacture and distribution

within the Chinese market and significant levels of audiocassette piracy (still an important format in China). The recording industry faces many of the same problems

with optical disk piracy confronting the motion picture industry. Millions of pirated

music CDs are readily available throughout China. Some of these pirate products

have found their way into the export market. China continues to rely on its failed

administrative enforcement system, which relies on numerous inspections, product

seizures and, when the pirate doesn’t flee, the imposition of small, non-deterrent

fines.

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1 Anne Stevenson -Yang and Ken DeWoskin, China Destroys the IP Paradigm, Far Eastern

Economic Review (March 2005).

Internet piracy in China, as in other countries in the world, has become a huge

problem for the recording industry. Thousands of active websites such as

www.9sky.com and www.chinaMP3.com are giving away, or offering links to, thousands of pirated songs. (These not-for-profit acts of piracy are not criminalized in

China, as they are, for example, in the United States.) International criminal syndicates are apparently using Chinese servers to hide their illicit activity

(www.boxup.com) and many Asian pirate sites are doing a thriving business in

China, such as www.kuro.com from Taiwan.

Market access restrictions are severe, contributing to piracy and market losses.

U.S. record companies cannot ‘‘publish’’ or release a recording without permission

of a state owned company and cannot manufacture, distribute or engage in retailing

of its products, which artificially segments the market and makes it extraordinarily

difficult for this world class industry to participate in the Chinese market. Its products are subject to censorship while domestic (as well as pirate) recordings are not— a national treatment violation.

All in all, the copyright industries estimate their total losses in excess of $2.5 billion in 2004 due to piracy in China. The simple fact remains that these losses and

the 90 percent piracy rates will NOT be significantly reduced without subjecting

major piracy to criminal enforcement accompanied by deterrent penalties and substantially increasing the administrative fines specified in the copyright law and imposing them in practice. To date, even after the JCCT commitments, this has NOT

happened and there is a real question whether the Chinese government as a whole

(Vice Premier Wu Yi has been a staunch defender of better enforcement) can muster

the political will to take these absolutely necessary actions—actions that have been

key to significant reductions in piracy levels in other countries in which our companies operate. China cannot exempt itself from the rules—that enforcement against

piracy requires deterrence and criminal remedies. The global community recognized

this when it fashioned the Article 61 criminal obligation in TRIPS and it has proven

to be the case in practice.

The Commission has asked the key question that has trouble everyone associated

with China’s IPR regime: ‘‘Will China ever enforce its IPR laws.’’ The article in the

Far Eastern Economic Review,1 provided to us by the staff, sets out the interesting

thesis that this failure has nothing to do with ‘‘stages of development’’ or ‘‘cultural

attitudes.’’ We completely agree. These shibboleths have regularly been argued to

excuse China (and other countries) from meeting their freely bargained-for WTO obligations. In fact, other countries have similar ‘‘cultural attitudes’’ and are at or near

China’s development level and they have done a far better job bringing deterrence

to their copyright enforcement system thereby reducing piracy rates. Piracy is an

economic crime and responds to economic disincentives placed in the pirates’ way

by an effective, deterrent enforcement system. If the risk is too high, the conduct

will cease or be substantially reduced. The authors also set out the view that Chinese government control over its economy and the ‘‘command’’ nature of the government’s involvement contains built in incentives to continue to permit infringements

as a way of protecting tottering state-owned enterprises. We have no expert view

on this but observe that China has sought to preserve the import and distribution

monopolies that are pervasive in the copyright sector. The thesis seems to apply

more, however, to the patent and trademark areas of IP protection, rather than to

copyright, where it is becoming clearer to us at least that the harm from copyright

piracy is falling increasingly on Chinese creators and Chinese companies (some

rather large too). These companies, because they are either state-owned (and find

it difficult to confront their own government for its failures), or are private (and the

government, like many governments in developing economies, are not yet responsive

to the entreaties of their private sector) face a governmental response that derives

primarily from internal bureaucratic needs, first and foremost. An illustration might

be the apparent unwillingness of the Chinese authorities to lower the thresholds for

initiating a criminal prosecution so that they become workable in practice (a result

not accomplished in our opinion in the new Judicial Interpretations issued in December 2004) and to follow with criminal prosecutions and deterrent penalties. The

reason given is that bringing more criminal cases would risk overwhelming the enforcement bureaucracy. However, many other governments face this same potential

argument and have nevertheless determined that criminal enforcement is a necessary condition to reducing piracy (as well as being a WTO obligation). Furthermore, we should not underestimate the problem that the central government faces

in controlling what happens at the provincial level. We believe, however, that,

through the Politburo and the Party structure, this impediment can be overcome,

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if the political will is there. It may be that such political will CAN be generated

if the proper ‘‘incentives’’ are there. An example of this would be when the Chinese

government (at the highest ‘‘political’’ level), in 1996–97, closed many of the CD factories that were exporting pirate optical disk product globally under threat of U.S.

trade retaliation.

