On September 24, the Supreme People's Court issued a notice: Cases
involving civil compensation due to insider trading, fraudulence
and market manipulation on the securities market should not be
accepted for the time being.
The notice immediately evoked strong responses from investors,
securities circles and the legal community. It is illegal
activities on the securities market that have done the most damage
to small and medium investors. The institutional defects concerning
civil compensation on the securities market have aroused
unprecedented concern.
Unregulated actions have often occurred on China's securities
market. Companies fabricate false accounts and release phony
information, and major shareholders appropriate corporate funds and
jointly manipulate stock prices. Before the Supreme People's Court
issued the notice, many cases had arisen in which investors sued
listed or intermediary companies for illegal operations, which
inflicted property losses on investors.
On
April 25, the China
Securities Regulatory Commission (CSRC) investigated and dealt
with four companies that jointly manipulated the stock price of
Guangdong Yorkpointso Ltd. From October 5, 1998, the four companies
bought and sold the company's stock among themselves by using 627
individual and three institutional stock accounts. The stock price
of Guangdong Yorkpointso was thus artificially pushed up from 5.6
yuan (US$0.68) in August 1998 to 126.31 yuan (US$15.28) in February
2000, the growth reaching 21.5 times at the highest. Guangdong
Yorkpointso became the first stock surpassing 100 yuan (US$12.1) on
the Chinese stock market. By February 5 this year, the four
companies had made 449 million yuan (US$54,312,326) in profit. The
CSRC confiscated the 449 million yuan in illegal income from the
four companies, plus an additional 449 million yuan in fines. Many
people holding the stock suffered losses of various degrees, some
as high as 700,000 yuan (US$84,674).
In
early August, Guangxia Industry, a listed company known for its
outstanding performance, was exposed by the media for disclosing
phony information. In two years, Guangxia created dazzling records
in terms of both stock price and performance. In the year 2000, its
stock price rose 440 percent, ranking first on both the Shanghai
and Shenzhen stock exchanges. Its capitalization exceeded 10
billion yuan (US$1,209,628,644). However, everything concerning the
company was false. Guangxia made up export contracts, fabricated
the list of exports, boosted performance, created false annual
reports and disclosed phony information. In early August, the
company was suspended from trading for one month. When trading
resumed, stock prices plummeted for 15 consecutive down limits from
more than 30 yuan (US$3.63) to about 5 yuan (US$0.6), setting a
record on the Chinese stock market. According to the mid-year
report, by the end of June, Guangxia had a total of 14,245
shareholders.
Following Guangxia Industry, was picked up by the CSRC. Less than
18 months after the initial public offering (IPO), major
shareholders had almost "eviscerated" the assets of the company. By
May 31, major shareholders and associated companies had
appropriated more than 2.5 billion yuan (US$302,407,161) of the
company's funds, which accounted for 96 percent of its net assets.
As a consequence, the interests of small and medium investors had
been seriously infringed upon and the asset safety of the listed
company was directly threatened.
According to the China Securities News report, preliminary
statistics show that since 1999, the CSRC has put 220 illegal
actions on file. Administrative sanctions have, so far, been
imposed in 92 cases, with fines and confiscation totaling 1.49
billion yuan(US$169,348,010).
Who Should Compensate for Shareholders' Losses?
In
the case of Guangdong Yorkpointso, 363 people have collectively
entrusted the Zhong Lun Law Firm to carry out litigation, demanding
24.6 million yuan(US$2,975,686) in compensation. The plaintiffs
took legal proceedings in Beijing and Guangzhou on September 20.
Recently, more than 100 investors also brought a suit against
Guangxia Industry at local courts in Shanghai and Wuxi.
Since 1998, when a Mr. Jiang in Shanghai sued Hongguang Industry
for causing losses to investors by inventing false information,
many other Chinese shareholders sought legal assistance to recover
their losses. But, so far, none have succeeded. In Jiang's case,
the court overruled his claim, saying that the disclosure of false
information did not have a necessary cause-effect relationship with
the losses of shareholders. Those who now sue Guangxia and
Yorkpointso face the notice of the Supreme People's Court demanding
that local courts temporarily suspend the acceptance of similar
cases.
Why Are the Cases Not Being Accepted?
Article 108 of the Civil Procedure Law of the People's Republic of
China stipulates four conditions for bringing a lawsuit. (1) The
plaintiff must be a citizen, legal person or organization that has
a direct interest in the case. (2) There must be a definite
defendant. (3) There must be a specific claim or claims, facts, and
a cause or causes for the suit. (4) The suit must be within the
scope of acceptance for civil actions by the people's courts and
under the jurisdiction of the people's court where the suit is
entertained. In legal terms, these cases meet the conditions for
taking action and the court has no reason to refuse to accept
them.
Why Does the Court Refuses to Answer These Suits?
According to interpretation of the Supreme People's Court notice,
the court now lacks the conditions for trying such cases.
Cao Shouye, a division director of the Supreme People's Court, said
there are two reasons for not accepting such cases at the moment.
One is related to legislation. The Securities Law provides very
abstract stipulations on civil liabilities. As the stipulations are
not specific enough, the courts have difficulties applying them.
The other is related to the administration of justice. Judicial
personnel have unsatisfactory quality, and relevant judicial
interpretations are yet to be unveiled.
Cao said that, according to State legal provisions and from the
perspective of case filing, the court should accept these cases.
However, as cases involving securities disputes are complicated
with wide connections and big influence, it is better not to accept
such cases for the time being, out of consideration of both the
legal and social effects of a trial.
Pitfalls in the System
Law experts pointed out that existing laws are strong on penalizing
violators for their administrative or legal responsibilities, and
weak on providing civil compensation to investors who suffered
losses. To a great extent, this encouraged violators to try their
luck while eroding investors' confidence in securities investment.
