What Is a Chinese Wall?

The term Chinese wall, as it is used in the business world, describes a virtual barrier intended to block the exchange of information between departments if it might result in business activities that are ethically or legally questionable.

How a Chinese Wall Works

The need for a Chinese wall in the financial industry has become more common since 1999, with the repeal of federal regulations prohibiting companies from providing any combination of banking, investing, and insurance services. The new law reversed restrictions on such combinations that had been in place since the Great Depression.

The 1999 law enabled the creation of today's financial giants such as Citigroup and JPMorgan Chase. And that created a need for a Chinese wall between departments.

[Important: In recent times, the term has been denounced as culturally insensitive. One judge suggested "ethics screen" as an alternative.]

For example, a financial services firm might have a corporate investment arm that is acting on the behalf of a public company planning a takeover of a rival company. The talks are highly confidential, not least because of the potential for illegal insider trading on the information. Yet the same firm has investment advisers in another division who may be actively advising clients to buy or sell stock in the companies involved. The Chinese wall is supposed to prevent any knowledge of the takeover talks from reaching the investment advisers.

The need for a Chinese wall policy was strengthened in 2002 by the passage of the Sarbanes-Oxley Act, which mandated that companies have stricter safeguards against insider trading.

The concept of a Chinese wall exists in other professions. They may be temporary or permanent. For example, if a legal firm is representing both sides in an ongoing legal dispute, a temporary wall may be placed between the two legal teams to prevent actual or perceived collusion or bias.

Special Considerations

The Chinese wall got its name from the Great Wall of China, the impervious 5,500-mile-long structure erected in ancient times to protect China from its enemies. The term entered the language shortly after the stock market crash of 1929 when Congress began debating the need to put regulatory barriers between brokers and investment bankers.

In more recent times, the term has been denounced as culturally insensitive. In 1988, Justice Harry W. Low, the presiding judge in Peat, Marwick, Mitchell & Co. vs. the Superior Court, wrote extensively about the offensiveness of the phrase and its negative connotation towards Chinese culture and business practices.

For that matter, the judge noted, the metaphor isn't even appropriate. The phrase is meant to define a two-way seal to prevent communication between parties, while the actual Great Wall of China is a one-way barrier to keep invaders out.

Justice Low offered the term "ethics screen" as an alternative.

Key Takeaways

  • A Chinese wall, in business, is a virtual barrier erected to block the exchange of information between departments.
  • The wall is intended to prevent the sharing of information that might lead to ethical or legal violations.
  • In the financial industry, the need for such barriers grew with the repeal of federal laws banning firms from any combination of banking, investing, and insurance services.