On November 12, 2021, a Chinese court entered a 2.46-billion-yuan ($385.26 million) verdict in a collective investor action against Kangmei Pharmaceuticals, certain of the company’s executives and the company’s outside auditor. The action was the first of its kind in China. The claimants in the case had alleged that the company had engaged in massive accounting fraud by inflating its revenues, profits, and cash. The verdict in the case follows a July 2021 public hearing in the case. A copy of a November 12, 2021 Global Times article about the verdict can be found here. A November 12, 2021 Reuters article about the verdict can be found here.
Background
Kangmei is a pharmaceutical manufacturing company. Its shares trade on the Shanghai stock exchange. The company was at the center of a massive accounting scandal that emerged in 2019. Among other things, the scandal allegedly involved falsified documents and billions of dollars in missing cash.
In late 2020, a group of investors launched a damages action against Kangmei in Guangzhou Intermediate People’s Court. The claimants alleged that the drug maker had inflated revenues, interest income, operating profits, and cash in its financials. The defendants in the action included Ma Xingtian, Kangmei’s former chairman and general manager, and five other company officials, as well as GP Certified Public Accountants, Kangmei’s auditor.
In April 2021, the China Securities Investor Services Center filed an application for the Kangmei action to proceed as a representative action on behalf of retail investors. The court’s acceptance of the application made the action the first representative investor action under new class action procedures that went into effect in 2020. At the time the representative action application was filed, the Chinese securities regulator issued a statement vowing “zero tolerance” of accounting fraud, adding further that “toxic tumors” must be “eradicated swiftly.”
The Guanzhou court held a public hearing in the action in July 2021, which resulted in the November 12, 2021 verdict. The court’s verdict found the defendants jointly and severally liable.
According to news reports, following the verdict, the Chinese Securities Regulatory Commission issued a statement that hailed the verdict as a “vigorous measure to implement the country’s revised securities law” and as a “pioneering, iconic and milestone effort to safeguard investors’ legitimate rights and interests.” The news reports also stated that the regulator had “vowed to improve the class-action litigation mechanism and push for special representative action suits on a regular basis.”
Discussion
As I discussed in a post earlier this year (here), in December 2019, the National People’s Congress adopted certain revisions to the Chinese securities laws, known as Securities Law 2019. Various regulations implementing the new law were put into place in 2020. Article 95 of the new Securities law provides that in civil lawsuits pertaining to misrepresentations, a representative may be appointed to participate in the legal proceedings on behalf of investors. As I noted in my post discussing the new law, commentators had expressed concern that the new procedures introduced a Western-style class action regime.
The Kangmei Pharmaceuticals action was the first to use the new representative action mechanism under the new securities law. The verdict in the Kangmei action certainly underscores the concerns expressed about the liability risk that the new procedures present. The Kangmei case involved an alleged massive scandal, but the size of the verdict is still remarkable.
The verdict in the case is a milestone development, both for the development of securities class action litigation in China and for the spread of collective investor actions globally. The magnitude of the verdict makes this development all the more remarkable. The verdict represents one of the highest-ever investor recoveries ever outside of the U.S. The massive verdict is not as large as, say, the $1.5 billion settlement in the Fortis collective investor action in the Netherlands, or the $1 billion settlement in the RBS action in the U.K., but the verdict amount is substantial enough to draw attention to the extent for securities law liability under the revised Chinese securities laws. The post-verdict statement by the Chinese regulator – to the effect that the regulator intends to push for special representative action suits on a regular basis – suggests that the Kangmei action may merely be the opening salvo.
As I said in my earlier discussion of the Chinese securities laws, the revision to the Chinese securities laws is just one of the most recent developments in the general rise globally of collective investor actions. As I have also noted elsewhere, the rise of collective investor action may be one of the most important global developments in the corporate and securities legal arena in the last decade. The massive verdict in the Kangmei case suggests that the collective investor actions may now represent one of the most significant potential liability exposures for listed companies in China. The Kangmei verdict is also the latest evidence that we have indeed entered a new era in global securities litigation.