Over the last few days, at least three U.S.-listed China-based companies have been hit with securities class action lawsuits after Chinese government regulatory crackdowns that targeted the defendant companies’ industries or the companies’ business approach. These developments not only highlight the kinds of regulatory risks all companies face, but also underscore the risks that companies doing business in China face in the political and business environment under the Chinese governmental regime. The recently filed cases also show how these risks can translate into securities class action litigation when the companies involved have securities listed on U.S. exchanges.
DouYu International Holdings Limited
The first of the three new securities suits involves DouYu International Holdings Limited, a Cayman Islands company with its principal place of business in China. Its American Depositary Shares (ADS) trade on Nasdaq. DouYu is a live streaming gaming platform. According to the securities class action lawsuit complaint that was filed on June 9, 2023 in the District of New Jersey (a copy of which can be found here), against the company and certain of its executives, the company, in a series of statements and in its periodic SEC filings, described the governmental regulatory supervision to which it is subject, including supervision of its online content moderation efforts. The company’s disclosure statements described its efforts to comply with the government’s supervisory and regulatory requirements.
According to allegations in the complaint, starting in 2021, the Chinese government signaled that it was planning new curbs on the live-streaming industry. News reports about the e-gaming industry in China and about the governmental crackdown specifically mentioned DouYu. In May 2023, the company announced that its government regulator had sent an inspection team due to alleged violations of content rules and regulation, and that the company expected the team to conduct a one-month on-site inspection. The company’s share priced declined on the news.
The complaint purports to represent a class of investors who purchased the company’s ADSs between April 20, 2021, and May 9, 2023. The complaint alleges that during the class period, the defendants made false and misleading statements and failed to disclose that: “(1) The Chinese government, due to concerns about issues such as video game and computer addiction, as well as content challenging its authority, could become increasingly aggressive toward DouYu regardless of how effective or sincere its attempts to comply with Chinese law were; (2) This increasingly aggressive posture subjected DouYu to a heightened risk of an investigation and subsequent government enforcement action and ultimately resulted in enforcement action; and (3) as a result the Defendants’ statements about its business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times.”
Futu Holdings Limited
The second of the three recently filed lawsuits involves Futu Holdings Limited. Futu is incorporated in the Cayman Islands and has its principal place of business in Hong Kong, Special Administrative Region, People’s Republic of China. Futu’s American Depositary Shares (ADS) trade on Nasdaq. The company provides digitalized financial services, including trade execution and clearing, margin financing and securities lending, and wealth management. The company is not licensed in China. In various public statements, however based on capital controls allowing Chinese citizens to move up to $50,000 a year offshore, the company serviced business in Hong Kong for Chinese nationals who set up accounts in Hong Kong. The company is not licensed in China, and its disclosure noted the uncertainty of the Chinese regulations and the associated regulatory risk.
In various public statements, Chinese officials expressly questioned business being done in China without a license. Various news reports specifically mentioned Futu as a potential target of regulators’ concerns. A December 30, 2022 Wall Street Journal article specifically reported that the Chinese regulatory said that Futu had violated Chinese financial law, and that Futu had been prohibited from soliciting new clients and customers. In May 2023, news reports said that two online brokerages, including Futu, had been ordered to remove apps aimed at Chinese customers. The complaint alleges that the company’s share price declined on this news.
On June 12 , 2023, a plaintiff ADS investor filed a securities class action lawsuit in the District of New Jersey against the company and certain of its executives. The complaint (a copy of which can be found here) purports to be filed on behalf of a class of investors who purchased the company’s ADSs between April 27, 2020, and May 16, 2023. The complaint alleges that during the class period, the defendants made false and/or misleading statements and/or failed to disclose that: “(1) Futu’s business was, quite simply, illegal as it related to operations in China as a result of its failure to obtain the proper licenses; (2) it did not fully disclose to investors that it was engaging in unlawful activity and instead falsely characterized the applicable Chinese laws as ambiguous; (3) the foregoing subjected the Company to heightened risk of regulatory enforcement; and (4) as a result, Defendants’ statements about its business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times.”
