Laying the groundwork for China's Securities Class Action System

Authors: Liu Siyuan / Zhao Feng

(This article was first published on China Law & Practice 2020 Annual Review, authorised reprint)

Liu Siyuan, Partner of Jingtian & Gongcheng, discusses the revised Securities Law and the rules issued by the Supreme People’s Court that provide support for the implementation of a securities class action legal system in China, and the benefits and difficulties for investors and listed companies in future litigation.    

On March 1, 2020, the latest revision of the Securities Law (证券法) was implemented, and the long-awaited class action rules came out. The class-action rules have attracted a lot of attention because this is the first time that class-action rules enacted in China and brought a significant increase in both cases and claimed amounts. Subsequently, after extensive research, the Supreme People’s Court (SPC) issued the Provisions on Several Issues Concerning Representative Litigations in Securities Disputes (the Judicial Interpretation of Representative Litigations) (关于证券纠纷代表人诉讼若干问题的规定), which provide support for the implementation of class action rules. On December 31, 2020, it was released on CSRC's press conference that the first Securities Class Action case was officially launched. Based on these rules, and the actions and responses from regulatory authorities and courts at all levels, this article analyzes the class action legal system (or “representative litigation”) and its prospects in future litigation.

Form of Action

Ordinary representative litigation

The Judicial Interpretation of Representative Litigations separates representative litigation into ordinary representative litigation and special representative litigation. Ordinary representative litigation covers litigation directly filed by investors or those that are triggered by investor registration organized by courts, which are respectively stipulated in the first and second paragraphs of Article 95 of the revised Securities Law.

The first paragraph of Article 95 provides that “when an investor files a securities civil compensation lawsuit pertaining to misrepresentation etc., if the litigation subject matter is the same type and there are multiple persons in one party, a representative may be appointed for the lawsuit pursuant to the law.” Moreover, according to the rules issued by the SPC, a court should apply procedures for ordinary representative litigation when: (1) the number of claimants is more than 10; (2) two to five proposed representatives are identified in the complaint; (3) and the claimants submit prima facie evidence proving facts of the securities infringement. With the development of the investor protection legal services industry, one investor protection lawyer may represent hundreds of investors. Therefore, investor protection lawyers usually take the initiative to begin ordinary representative litigation.

The second paragraph of Article 95 stipulates that “in a lawsuit filed pursuant to the provisions of the preceding paragraph, where there may be many other investors who have the same litigation request, the people’s court may make an announcement, state the information of the case of the said litigation request, and notify the investors to register with the people’s court within a certain period. The judgment or ruling of the people’s court is binding on the investors who participate in the registration.”

Generally, in registration announcements issued by courts, the following information may be included: (1) the punishment made by regulatory authorities against listed companies on misrepresentations; (2) the scope of rights holders who satisfy all requirements of registration, and such requirements may include the restriction on the date of buying shares, and the restriction on selling or continuing to hold the shares after a certain date; and (3) the method and period of investor registration, including registration address, website, information, mailing address, and contact number, etc.

Special representative litigation

The third paragraph of Article 95 of the revised Securities Law provides for the rules of special representative litigation, and states “an investor protection organization entrusted by more than 50 investors may participate in the lawsuit as a representative, and register with a people’s court pursuant to the provisions of the preceding paragraph for rights holders who are confirmed by a  securities registration and settlement organization, except where the investors clearly state that they are unwilling to participate in the lawsuit.”

According to this rule, two investor protection funds set up by China Securities Regulatory Commission (CSRC) can recruit 50 investors and then obtain information of all investors who meet the requirements of the claim from the China Securities Depository and Clearing Co., Ltd. The number of qualified investors may reach tens of thousands or even hundreds of thousands. The court will then issue an announcement of all qualified investors’ information. Investor protection organizations can file lawsuits on investors’ behalf by default even without the investors’ express consent or authorization, unless the investors explicitly opt out of litigation. That is to say, the principle is that “an investor waives his/her rights only if he/she clearly states so, otherwise his/her silence will be regarded as a consent to participate in a lawsuit".