Regardless of the reasons why the Chinese government has not, at least yet, decided to take deterrent criminal actions against major acts of piracy (as required by

TRIPS), to make necessary amendments to its criminal law (as required by TRIPS),

to further amend its Judicial Interpretations to reduce the hurdles to effective criminal prosecutions, and to increase administrative penalties and impose them at deterrent levels, they are nevertheless under an international obligation (in the WTO),

and a bilateral obligation (under the 1995–1996 bilateral agreement settling the

Section 301 case) to do so. Moreover, it is not in China’s own interest to undermine

its own domestic creative industry and to continue to foster trade friction with its

key trading partners. Other governments in the Asian region have made the political determination that effective enforcement is in that country’s own interest.

China must do the same and do so NOW. Thank you very much for the opportunity

to participate in this Roundtable.

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1We are pleased with Vice Premier Wu Yi’s commitment, made on behalf of the Chinese government at the April 2004 Joint Commission on Commerce and Trade (JCCT) meetings, to make

specific improvements in IPR laws and regulations; strengthening IPR education and enforcement; ratifying the WIPO digital treaties; establishing a joint U.S.-China IPR interagency working group to tackle enforcement issues; and promulgating the judicial interpretations on criminal

liabilities standards covering prosecution, conviction, and sentences. However, the 2004 commitments have not bee fulfilled and more work needs to be accomplished.

PREPARED STATEMENT OF JAMES M. ZIMMERMAN

MAY 16, 2005

AMCHAM-CHINA’S VIEWS ON CHINA’S IPR ENFORCEMENT RECORD

Thank you Mr. Chairman and staff members for this opportunity to present the

views of the American Chamber of Commerce, People’s Republic of China.

My name is James M. Zimmerman. I am the Vice Chairman of the Board of Governors of AmCham-China and Co-Chair of AmCham’s Legal Committee. I am a

partner and Chief Representative of the Beijing office of the international law firm

of Squire, Sanders & Dempsey L.L.P.

AmCham-China, which is based in Beijing, is an organization that represents the

interests of the American business community in China. Along with its sister organization in Shanghai, AmCham-China represents over 2000 companies and individuals

from virtually every state in the union, including small to medium sized businesses

and U.S. exporters without a formal presence in China. We do not represent the interests of Chinese companies or the PRC government. AmCham-China and its member companies are in the field every day fighting for market access for U.S. products

and services.

One of our core tasks is to meet with the Chinese government on a broad range

of issues such as for greater market access of U.S. goods/services, timely implementation of China’s WTO obligations, increased enforcement of intellectual property,

and continued improvement of China’s legal system and business environment.

AmCham-China and its member companies—given our on-the-ground presence

and years of in-country first-hand experience—are committed to assisting this Commission and Members of Congress in obtaining information and data to assist it

with respect to its investigation concerning the issues addressed in this forum today.

I am here today to share our concerns and efforts with respect to IPR protection

and enforcement in China.

Since its accession to the World Trade Organization (WTO) in December 2001,

China has made significant improvements to its laws governing intellectual property

rights (IPR). However, there has been minimal progress in establishing a system of

effective enforcement.

Indeed, counterfeiting and piracy problems in China are worsening and affecting

both Chinese domestic and foreign brands. More sophisticated infringement

schemes, combined with an increasing number of exporters, mean more counterfeits

are showing up in foreign markets. Piracy not only amounts in a tremendous loss

of revenue to IPR holders, but is also a consumer health and safety issue since counterfeit product rarely meets stringent quality standards.

The violation of intellectual property rights impacts almost all industry sectors including consumer and industrial goods. Among a few examples, computer software,

films, music recordings, clothing, cosmetics, auto parts, pharmaceuticals, and food

and beverages have all felt the sting of piracy.

In the media sector, it is common for a newly released film in the United States

to surface within days of its American release as a pirated copy in China. Pirated

DVDs in high quality packaging are now widely available in DVD stores throughout

Beijing, despite the Chinese government’s repeated commitments to crack down on

piracy.

