Chinese wall

This article discusses various theoretical concepts that have been named a Chinese wall. For the ancient fortification in China, see Great Wall of China.

In business, a Chinese wall is a metaphor used to refer to the practice of making sure that different parts of the firm are kept apart so that information does not circulate freely and to prevent conflicts of interest. The term is especially common in areas such as brokerage, law firms and management consulting.

The term was coined in the United States following the stock market crash of 1929. The U.S. government saw the need to maintain separation (or an information barrier) between investment bankers and brokerage firms. This was intended to limit the conflict of interest between objective analysis of companies and the desire to have a successful initial public offering. Rather than regulate for physical separation, or even prohibiting one company conducting both sorts of transactions, the government allowed such companies to maintain a "Chinese wall" as a form of gentlemen's agreement.

Finance

The concept of a Chinese Wall is that of establishing a zone of non-communication between distinct sections of a business, in order to prevent possible (and probable) conflict of interest.

A Chinese Wall is most commonly employed in investment banks, where such banks offer corporate finance services to companies (managing the fund-raising, for example), and at the same time also provide financial research information to a more general audience.

Because it is possible to manipulate the financial research reports to encourage the general public to purchase shares in a company (for example), the conflict of interest arises when such a company is also the customer of this particular investment bank.

In fact, despite Chinese walls, these situations of conflict of interest allegedly arose during the heydays of the "dot com" gold rush, where research analysts essentially marketed companies which they, or related parties, own shares of. By putting out positive research advice, or even simply by choosing to talk about their client amongst the thousands of possible companies they might have discussed, the share price of these companies could be boosted without regard for actual financial worthiness. In a way, this was one of the many factors contributing to the dotcom "bubble" which eventually burst around the first half of 2000, resulting in a lengthy sluggishness in world markets for years to come.

The U.S. government has since passed laws improving the Chinese Wall concept (e.g. Sarbanes-Oxley Act) to hopefully prevent such grievous dereliction of duty by research analysts and their banking employers.

There are some who critique the Chinese wall, saying that it prevents some small companies from being properly valued, since without the ability to get exposure via a tie-in with the investment bank, most investors would simply not know about them.

Law

The Chinese wall is also used in law firms in situations where one part of the firm, which is representing a party on a deal or litigation, is separate from another part of the firm that might otherwise have an adverse effect on the party's interests. In some cases in the United Kingdom a law firm may represent both parties, but only if a pretence is maintained that there is no communication between partners.

Journalism

The term is also used in journalism to describe the separation between the editorial and advertising arms of a media firm.

The Chinese wall is regarded as breached for advertorial projects.

Computer science

In computer science, Chinese wall refers to a reverse engineering method involving two separate groups. One group reverse-engineers the original code and writes thorough documentation, while the other group writes new code based only on the new documentation. The first group never writes new code, and the second group never looks at the original code. This method insulates the new code from the old code, so that the new code is not considered a derived work of the old code. See also clean room design.

Metaphor and myth

The term Chinese wall may refer to the Great Wall of China, and to its scale and effectiveness at separating one side from the other.

It is more likely to refer to a traditional practice among Chinese mandarins in the Late Imperial period. Theoretically if a junior mandarin saw a senior mandarin on the road he was expected to bow and present his compliments. In Beijing this tended to happen quite a lot and so traffic was frequently blocked. Instead mandarins came up with a method of pretending they did not see each other on the road by the clever placing of a retainer with an umbrella. Because they did not "see" each other, they were not obliged to stop. In effect they placed a "Chinese wall" between themselves.

See also

• Glass-Steagall Act