Impact of Special Representative Litigation

Drastically reduces the cost of investors’ claims

Securities fraud litigation is categorized as a type of professional litigation. Investors often entrust professional investor protection lawyers to participate in litigation on their behalf and pay corresponding attorney fees.

If courts apply procedures for ordinary representative litigation and issue registration announcements, investors only need to participate in the registration as required. Investors may get a free ride from the representative and the representative’s lawyer without appointing their own lawyers in follow-up procedures, and enjoy the fruits of litigation. Also, the courts may decide on the amount of compensation in accordance with a legally effective judgment, even though the investor did not directly participate in the registration.

According to the special representative litigations rules, besides the 50 recruited investors, other investors are not required to expressly authorize investor protection organizations to represent them and all they need to do is wait to receive compensation from listed companies. Therefore, investors not only save on attorney fees, but they can also avoid litigation costs caused by lengthy judicial proceedings.

Significant increase in the number of claimants and the amount of claims

The enactment of special representative litigation is a burdensome topic for listed companies. In the case of special representative litigation filed by investor protection organizations, the number of claimants may increase exponentially. Up to December 2020, the highest amount claimed in ordinary securities fraud litigations of a listed company was between Rmb400 to 600 million. Under the special representative litigation rules, the total amount of claims may increase by 5-12 times, resulting in a claim scale of more than one billion or even in the billions.

Potential Problems

Difficulties in selecting special representative litigation cases

Although the CSRC Investor Protection Bureau and two investor protection organizations set up by it established the principle that case selection should consider various factors such as solvency, social influence, and malice, there is still a dilemma in practice when cases are selected. Generally, cases with severe malice and great social influence will be cases that have serious financial fraud issues. Therefore, listed companies are likely to start delisting procedures and bankruptcy proceedings after they are subjected to punishment, which may result in listed companies not being able to pay compensation to investors. Even if listed companies are able to take on compensation responsibilities, the compensation paid in securities/fraud litigation will significantly reduce the companies’ net assets, which will affect the interests of existing shareholders (including small and medium investors), existing creditors, and all of its employees.

In addition to listed companies, there are also difficulties in claims against other potentially responsible entities: (1) when such claim is made against a relevant responsible natural person, investors generally face difficulties when enforcing judgments; and (2) when such a claim is made against a responsible intermediary, a problem that arises is although a securities company has a good economic capability, most intermediaries, such as auditing agencies and evaluation agencies, have limited debt-paying ability (generally no more than the amount of insurance compensation).

Difficulty in initiating special representative litigation

Article 32 of Judicial Interpretation of Representative Litigations provides that “where the people’s court has issued an announcement of registration of rights, the investor protection agency may participate in litigation as a representative under the special authorization of more than 50 rights holders during the period of announcement.” Based on this rule, in such a progressive mode, only if courts issue registration announcements can investor protection organizations initiate special representative litigation. The issuance of registration announcements by local courts has become fundamental for investor protection organizations to decide whether to initiate special representative litigations. The activation of China's first Securities Class Action case also indicated the establishment of cooperation mechanism between the CSRC and judicial system in Securities Class Action cases.

Increased pressure for courts to determine the amount of loss

The cause for investors’ losses is complex. In addition to information disclosure violations, the cause may also include risks associated with the capital market as a whole, and other operational risks of the specific listed company. The qualification of the influence of each factor has always been an extremely difficult issue both academically and in practice. Recently, the Shanghai Financial Court jointly cooperated with Shanghai Jiao Tong University to accurately measure the specific loss of each investor influenced by listed companies’ information disclosure violations by using financial analysis methods (a multi-factor model and event-study analysis). However, such methods have not been popularized in other districts due to the complexities and difficulties in understanding how they are applied.

