Editorial: Setting a Precedent With China’s First Securities Class-Action Case
In the past few days, the Guangzhou Intermediate People’s Court and the China Securities Investor Services Center (ISC) have successively issued announcements. The former has clarified the scope of investors qualified to register with the court and join the lawsuit against Kangmei Pharmaceutical. The latter has declared that it will accept the entrustment of investors to intervene as their litigation representative. The amended Securities Law stipulates that if an insured institution accepts the entrustment of more than 50 investors, an “ordinary” representative action can be converted into a “special” action with the institution as the representative. In this case, a large number of injured investors are entitled to claim compensation from Kangmei Pharmaceutical. This heralds an inaugural “special representative” action in China’s stock market.
China’s gigantic securities market is permeated with criminal activities such as false statements, insider trading and market rigging. Numerous investors, especially medium and small investors, have little access to judicial remedies after suffering a loss, and are compelled to be the “silent majority.” In the face of this outrageous and helpless situation, China has taken countermeasures.
The long-awaited action is an important exploration into resolutions for the long-term weaknesses of judicial remedies. This epoch-making lawsuit is highly anticipated due to the heinous financial fraud committed by Kangmei Pharmaceutical. Although this first case is certainly flawed, despite the current constraints, we should strive to establish the case of Kangmei Pharmaceutical as precedent that can guide the behavior of China’s capital market and the construction of a country under the rule of law. There are few such classic cases, but they pose a strong deterrent against crime. Some people have expressed the concern that the class action mechanism will be abused and leave accused companies in a vulnerable position. However, as grossly insufficient protections for investors constitute a major challenge that we currently face, the bigger threat may lie in the absence of this class action lawsuit than in its abuse.
There is no lack of representative action mechanisms in Chinese law. Article 53 and Article 54 of the Civil Procedure Law outline representative actions with determined and undetermined numbers of litigants. However, in the securities world, representative actions with undetermined numbers of litigants have been barred by the judiciary. Even when many investors are involved, separate cases are often filed. But the reality is that investors are deterred by the high cost of individual actions and joint actions. On March 1, 2020, the amended Securities Law went into force and started to break the deadlock. The Securities Law retained the ordinary representative action system and further established the special representative action system, which claims that “entrusted by more than 50 investors, an investor protection agency is entitled to join the action as a representative and register with the court in accordance with the provisions of the preceding paragraph for the rights holders confirmed by the securities registration and clearing institutions unless the investors clearly indicate that they do not want to join the action.”
This move is of groundbreaking significance. Distinguished from the ordinary representative action which requires litigants’ express intention to join the action, the special representative action follows the principle of “those litigants who do not explicitly express their disinclination to join the action will be deemed as participating.” Meanwhile, supplemented by such supporting measures as no prepaid court acceptance fee, the special representative action system has considerably simplified investors’ procedures for joining the action and reduced their litigation costs. Moreover, the special representative action system takes the investor protection agency as the representative of the action, which endows the system with distinctive Chinese characteristics. Aside from the ISC, China Securities Investor Protection Fund is another investor protection instrument. The intervention of investor protection agencies has facilitated litigation.
Accordingly, it is urgent to continuously improve the professional level of investor protection agencies. As a complex form of action, the special representative action is necessarily supported by certified legal accomplishments and rich experience in juridical practice. Meanwhile, its professionalism is closely associated with the clear institutional arrangements of the operating system, which encompasses the decision-making procedures, implementation steps, approaches to information disclosure, relationship of rights and obligations with litigation participants, cost management and staff code of conduct.
With self-building in the pivotal position, ISC is confronted with the essential question of designing incentive and constraint systems. For ISC, the severe challenges ahead include not only serving as an active institution in filing lawsuits for investors while continuously warning itself to “avoid trouble whenever possible,” but also remaining vigilant to myriad temptations within a framework of constraints. Investor protection agencies should also truly understand and respond to the claims of investors, and ensure that represented investors are kept informed of the progress of the case. By constantly improving their own transparency and governance systems, investor protection agencies can successfully accomplish their missions.
The hardships and hindrances that a class action encounters cannot be underestimated. Due to the significant role of listed companies in the local economy and huge amounts in compensation claims, class action cases are vulnerable to local and departmental interests. Even Kangmei Pharmaceutical, which is under the trusteeship of the State-owned Assets Supervision and Administration Commission of Guangdong province, is entangled in an intricate net of interests. Given the availability and efficiency of judicial resources, judicial authorities may not be fully motivated to accept such actions.
Therefore, in the long run, the key to empowering class action cases is to establish a regulatory framework. In July 2020, the promulgation of a variety of corresponding regulations created preliminary conditions for class actions with Chinese characteristics, such as the Regulations on Issues Concerning Representative Action in Securities Disputes by the Supreme People’s Court of the People’s Republic of China; Notice on Work Related to the Investor Protection Agency’s Involvement in Special Representative Action in Securities Disputes by the China Securities Regulatory Commission (CSRC); and Rules of the China Securities Investor Services Center on Special Representative Action (Trial) by ISC. The aforementioned fundamental regulations will be further refined with the progress of juridical practice.
The protection of investors’ rights and interests is a multipronged issue. China’s securities market has always “paid more attention to regulation and less to litigation.” Moreover, the administrative enforcement of law is not very effective despite being emphasized, which makes civil and criminal actions more fragile. To purify the capital market, the cost of delinquency should be increased. The amendment to the Criminal Law that went into force last month significantly increased the penalties for crimes such as fraudulent issuance and false information disclosure, and removed the upper limit of 200,000 yuan ($30,450) on fines for false information disclosure. The emphasis on both civil and criminal cases will definitely provide strong support for class action cases.
Exactly 20 years ago, Chinese economist Wu Jinglian compared China’s stock market to a “gambling house,” which caused an uproar. Although progress has been made in building a country under the rule of law, violations of investors’ rights and interests have not been rooted out. Such violations are no longer so unscrupulous and have instead become more covert. As the original intention of the class action is to seek justice for injured investors, it offers investors a vivid lesson. “The first class action case in China’s stock market” is the latest bid to show investors fairness and justice.
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