Piracy is a deeply frustrating problem for our members. More than three-quarters

of respondents to the 2004 AmCham-China & AmCham-Shanghai membership questionnaire are negatively impacted by China’s poor IPR protection. Ninety percent of

our members believe China’s IPR protection is ineffective.

AmCham-China believes that the answer to the problem will only be tackled with

stronger national leadership to address IPR enforcement issues.1 Large department

stores and markets openly selling counterfeit and pirated goods are widespread

throughout China, including in Beijing itself. Chinese agencies report that they periodically raid these markets, sometimes imposing modest administrative fines on

vendors. However, the fact that these markets continue to operate in the public eye,

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2On January 19 2005, an AmCham delegation met with key members of the PRC Supreme

Peoples Court (the ‘‘SPC’’) to exchange views on the Interpretation by the SPC and the Supreme

People’s Procuratorate (the ‘‘SPP’’) on Several Issues Concerning Application of Laws in Handling Criminal Cases Involving the Infringement of Intellectual Property (the ‘‘Judicial Interpretation’’) that was effective in December 2004. While the language of the Judicial Interpretation

left much to be desired, Justice Huang Songyou, Vice President of the SPC, assured us that the

Chinese government was serious about fulfilling its WTO commitments and gave priority to IPR

protection. As stressed to the SPC, the key to enforcement is credible criminal sanctions that

deter commercial-scale IPR counterfeiters and pirates. We believe that the SPC (the highest

court in China) understands that effective action must be taken.

with seemingly no fear of meaningful legal penalty, creates the impression that China’s national leadership lacks the will to stop counterfeiting and piracy.

Among other things, we believe that strong IPR protection is not just to protect

the interests of foreign multinational corporations but also to guard the rights and

interests of domestic intellectual property rights holders and to protect the health

and safety of consumers worldwide that may purchase pirated goods.

With these general comments in mind, AmCham-China supports the USTR in

placing China on a Priority Watch List and initiating WTO consultations with

China under the TRIPS agreement. We believe that China needs to be put on notice

in the strongest and most direct terms possible, that the IPR problem must be effectively contained or the USG will be forced to either take WTO action (with all the

uncertainty that entails given the untested nature of the WTO TRIPS Agreement).

AmCham is in favor of exploring ways to taking action against specific regions,

cities, or provinces in the PRC that are areas of flagrant IPR abuse, or specific Chinese companies which engage in repeated and gross violations of IPR.

While enforcement efforts have been lax, we believe the Chinese are growing more

aware of their poor performance on IPR there is nowhere near the required effective

and deterrent enforcement measures as required by WTO. As we have stressed to

the PRC leadership, the key to enforcement is credible criminal sanctions that deters commercial-scale IPR counterfeiters and pirates.

For its part, AmCham-China has developed an exchange and education program

of its own to encourage more effective enforcement in China and this program in

general includes, among other things, the following components:

• IPR Index of Enforcement: AmCham-Beijing has created an IPR Index which

measures whether China’s IPR enforcement is improving or not. We are currently conducting the baseline survey and plan to publish the results three

times a year. This information will be available to the public, including the PRC

and U.S. governments. We recognize that we in the private sector—here and

in China—need to provide much more data on specific examples of inadequate

Chinese enforcement. Our IPR Index will aid this effort and we are also taking

steps to advise and inform our members of the importance of collecting and

sharing such information directly with the USG.

• Legal Exchange and Education Efforts: AmCham is pressing various PRC government agencies and judiciary to take certain key steps during the next year.2

In short, we have stressed to the PRC government that several laws must be

amended/adopted to provide stronger protection, enhanced penalties, and further clarification of standards. As part of its efforts, AmCham-China and

AmCham-Shanghai jointly publish an English/Chinese language issues White

Paper on an annual basis for purposes of educating the Chinese government on

areas of concern for U.S. business, and included in the White Paper is a detailed analysis of U.S. industries’ concerns with IPR enforcement. At the end

of this Statement is a draft of excerpts from our White Paper and reflects some

of the issues we continue to emphasize to the PRC leadership.

• Benchmarks and Performance Criteria: This will be indicative of its commitment to IPR (we developed this list independently but it bears many similarities

to the list of tangible results expected of China in USTR’s April 30 Special 301

Report):

—Impose criminal sanctions against a significant number of large-scale

Chinese counterfeit operations. This crackdown should be widely publicized

in the media.

—There should be a significant decline in seizures of counterfeit goods at

US and EU ports as a result of Chinese customs interception actions.

