One of the more interesting developments in recent years has been the global rise of collective procedural mechanisms for aggrieved investors to seek redress from corporate parties for disclosure misrepresentations or omissions. In that vein, the recent revision of the securities laws of the People’s Republic of China are particularly interesting.
As discussed in a recent memo from AIG, presented in conjunction with the Shanghai-based JunHe law firm, the revised Chinese securities laws include among many other changes new provisions allowing for collective investor actions. According to the AIG memo, entitled “Securities Class Actions under the New Securities Law in China” (here), the revised law introduces “western-style class actions to China.”
On December 28, 2019, the 15th Meeting of the Standing Committee of the 13th National People’s Congress adopted revisions to the Securities Laws of the People’s Republic of China, referred to as the “Securities Law 2019.” As detailed in a memo from the Han Kun Law Offices (here), the Securities Law 2019 is “widely regarded as unfurling a new chapter in the comprehensive implementation of the securities issuance registration system, marking a significant step for China’s capital markets on the road to marketization, rule of law, and internationalization.”
Among other key changes, the revised law provides for a move from a an “approval-based” IPO system to a “registration-based” system. In effect, regulator reviews will, according to the Han Kun law firm’s memo, “be adjusted from subjective determinations” about compliance and business qualifications to “objective determinations” of whether the applicant meets the specified requirements of the registration system.
The new law also introduces a new information disclosure regime, including the introduction of higher requirements on those obliged to make information disclosures. The new regime explicitly specifies disclosure quality requirements; information disclosed is, according to the Han Kun law firm memo, required to be “true, accurate and complete, concise and clear, easy to understand, and shall note contain any false information, misleading representations or major omissions.” In addition, for companies whose shares trade overseas as well as in China, information disclosures must be synchronized, so that information disclosed overseas must be simultaneously disclosed domestically. The securities law revision also “greatly enhances the punishment for relevant securities violations,” with significantly increased regulator fines.
The Framework for Representative Legal Actions
Article 95 of the new Securities law provides that in civil lawsuits pertaining to misrepresentations, a representative may be appointed to participated in the legal proceedings. The law further provides that an investor protection organization entrusted by more than 50 investors may participate in the lawsuit as a representative on behalf of rights holders except the investors who clearly state that they are unwilling to participate in the lawsuit. According to a memo by the JunZeJun law firm (here), these provisions alter previously existing procedures “permitting ‘implied opting-in’ and ‘express opting-out’ by investors concerned where investor protection institutions participate in litigation as representatives.”
According to the AIG memo, the way these procedures will operate is that a representative investor protection organization may “register for investors” with the court once the investors’ information has been verified by the securities registration and clearing organization. Under this “opt-out principle” most of the eligible plaintiffs “will be included in the litigation.”
As the AIG memo notes, once a special representative litigation is filed against a listed company or its directors, officers, or supervisors, “the civil liability and damages they face could be huge.” The “opt-out principle under the New Securities Law thus enables a US-style class action environment.”
The AIG memo also notes that since the New Securities Law went into effect, various implementing rules have been put in place.
First, on March 24, 2020, the Shanghai Financial Court issues the Regulations of the Shanghai Financial Court on the Securities Dispute Representative Litigation Mechanism “reaffirms that the law applies to significant civil disputes resulting from misrepresentation, insider trading, [and] market manipulation” in the securities sector. The regulations also “provide clarity” with respect to the special representative litigation under Article 95, including “the requirements of the special representative, method in collecting plaintiffs name list, ‘Opt-Out’ procedures and legal consequences, the scope of authorities of the special representative,” among other things.
Second, on July 23, 2020, the Supreme People’s Court released Regulations of the Supreme People’s Court on Several Issues about Securities Dispute Representative Litigation, which “provide comprehensive guidance on the jurisdiction of the case, the pre-condition for starting a case, the determination of the plaintiffs and the representative, the procedures in the case and the allocation of litigation costs” associated with representative litigation. The rules also include provisions allowing for situations where there are multiple investor protection organizations involved.
Although the AIG memo notes that the potential liability under the new representative action procedures enable a “US-style class action environment,” the new procedures do not introduce US-style class action procedures, notwithstanding the “opt out” approach. The representative aspect of the new litigation procedures is closer to the “stichting” mechanism under the Dutch collective settlement procedures. In that respect, the memo is accurate when it states that the new securities laws introduce “western-style securities class actions.”
It remains to be seen how all of this might play out, but there is no doubt that, as the AIG memo states, the new procedures create an environment in which publicly traded companies hit with one of these new-style representative actions could indeed face the possibility of “huge” civil liability or damages.
Under these circumstances, it is hardly surprising that the existence of these new procedures has concentrated the attention of the officials of companies whose shares are listed on Chinese exchanges. The AIG memo notes that interest in and demand for D&O insurance has “risen substantially.” The AIG memo notes that in the first half of 2020, “AIG has experienced a greater than 400% increase [in the] number of D&O insurance inquiries from listed companies compared to the same period in 2019.”
The AIG memo does not identify any actions that have yet been filed under the new provisions and it undoubtedly will be a substantial time before the impact of the new provisions can be assessed. But in the meantime, there is little doubt that the new procedures represent a significant change in the availability of collective investor redress in China.
All of this reinforces a view that I have long held about evolving D&O liability issues. Over the years, it has been my privilege to speak around the world to audiences of D&O insurance professionals and lawyers about D&O liability issues (including even in China). Often, I am the only American in the room. I am accustomed from these various events to hearing other commentators sharply criticize the U.S. litigation system, which is usually described as “excessive,” “costly,” and even “abusive.” But as the years have gone by, I have also noticed something else – that is, despite all of the disapproval heaped on the U.S. litigation model, slowly but surely many different legal systems have adopted various legal measures that resemble aspects of the U.S. legal system. To be sure, no country has wholesale adopted the U.S. model. But when I see a country as large and as important as China adopt an “opt-out” collective action model for investor protection, what I see is a general convergence around various mechanisms for collective redress.
Here’s another observation as well. One of the reasons I am invited to speak to these various overseas audiences is that for most of the time up until now, any conversation about D&O claims necessarily involves a discussion of U.S. claims, simply because all of the meaningful claims were in the U.S. That aspect of D&O claims is no longer true, as there are now numerous significant D&O claims examples outside the U.S. When I look at developments like the adoption of an opt-out collective redress mechanism in China, it convinces me that in the future even less of the overall significant D&O claims will be in the U.S; increasingly, in the future, the significant D&O claims will be elsewhere — perhaps even in China.
In any event, the legal changes in China have important implications for Chinese-listed companies, their executives, their advisors, and their insurers. The AIG memo concludes with a short series of measures that Chinese companies should adopt in light of the new liability environment in China. As the memo notes, there is not doubt that while the new securities laws represent a “great leap forward for investor rights,” they also “could result in added risks for listed companies and their senior executives.”