(Editor: Leona)

The government says many items sold on Alibaba’s Taobao marketplace are not legitimate; Alibaba says the report is flawed.

Alibaba Group’s Taobao marketplace accounts for more than half of China’s online sales. Its big draw is low price, as more than 8 million merchants compete for the business of hundreds of millions of shoppers. But that wide-open bazaar, with more than 1 billion product listings at any time, has often been criticized for offering products that were counterfeit, or for allowing merchants to sell a brand’s products without the brand’s authorization.

But a government agency released a report yesterday claiming that only 37.25% of items it purchased from Taobao sellers were completely legitimate. That followed a December report from same agency, the State Administration for Industry and Commerce, that claimed 10.6% of products sold on major Chinese web sites on the big Singles’ Day online shopping holiday Nov. 11 were not legitimate products from authorized dealers.

The government report was sharply critical of Alibaba, whose two big online marketplaces, Taobao and Tmall, together account for about 80% of consumer online purchases in China.

“For a long time, Alibaba hasn’t paid enough attention to the illegal operations on its platforms, and hasn’t effectively addressed the issues,” the report says. “Alibaba not only faces the biggest credibility crisis since its establishment, it also casts a bad influence for other Internet operators trying to operate legally.”

Alibaba responded by saying it will file an official complaint to authority to criticize the SAIC officer who led the inspection, Liu Hongliang, director of the online regulation department at SAIC.  Alibaba claims “he made a non-objective conclusion in a wrong way” and that the report is “harmful to Alibaba and Chinese online businesses.”

Media reports about the dispute sent Alibaba’s stock price down 4% in Wednesday trading, and could prove embarrassing for Alibaba, which has a stock market value of nearly $257 billion, far ahead of Amazon.com Inc.’s $142 billion market valuation. Alibaba gained that lofty valuation through its dominant position in e-commerce in China. The company reported that purchases on Taobao in the third quarter of 2014 totaled 380 billion yuan ($60.8 billion) and on Tmall, a more brand-friendly marketplace that hosts more than 50,000 storefronts of 176 billion ($28.2 billion). Together they represent just over 80% of the value of online retail sales in China in Q3 2014, which totaled 691.4 billion yuan ($110.6 billion), according to Chinese market research firm iResearch.

Alibaba’s point of view on the SAIC report was further explained in a post on the Alibaba account of China’s popular Weibo social network signed by “a Taobao employee.” “There are many flaws in the inspections,” the post says. “According to Chinese law, after an inspection, SAIC should send notices to merchants and allows merchants to request re-examination if there are disagreements with the results. SAIC didn’t give merchants a chance before it publicized the result. In fact, three merchants say they didn’t sell the sample products involved in the SAIC inspection, and it seems SAIC has made some mistakes.”

The furor stems from a relatively small test SAIC made last year, buying a total of 92 items from six e-commerce sites. Of the 51 items purchased on Taobao, only 37.25% were authentic and from authorized sellers, the report says. Of the 20 items purchased on the site of Alibaba’s chief rival, JD.com, 90% passed muster, as did six of the seven items purchased on Tmall, eight of the 10 items purchased on Yhd.com, and all three of the items purchased from Jumei.com. The one item purchased Zol.com failed the test.

Taobao and Tmall are both marketplaces operated by Alibaba. Yhd.com is a subsidiary of Wal-Mart Stores Inc. and Zol.com is a subsidiary of U.S.-based media company CBS Interactive.

SAIC’s definition of a legitimate goes beyond ascertaining that the product is authentic, that is, as described and not a counterfeit. For example, if a merchant sells a genuine Estee Lauder lotion but cannot present to the government that it has legal authorization to sell that product in China, SAIC would categorize the product as “non-legitimate.” Moreover, even a product sold by a brand itself on its own store on Taobao.com would be cited as illegitimate if it had a labeling error.

SAIC says it presented the findings to Alibaba in July, but held off making the results public in order not to interfere with Alibaba’s initial public offering of stock on the New York Stock Exchange. That IPO took place in September, and Alibaba raised $25 billion, the most ever raised in an IPO.

In response to Alibaba’s criticisms of its report, SAIC released to a transcript of the July meeting, in which government officials accused Alibaba of being “arrogant” and claimed China’s leading e-commerce company “conducts many illegal activities in operating the marketplaces.” The SAIC says Alibaba allows merchants to operate without legitimate business licenses and to sell fakes, fails to respond to customer complaints and that Alibaba employees take bribes.

An Alibaba spokeswoman responded to the latest SAIC report by saying, “Taobao is a victim of counterfeit goods and not a beneficiary. A new economy platform with more than one billion product listings requires services that cannot be matched nor compared to traditional trading marketplaces. ” We understand the difficulties faced by the regulatory authority in regulating a fast-changing innovative environment, but we hope the authority can see the millions of young people are taking risks, innovating and persevering as entrepreneurs. We hope we can all work together to solve this problem through internet technology and big data.”

Seeking to polish its image in the West ahead of its IPO Alibaba has emphasized that it works hard to prevent counterfeit and unauthorized goods from being sold on its marketplaces. Alibaba, the company says it has dropped 90 million product listings in the first three quarters in 2014 for being illegitimate, with more than 90% of these removals initiated by Alibaba itself. However, on its own blog today Alibaba said it will set up a 300-employee task force to fight counterfeits.