—Chinese patent authorities should avoid retroactive rulemaking which undermines the perceived value of Chinese patents and creates unpredictability for foreign investors. An example of this behavior is the invalidation

of Pfizer’s Viagra patent.

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—China should substantially increase its budget dedicated to enforcement

of IPR and give national police the authority to operate across jurisdictions

within China.

—China should substantially increase the budget for the Trademark Office

to resolve the backlog of invalidation cases pending (i.e., 20,000 cases and

some pending since 1999).

AmCham further believes that the U.S. Government should dedicate additional

resources to counter the effect of PRC-based counterfeiting and to support China’s

efforts to develop an effective enforcement system, including the following:

• Significant increase of U.S. Customs personnel dedicated to interception of Chinese counterfeit goods.

• Increase in U.S. Customs’ cooperation in cross-border criminal investigations

with China and EU.

• U.S. government, particularly USPTO, to engage in more cooperative technical

assistance programs to assist China in raising the level of IP practice so that

U.S. companies can benefit. An improved patent/trademark examination system

may expedite the grant of IP rights to U.S. companies.

In summary, the AmCham-China and AmCham-Shanghai believe that China has

made progress in the past three years with respect to its IPR laws, but much focused and aggressive work remains in order to elevate China’s system to international standards and to give worldwide IPR holders a comfort level that their

intellectual property interests will be respected and protected in China, and that infringing parties will be punished. China’s IPR standards and regulatory system—

as a work in progress—requires strong national leadership and the dedication of

capital and resources to be more effective and respected.

Thank you for this opportunity.

EXCERPTS OF AMCHAM-CHINA AND AMCHAM-SHANGHAI’S DRAFT 2005 WHITE PAPER

CONCERNING INTELLECTUAL PROPERTY RIGHTS ISSUES

Central Government Resources: The Chinese leadership needs to devote more of

its political capital and bureaucratic resources to shaping a national IPR strategy

and putting into place an effective IPR enforcement regime. There is a need for revised laws, regulations, and policies. The most glaring deficiency in China’s IPR regime at this time is in the need to revise the one key law that was not revised when

China joined the WTO—its criminal code, which should be revised to provide stronger protection, enhanced penalties, and further clarification of standards. More attention is needed on the ‘‘big impact items to improve local enforcement, raise public

awareness and strengthen intellectual property customs protection, and enhance

interagency coordination.

Interagency Coordination: The lack of coordination among the many Chinese government agencies responsible IPR enforcement prevents effective enforcement. The

Administrations for Industry and Commerce Trademark Divisions (AIC), AIC Economic Supervision Divisions, Technical Supervision Bureaus (TSB), Copyright Administration offices, Customs, Public Security Bureaus (PSB) Social Order Divisions,

and PSB Economic Crimes Investigation Divisions (ECID), to name a few, have

overlapping jurisdiction and authority. Jurisdictional issues need to be resolved and

a program adopted to improve coordination.

Customs Enforcement: Since its WTO accession, China has liberalized its foreign

trade regime. This is a welcome development. An unintended consequence, however,

is that exports of counterfeit and pirated goods from China have increased sharply

in the past two years and are now a global problem. Further liberalization contemplated by the revised Foreign Trade Law may well accelerate this trend. Although verbal assurance from the Supreme People’s Court provides otherwise, there

is nothing in the written laws that indicates that it is illegal to export counterfeit

goods from China. This should be rectified and enforcement resources provided.

The PRC Intellectual Property Customs Protection Regulations, in effect from

March 1, 2004, and the related implementing rules, promise to improve IPR customs

enforcement. We are hopeful that Chinese customs will invest in the organizational

and equipment upgrades necessary to make these regulations fully effective. This

includes the purchase of a centralized computer system to enable customs officials

to track the activities of counterfeiters and copyright pirates.

The regulations themselves, however, contain several weaknesses. There are no

provisions to transfer suspected cases of criminal liability to the public security organs. AmCham-China and AmCham-Shanghai are also concerned about the removal

of administrative penalties from the customs regulations and hope that such penVerDate 11-MAY-2000 16:38 Jun 23, 2005 Jkt 000000 PO 00000 Frm 00078 Fmt 6601 Sfmt 6621 21813.TXT China1 PsN: China1
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alties will be reinstated. Presently, however, there appear to be no punishments for

willful trade in infringing goods.

