Here at The D&O Diary, we cover the liabilities of corporate directors and officers. Geopolitical concerns are not typically part of our beat. But as we all finish up the year and get ready to start 2024, geopolitical concerns are necessarily part of what we are worried about in the current climate. That is true as a general matter and within the specific context of this blog; as the evidence has shown this year, geopolitical concerns have translated into corporate and securities lawsuits, and there is plenty to worry about for next year as well.

Geopolitical issues are of course the domain of world leaders and politicians. Geopolitical issues are also, these days, at least, of concern to investors as well. As the Wall Street Journal detailed in a December 2, 2023, article entitled “The Big Risk Causing Investors to Shun China” (here), geopolitical concerns are now a “top consideration” for prospective buyers of Chinese securities, and there concerns are, according to the Journal, “turning many people off investing in China.”

Relations between Beijing and Washington have deteriorating and in the past year the U.S. restricted Americans from investing in certain Chinese companies and imposed export restrictions on advanced semiconductor chips. The Journal article quotes one private equity investor as saying that “For every deal we now look at geopolitical risk,” even before the firm evaluates the individual business.

With the trade tensions between China and the U.S., stakes were already high, but the Russian invasion of Ukraine “crystalized for investors the risks of being heavily exposed to China,” particularly in light of raising concerns about China’s intentions toward Taiwan and toward the South China Sea generally.

The connection between these concerns and D&O liability exposures may not be immediately obvious, but the connection is there, as I have previously discussed on this blog (for example, here). During the past year, there have been at least two securities class action lawsuits filed in which the trade issues between the U.S. and China are at the center.

First, as discussed here, in July 2023, a plaintiff shareholder filed a securities class action lawsuit in the Northern District of California against the data storage company, Seagate Technology Holdings. The lawsuit was filed after the company was hit with a $300 million U.S. Department of Commerce administrative penalty for violation of Export Administration Regulations (EAR) pertaining to the Chinese technology company, Huawei Technologies Co. Ltd.  The lawsuit alleges company failed to disclose it was in “blatant violation” of U.S. export rules, which resulted in the massive penalty and loss of shareholder value. 

Second, as discussed here, in November 2023, the executives of health monitoring platform company Rockley Photonics Holdings were hit with a securities lawsuit filed in the Central District of California, after the company itself filed for bankruptcy. The company, which had merged with a publicly traded SPAC, was in its early stages dependent on revenue from a joint venture. The company’s JV partner, Hengtong, was a China-based firm. Hengtong acquired an undersea cable business from Huawei, following which Hengtong found itself listed on the Department of Commerce’s “Entity List,” as a result of which the JV’s revenues declined, and the company eventually filed for bankruptcy.

Trade regulation and export controls are not the only potential sources of corporate and securities litigation arising from geopolitical risk. For companies doing business in China, there is the added risk of the company’s autocratic government, which can make doing business in China unpredictable and even perilous, in ways that also translate into D&O risk. Three cases filed during the year illustrate this risk.

First, as discussed here, in early June 2023, DouYu International Holdings, a China-based game streaming company whose securities trade on Nasdaq, was hit with a securities suit. The company had been caught up in a Chinese government crackdown on what the government perceived as gaming companies causing Chinese youths to become addicted to video games. The complaint alleges that the company misled investors about its exposure to and possible impact from the regulatory crackdown. The company’s woes have continued since the lawsuit was filed; late last month, the company reported in a regulatory filing that it had learned that its CEO had been arrested. The company also said that it had received no official notice of the arrest, nor did know the reasons for his arrest.

Second, as discussed here, later in June, Futu Holdings, a Hong Kong-based financial services company providing digital services to China residents. The company has securities listed on Nasdaq. The company was not licensed to do business in China, but provided digital services to China residents in reliance on capital control provisions allowing Chinese citizens to move money offshore, subject to certain restrictions. In news articles and elsewhere questions were raised about the company’s ability to do business in China; eventually news reports appeared suggesting that the company had first been barred from soliciting any new customers, and that the company had been ordered to remove apps aimed at Chinese customers. The company’s share price declined on this news. A company investor filed a securities suit against the company in the District of New Jersey, alleging that the company had not disclosed that its business model made it vulnerable to a regulatory crackdown.

The third of the three lawsuits involved UP Fintech Holdings Limited, also a digital-based financial services company with a business model similar to that of Futu Holdings. Like Futu, UP Fintech was not licensed to do business in China. As discussed here, the same crackdown that caught up Futu also caught up UP Fintech. After the news of the crackdown emerged, the company was sued in the District of New Jersey by security holders alleging that the company had not disclosed that its business model would subject the company to the regulatory crackdown.

One thing that these three cases show is that 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 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. In our increasingly global economy, this proposition could be a very important concept, perhaps increasingly so – particularly, but not exclusively, in China.

The two cases discussed above against companies whose business or operations were complicated by laws and regulations concerning trade sanctions and export controls underscore the fact that international trade regulatory regimes have become increasingly important for companies and their executives. These regulatory regimes include U.S. sanctions, export controls, anti-money laundering (AML), and anti-bribery and corruption laws. Recent developments, such as the War in Ukraine, trade tensions with China, and issues involving digital assets have heightened these concerns. Violations of these regimes can result in regulatory enforcement actions as well as in related civil litigation. The cases discussed above show how these concerns can translate into securities litigation.

As I have previously pointed out, the prospect for securities litigation arising out of trade sanctions and export control-related issues is not necessarily new; there have been examples of corporate and securities lawsuits arising out of trade sanction and export control issues over the last several years. However, in the current tense geopolitical environment, all of these concerns seem to loom larger. The increasing tensions with China and the ongoing “hot” wars in Ukraine and in Gaza heighten the concerns surrounding geopolitical risk.

There are a couple of developments on the 2024 calendar that have very important implications for these geopolitical issues. The first and most obvious is the upcoming U.S. Presidential election in November 2024. The second is the January 2024 Presidential election in Taiwan. Both Washington and Beiing will be watching the election closely as it is widely accepted that the outcome of the election could have important geopolitical implications, as discussed here.