- Introduction of 'representative litigation' will allow China's 12 million retail investors to elect a representative to sue companies instead of filing individual cases
- Amendment to securities law very necessary as individual lawsuits are a huge burden on courts, have led to low efficiency in loss recovery, lawyer says
China's vast army of mom-and-pop investors has long faced an uphill battle when it came to recovering losses from investments in fraudulent listed companies. This might change soon.
An amendment to the country's securities law approved by Beijing last month has for the first time introduced class-action lawsuits, or "representative litigation" as it is termed.
The new system is likely to help China's 12 million retail investors recoup their losses, said lawyers, as investors no longer need to file individual cases and can, instead, elect a representative to sue companies.
"This could potentially bring a huge change to the investment environment for minority shareholders in China, in terms of rights and interests protection," said Zhu Xiahua, a lawyer at Shanghai Walson Law Firm. Zhu is also a pro bono lawyer with the China Securities Investor Services Centre, a non-profit institution under the China Securities Regulatory Commission (CSRC).
"It's a very necessary change, because the current individual lawsuit system has created a huge burden on local courts, and led to low efficiency in loss recovery," she said.
This could potentially bring a huge change to the investment environment for minority shareholders in China, in terms of rights and interests protectionZhu Xiahua, lawyer at Shanghai Walson Law Firm
Before the amendment was passed, Chinese investors had to initiate legal cases against fraudulent companies on an individual basis after the securities watchdog completed its investigation and issued administrative penalties. A typical court case could last two to three years, as companies usually appealed against the first trial, lawyers said.
This meant that most investors who had lost money would choose not to file a legal case to recover their losses. Only fewer than 10 per cent of investors would seek compensation, Zhu said.
"Only a small portion of investors would participate in litigation, and companies wouldn't compensate them if they were not sued," said Wang Zhibin, lawyer at Shanghai-based Bright & Young Law Firm, which has represented about 10,000 investors in more than 40 cases. "If investors file a collective case, the compensation amount could be a lot more, and create a better deterrent for potential offenders," he said.
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Efforts to protect minority shareholders are of great importance as China gradually opens its capital markets to offshore investors. A string of high-profile frauds rocked the 60 trillion yuan (US$8.7 trillion) stock market and led to losses worth billions for small investors in 2019.
Shanghai-listed drug maker Kangmei Pharmaceutical, for example, was long considered a blue-chip stock with stable earnings, until in April it disclosed an "accounting error" and that it had overstated its cash holdings by 30 billion yuan. Regulators found it had inflated its financials by 88.7 billion yuan over three years. As a result, the company has lost more than 40 billion yuan in market value since April 2019.
Kangde Xin Composite Material Group, a producer of polypropylene laminating film, was found to have inflated its profit by 11.9 billion yuan over four years, after auditors could not verify 12.2 billion yuan worth of cash deposits in May.
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Kangmei Pharmaceutical had more than 220,000 shareholders by the end of March, while Kangde Xin shares were owned by more than 155,000 people at the time.
Small investors might also not be able to compete with the influence of large, state-owned companies over local courts. This often translates as courts delaying sessions and rulings, Bright & Young Law Firm's Wang said. In one of the cases he represented, a local court had been delaying sessions since May 2018 in violation of regulations, while all the investors could do was to write to the court and ask it to hurry up the process, he said.
Moreover, an increasing amount of companies that were asked by courts to compensate investors have filed to do so because of poor financials, which has resulted in huge disappointment among minority shareholders.
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"The structure of the new securities law is far from sufficient, in terms of regulating the complexities in China's capital markets," said Xu Caiyuan, an activist investor who became the first person in China to sue the CSRC in 2016 after a market crash the year before.
Meanwhile, local courts and regulators will still need to work out the many thorny details that will come up with implementing the class-action lawsuit system, Shanghai Walson Law Firm's Zhu said. "There has not been a class-action case so far. We will only know the effectiveness of any legal clause after it's been used," she said.
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