UP Fintech Holdings Limited
UP Fintech Holdings Limited is a Grand Caymans company with its principal place of business in China. The company’s American Depositary Shares (ADS) trade on Nasdaq. UP Fintech is in a very similar business as Futu. UP Fintech provided similar services to Chinese citizens as Futu, and similarly to Futu, UP Fintech did not have a license in China. The company also said that the regulatory requirements were uncertain but that it believed it was in compliance with applicable requirements. The same crackdown described above with respect to Futu also affected UP Fintech, and the December 2022 Wall Street Journal article cited above with respect to Futu also specifically mentioned the governmental regulator’s crackdown on UP Fintech. The May 2023 Chinese government action banning Futu’s app also applied to UP Fintech and its app.
On June 20, 2023, a plaintiff investor filed a securities class action lawsuit in the Central District of California against the company and certain of its executives. The complaint, copy of which can be found here, purports to be filed on behalf of investors who purchased the company’s ADSs between April 29, 2020, and May 16, 2023.
The complaint alleges that during the class period, the defendants made false and/or misleading statements and/or failed to disclose that: “(1) UP Fintech’s business was, quite simply, illegal as it related to operations in China as a result of it failure to obtain the proper licenses; (2) it did not fully disclose to investors that it was engaging in unlawful activity and instead characterized the applicable Chinese laws as ambiguous; (3) the foregoing subjected the Company to a heightened risk of regulatory enforcement; and (4) as a result, Defendants’ statements about its business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times.”
All companies face some level of regulatory risk. However, there is a considerable additional level of regulatory risk involved for companies doing business in China. For starters, the companies in China are subject to a peculiarly Chinese-related risk of governmental crackdown. Readers will recall that in an earlier time, Chinese high tech companies faced an aggressive crackdown on their business activities; as I documented on this site (here, for example), the crackdown resulted in a rash of U.S. securities class action lawsuits against affected U.S.-listed Chinese companies. Similarly, the Chinese government crackdown on Chinese education firms (including firms providing tutoring and test prep services) also resulted in securities suits against U.S.-listed Chinese education companies (as discussed here). The three most recently filed lawsuit discussed above reflect this same factual sequence, in which U.S-listed Chinese companies facing a regulatory crackdown got with U.S. securities class action lawsuits.
I will say that in reading the complaints, which quote extensively from the companies’ periodic reports, that the companies’ disclosures reflect their concern and apprehension about the companies’ regulatory risks. The companies each disclosed the regulatory uncertainty they faced, the ambiguity of the regulatory requirements, and the problems the company could face if the regulator were to take action against them. One of the elements in all three of these lawsuits will be whether investors actually were misled about the regulatory risks the company faced.
Another feature these three lawsuits have in common is that the companies were pursuing novel or emerging business ventures, to which the applicability of existing regulatory regimes was unclear. To be sure, it could be argued that all three companies were also pushing the limit on what governmental regulators might expect or require, but it could also be argued that these risks associated with this approach were also disclosed to investors.
There is an important element to all of this that should note be overlooked, an element I have discussed in earlier posts about the high tech and education sector crackdowns. That is, the Chinese regulators can and will act quickly in ways that can completely undermine or even eliminate companies’ business models. As I have argued before, these circumstances not only present regulatory risk, they also involve political risk.
The government’s actions here reflect not only the regulation of business; they also are designed to control culture and society. The online content on the DouYu platform is a threat to the government’s compulsive need to control the flow of ideas. The extraterritorial investment that Futu and UP Fintech facilitate also undermines the government’s ability to monitor and control its citizens activities.
The fact is political risk is an inherent circumstance for any firm doing business in China. And as these new lawsuits demonstrate, political risk can translate into securities litigation risk. I have emphasized these points at such length here in order to try to develop the thought that securities litigation risk can arise out of political risk. In our increasingly global economy, this proposition could be a very important concept, perhaps increasingly so – particularly, but not exclusively, in China.
There is one final thing that these three new lawsuits have in common, and that is that all three were filed by the same plaintiffs’ law firm – The Rosen Law Firm. The three complaints in fact have a certain similarity; the Futu and UP Fintech lawsuits are substantially similar. The law firm’s lawyers clearly have decided there may be a business opportunity in suing U.S.-listed Chinese companies. However, it remains to be seen how these cases will fare.