In Depth: Why More Chinese Companies Are Getting Sued by Aggrieved Investors

In the U.S., class-action lawsuits serve as an effective means for investors to recover losses due to corporate malpractices, such as the disclosure of false information. However, in China, such lawsuits were only made possible in 2020 with the implementation of the revised Securities Law, allowing shareholders to collectively sue companies through a representative action mechanism. Despite this significant legal advancement, these lawsuits have been infrequently employed in China due to high costs, lack of financial incentives for lawyers, and challenges in courts accepting cases, among other issues [para. 1][para. 2][para. 3].

Nevertheless, there's a shift as China's financial regulators aim to bolster confidence in a stock market that has faced numerous fraud scandals. In December, several new representative action cases emerged, like the one involving Kangde Xin Composite Material Group Co. Ltd., a significant corporate fraud case in China. This includes a lawsuit by 11 investors against the company and its executives for false information disclosure, highlighting the potential of such mechanisms to address corporate fraud [para. 4][para. 5].

Other notable cases include Jin Tong Ling Technology Group Co. Ltd. and Jiangsu Misho Ecology & Landscape Co. Ltd., both of which faced lawsuits accepted by courts for fraudulent activities like inflating profits. These cases reflect increasing regulatory scrutiny and the potential for China's representative action system to evolve in response to market needs [para. 6][para. 7].

China’s approach includes two types of representative actions under the revised Securities Law: the ordinary representative action (ORA) and special representative action (SRA). While an ORA involves multiple shareholders suing on behalf of others who join, an SRA allows a designated representative to sue on behalf of all eligible shareholders unless they opt out. The China Securities Investor Services Center (CSISC) can act as a special representative if certain criteria are met, which can influence the adoption of the SRA mechanism [para. 8][para. 11].

As the number of securities class actions is quite low in China, with just a few cases like Kangmei Pharmaceutical Co. Ltd. and Essence Information Technology Co. Ltd. reaching resolution, questions remain regarding the system’s effectiveness in dispelling investor concerns. While a Guangzhou court ordered Kangmei to pay nearly 2.46 billion yuan to affected shareholders, Essence Information Technology’s settlement provided over 280 million yuan in compensation, demonstrating the potential benefits of successful litigation [para. 15][para. 16][para. 17].

The prevalence of such lawsuits is notably less in China compared to the U.S., where class-action lawsuits are more common and largely driven by lawyers on a no-win no-fee basis. This distinction underscores fundamental differences in the legal ecosystems of both countries, with China aiming to prioritize public interest and investor protection over financial incentives [para. 24][para. 25].

Challenges in initiating representative actions persist, with local courts often hesitant due to potential economic implications involving local companies. This is particularly evident in cases involving influential state-owned enterprises. Moreover, the judicial system's limited resources and the complexities involved in processing such cases contribute to prolonged and complicated legal processes, further hindering the widespread adoption of securities lawsuits in China [para. 29][para. 34][para. 35].