With the application of the special representative litigations rules, the number of claims will increase exponentially and put listed companies and other entities under huge pressure for compensation claims, which may affect their production and operations. Therefore, courts need to find a balance between the interests and protection of both investors and listed companies. This requires the courts to determine the loss amount more accurately and scientifically. Otherwise, there may be a situation where investors will receive a judgment in their favor, but the listed companies are already insolvent.

The special representative litigation mechanism has just been published, and there has not yet to be a case initiating the special representative litigation. The rules are still in their developmental stage and their future application will no doubt encounter countless obstacles and bumps. It is hoped that after continuous trials and revisions, the interests of both investors and listed companies can be equally protected, and the long-term stable development of China’s capital market can be maintained.

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合伙人

010-5809 1385

liu.siyuan@jingtian.com

刘思远律师毕业于清华大学法学院，先后获得法学学士、法学硕士学位。

刘律师2017年加入北京市竞天公诚律师事务所并成为证券部合伙人。刘律师的主要执业领域为证券合规、证券诉讼。执业期间，曾办理中信证券司度案、光大证券乌龙指案、雅百特跨境财务造假案、康得新信息披露违法案、深大通不配合调查案、恒康医疗大股东操纵市场案、某公募基金经理内幕交易案、某四大会计师事务所勤勉尽责案、方正证券虚假陈述民事赔偿诉讼、蓝色光标业绩承诺纠纷等几十件有代表性的证券类案件，并为多家上市公司、金融机构、中介机构提供常年证券合规法律服务。刘律师是中国法学会案例法学研究会理事、财新网专栏作家、投保基金调解员，连续三年被LEGALBAND评选为合规领域“中国顶级律师”。

刘律师的工作语言是中文和英文。

刘思远律师历史文章

1. 新型操纵证券市场行为解析——从恒康医疗案看信息型操纵的行为特征

2. 2017年证券欺诈责任纠纷十大案件回顾

3. 深度解读新规中的强制退市条件

4. 证券欺诈诉讼的“矛”与“盾”

5. The Art of War: security-fraud litigations in China

6. 上市公司的锅为什么要中介机构背？

7. 中介机构尽调会因何被罚？

8. 券商会计师律师：函证程序中的常见“雷区”

9. 外资券商“抢滩”A股——你所需要知道的证券合规风险

10. 做上市公司董监高风险有多大？

11. Safe Landings: Navigating the Chinese Securities Market

12. New Trends of CSRC Enforcement Against Securites Violations

13. A股爆雷！谁来担责？

14. 新证券法解读——第一讲：对信息披露行为的规制

15. 当监管机构来敲门，我该怎么办？——兼评新《证券法》第二百一十八条处罚情形

16. 提高罚款无法根治上市公司“割韭菜”问题

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律师

010-5809 1595

zhao.feng@jingtian.com

赵枫律师系竞天公诚律师事务所律师，研究生毕业于北京大学，获得法律硕士和JD学位，本科毕业于南开大学，获得管理学学士学位（财务管理专业）。

赵律师的执业领域专注于证券合规、政府调查及刑事案件，擅长办理涉及财务、金融背景的案件，并具有丰富的为涉外企业提供法律服务的经验。赵律师曾参与雅百特信息披露违法、某国际银行因涉嫌操纵市场被调查、方正证券虚假陈述民事诉讼等多件案件。

赵律师的工作语言为中文和英文。

赵枫律师历史文章

1. 新型操纵证券市场行为解析——从恒康医疗案看信息型操纵的行为特征

2. 2017年证券欺诈责任纠纷十大案件回顾

3. 上市公司的锅为什么要中介机构背？

4. 中介机构尽调会因何被罚？

5. 券商会计师律师：函证程序中的常见“雷区”

6. 外资券商“抢滩”A股——你所需要知道的证券合规风险

7. 做上市公司董监高风险有多大？

8. Safe Landings: Navigating the Chinese Securities Market

9. New Trends of CSRC Enforcement Against Securites Violations

10. 私募基金中的是非题——保本保收益约定的认定和法律后果

11. “刑行民组合拳”出击  惩处证券违法新时代

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