Chinese regulations require IPR owners to carry a heavy burden for protecting

their intellectual property. For example, companies must provide customs officials

with precise information as to which port(s) counterfeit goods will be going through,

even though such information is very difficult to obtain. IPR owners also are required to post bonds to cover the risk of counterclaims in the event that a court

finds the detained goods are not counterfeit. The procedures and amounts are unreasonably burdensome, especially because the courts require a separate bond in the

event that a seizure leads to litigation. We believe IPR owners should be allowed

to post a single bond at the China Customs in Beijing covering the risk of counterclaims for all customs branches.

*Criminal Enforcement: The AmCham welcomes the release of the Judicial Interpretation on Issues Concerning Application of Laws in Handling Criminal Cases Involving the Infringement of Intellectual Property, effective in December 2004. While

the Judicial Interpretation significantly reduces the numerical thresholds to trigger

criminal IPR prosecutions, we are disappointed that the Judicial Interpretation fails

to include language concerning, among other things, the criminal liability for exporters of counterfeits and organizational end-users (and specifically with respect to the

misuse of software products); methods for calculating value of semi-finished infringing products; enhanced penalties for repeated offenders, violations of health and

safety, and other aggravating circumstances; and a clear definition of ‘‘illegal business income’’ which appears to allow the use of the infringing party’s prices and not

the actual loss by the genuine owner of the IPR. Moreover, the distinction between

individual and corporate infringing activity (with the threshold for unit or corporate

activity being significantly higher than for individual activity) is unfortunate since

it will simply encourage criminals to incorporate to avoid criminal liability. In the

end, the true test of effectiveness of the Judicial Interpretation—and the resulting

work of the courts and prosecutors—will be whether it is effective in deterring the

rampant infringement of IPR in China and in bringing more criminal prosecutions

and convictions in IP cases.

Administrative Enforcement: The existing system for administrative enforcement

of regulations against piracy and counterfeiting needs to be improved. The AIC and

the TSBs are key agencies providing support to intellectual property rights holders,

but their effectiveness is limited by policy and legal problems. For example, there

are no minimum standards for administrative fines; only a maximum standard.

Consequently, our members report the amount and scope of administrative fines is

dropping. We encourage the government to unify standards at the local level, combat local protectionism, and enhance interagency coordination.

Administrative Fines for Trademark Infringement: The State Council issued implementing regulations for the PRC Trademark Law, which entered into effect on

September 15, 2002. These regulations provide, inter alia, for a dramatic increase

in the maximum administrative fines that may be imposed on counterfeiters, from

the prior 50 percent of turnover to the current 300 percent. Unfortunately, these increases in maximum potential fines have yet to result in a significant increase in

actual penalties imposed. This is mainly due to the lack of guidelines from the State

Council and the Trademark Office of the SAIC as to how fines should be calculated.

Administrative Enforcement of Software Copyright: Copyright authorities at the

local level are crippled by inadequate manpower, training, and resources. Appropriate steps should be taken to ensure that the National Copyright Administration

(NCA) and their local offices responsible for enforcing copyrights are adequately

supported, such that rights holders can have reliable access to administrative and

civil remedies provided under relevant laws against end-user and other copyright

pirates. Effective coordination needs to be established with the SAIC to increase the

enforcement capability of the local Copyright Administration offices. There must be

reliable administrative enforcement coupled with deterrent penalties to prove that

corporate end-user piracy bears administrative liability. We look forward to the

prompt enactment of administrative rules by the NCA and the Ministry of Information Industry (MII) to deal with Internet piracy, takedown notice procedure and ISP

liability.

The following issues related to the Computer Software Protection Regulations

(issued by the State Council on June 4, 1991 and amended on December 20, 2001)

should be addressed: (1) the regulations should be modified to clarify that temporary

copies of software are protected; (2) the exception under Article 17—which allows

for the unlimited use of any software for the purposes of learning and studying the

design—should be amended since it goes well beyond what is permitted under the

Berne Convention and the TRIPS Agreement; (3) the exception under Article 30 of

the Regulations—which creates a significant loophole in the liability of corporate

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end-user pirates by allowing an exception to liability in cases where a party is

deemed to have acted without knowledge—should also be amended as inconsistent

with international standards; and (4) the requirement under Article 30 that allows

for a compulsory license in situations if destruction of the illegally used software

would bring great loss to the infringer—should be deleted or amended as it is vague

and goes beyond the exceptions and limitations permitted by the TRIPS Agreement.

Local Standards and Local Protectionism: There is significant variation among

localities for interpreting liability thresholds. Currently, the provinces and municipalities have very different thresholds for determining copyright infringement. For

example, the Shanghai PSB has issued its own IPR crime arrest and investigation

guidelines, but we are not aware of any current efforts to provide nationwide standards. In many cases, local protectionism renders administrative enforcement ineffective. After raiding counterfeiters, trademark owners too often encounter local AICs

that are reluctant (delays are often more than six months, and sometimes more

than a year) to release the official administrative penalty decision letters. This has

seriously hindered trademark owners’ efforts to recover damages from counterfeiters

in court. We welcome steps to bring cases against administrative authorities for

abuse of their authority in rendering insignificant fines. We also believe that administrative authorities should be encouraged to make their decisions publicly available

to ensure the system is fully transparent and in accordance with the law.

Patent and Trademark Registration and Protection: Improving the trademark registration process would help deter counterfeiters who preemptively register wellknown trademarks, trademark imitations, and even blatant copies of the trade dress

of others. Unfortunately, the China Trademark Review and Adjudication Board

(TRAB) and Chinese courts do not take bad faith into consideration in cases of preemptive trademark registration, trademark imitation, and trade dress infringement.

There is also considerable delays with respect to trademark invalidation petitions

before the Trademark Office, which reportedly has 20,000 undecided cases pending

with some disputes filed in 1999 remain undecided.

Similarly, the China Patent Reexamination Board (PRB) and the Chinese courts

rarely take bad faith into consideration when reviewing preemptive patent filing at

either the invalidation process with the PRB or infringement suits in court. Currently, a legitimate rights owner has little recourse against counterfeiters that file

utility and design patents, knowing that such filings lack novelty.

Delays in receiving patents or being granted market access are another problem.

SIPO is understaffed to handle the large volume of applications. With the resulting

backlog of patent applications, it can take up to five years to receive a patent.

The thin legal grounds underlying the State Patent Office’s decision to invalidate

the use-patent for Viagra represent a step backwards. In its decision to invalidate

the patent, SIPO relied on new guidelines issued after the patent had been granted,

and then did not allow the patentee the opportunity to meet the revised data provision standard of the new guidelines. The SIPO decision has been appealed to the

courts and at this writing is still in litigation. Although we are most concerned with

SIPO’s rationale and procedure in invalidating this patent, which set an unfortunate

precedent, we also note that the patent did not protect that legal producer. Domestic

pharmaceutical companies widely copied the product and sold it through a variety

of legal and illegal channels.

Patents and Standards: The intellectual property policies of the standards working groups in China do not conform to international practices. International standards organizations have an intellectual property policy that defines how intellectual

property is contributed and made available for implementation of standards. Generally, Chinese standards groups in high tech areas (Advanced Visual Standard

(AVS), Radio Frequency Identification (RFID), Linux, Intelligent Grouping and Resource Sharing (IGRS), etc.) either have no such policy, or an unreasonable policy

requiring mandatory patent pool participation, unreasonable disclosure, and compulsory licensing.

The common practice is to require members of standards working groups to place

all related patents in the patent pool and to entrust only the standards group to

license the technology. In addition to creating monopolistic control, mandatory patent pool participation devalues patents in subsequent negotiations, cross licensing,

and defense of intellectual property. Patent disclosure obligations in working groups

typically apply to the entire company rather than the individual representing the

company, and cover not only patents necessary to the standard in question, but all

related patents, including third party patents and patent applications. Such disclosure standards are overly broad and impractical. This is compounded by rules in

some working groups that non-disclosed patents must be licensed royalty free or not

asserted.

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The AVS Working Group is making an effort to cooperate with international

standards experts to develop an appropriate IPR policy and related legal documentation. We recommend that relevant agencies and other Chinese standards organizations study this example.

Patent Protection for Computer Software: Patent examination guidelines and practices only allow patenting software-related inventions in the form of the computer

that executes software (apparatus claims) or methods for operating computers using

software (process claims). Protection is not allowed for computer readable media

claims or programs that cause a computer to implement an innovative process (program product claims). As a result, the only one likely to be a direct infringer is the

end-user who actually uses the software. This limits the use of software-related patents to protect the intellectual property of the industry. Many governments, such

as the United States, Germany, Japan, and Korea have already recognized program

product claims. China’s failure to do so is not only discouraging to foreign companies, but also denies protection to Chinese software enterprises at home and leaves

them facing an unfamiliar environment in international markets full of competitors

seasoned in patent protection of program products. We recommend revision of the

patent examination guidelines to accept program products claims.

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