A complete system of securities law should put equal emphasis on
civil, administrative and criminal responsibilities.
Law experts also pointed out that, in terms of substantial law, it
is commonly recognized that China's Company Law
and Securities
Law are weak on civil liability. They have no definite
principles or methods regarding the assumption of civil liability.
Nor do they have stipulations on the criteria to be used to judge
the cause and effect between shareholders' losses and insider
trading, fraudulence and market manipulation. Therefore, civil
liabilities as stipulated in Company Law and Securities Law are
futile in deterring violators.
Second, in terms of the right of action, China has yet to establish
a shareholders' representative litigation system. Article 111 of
Company Law said, "When the decisions made at a shareholders'
meeting or by the board of directors violate laws, administrative
regulations and the lawful rights and interests of shareholders,
the shareholders have the right to file a lawsuit at the people's
court asking it to stop those acts of infringement." But the same
stipulations did not grant shareholders the right to seek
compensation from the board of directors, concerned directors or
infringers. Nor do they stipulate that compensation should be made
to those shareholders. When major shareholders harm a listed
company, the company's board of directors would not investigate its
own responsibilities, but small shareholders do not have the right
or the incentive to file a lawsuit on the company's behalf.
Third, in terms of litigation, there is no class action in China.
Although Article 55 of the Civil Procedure Law stipulates the
majority litigation system, it is difficult to put it into
practice. The cost of a lawsuit is too high for small shareholders
and therefore, even if they win, the compensation they received
would not cover legal costs. In practice, there have been no
successful cases of this type.
Fourth, a court's decision on a civil case in China does not have a
"spillover" effect. The obligees of the same case cannot benefit
from the court's decision if they did not register for the lawsuit,
even if they sustained losses. In the case of the Yorkpointso
lawsuit, only a certain number of representatives filed it. If the
court's decision is in their favor, only those 363 shareholders who
filed the lawsuit can benefit from the court's decision. Other
shareholders, if they also want compensation, must file another
lawsuit.
Basically, it is because there are no appropriate existing laws
that the court has to turn down the request for a trial.
Protection of Small and Medium Investors
There are tens of millions of shareholders in China, and it is a
pity that the legal system hardly provides any real protection for
such a large number of medium and small shareholders.
The attorney of the plaintiff of the Yorkpointso case said bluntly
that the current regulatory system couldn't provide enough
protection to investors. It is only satisfied with providing
information to investors, and educating them about the risks of the
stock market.
Experts believe a civil compensation mechanism must be introduced
into China's stock market. It must be operative, and not merely
explain policies to shareholders. "We must also make new
breakthroughs in legislation and the administration of justice,"
they suggest. "For instance, to make provisions on civil liability
in the stock market, we need to revise the Securities Law,
formulate rules of its implementation and work out related judicial
interpretation. Besides, we must consider establishing a system of
shareholders' representative litigation and class action." Some
experts maintained that misconduct on the market could be treated
as a special act of infringement, and its civil liability should be
defined so that it is convenient to be tried.
Regarding the burden of proof, some experts maintained that since
it is always difficult, and often impossible, for small
shareholders to submit evidence, the court could reverse the
process, asking the accused to provide evidence that they are not
guilty.
To
ensure civil compensation, some experts suggested that a securities
damage compensation fund be created, coming from the unlawful
earnings of violators and kept by financial institutions designated
by the securities regulatory department or the court. The fund is
to be used for making payments to investors who suffered losses.
When such investors claim their rights in a class action, the
custodian will pay compensation to the victims in accordance with
the decision of the court.
A
center for the protection of the rights and interests of medium and
small investors is being created. Progress is being made in such
technicalities as the form of organization and the qualifications
of subject of procedure. As a non-profit organization, it will buy
stock on the market and become shareholders of all listed
companies. Once an infringement occurs, this organization will
assume the position of a litigation representative, and bring a
lawsuit against the infringing party, claiming civil compensation.
The final court decision is effective to all small shareholders
that suffered losses.
How Long Shall We Wait?
Zhou Xiaochuan, Chairman of the CSRC, recently reiterated that the
CSRC encourages investors to use legal means to protect their
rights and interests. Meanwhile, there are more and more calls for
the improvement of the civil compensation system on the stock
market. With such public opinions, how long will the case remain
unacceptable to the court?
Wu
Xiaoqiu, Director of the Finance and Securities Research Institute
of the Renmin University of China, said that such lawsuits are
reasonable, understandable and legal, that there is no reason
whatsoever to refuse them. Although the court's refusal to accept
the case for the time being is understandable, it won't be
indefinite. He said, "Now that people have realized that there are
legal pitfalls in the securities civil compensation system, we must
make the best use of our time to improve the legal system. We
should not stall for time, or it would be unfair to investors, and
would hamper the development of China's capital market, as well as
construction of the legal system."
Wu
also said, "I think investors should keep their evidence. The court
will sooner or later accept their cases, and I believe that day
wouldn't be far away."
Cao said the Supreme People's Court has recently begun to study and
draft documents giving judicial interpretations to the Securities
Law. This would pave the way for shareholders to sue for civil
compensation. In his optimistic estimation, the documents will be
finalized next year.
According to China's existing laws and regulations, the plaintiff
will face the problem of prescription of action, which is normally
two years. Will this announcement of the Supreme People's Court
postpone investors' accusations against the listed company? This is
an issue of common concern at present.
Cao said this is a possible problem. But if the judicial
interpretation comes out, and the lawsuit has passed the
prescription of action according to the general rules of the civil
law, the case would be dealt with as an exception. The issuing of
this announcement by the Supreme People's Court would not hamper
protection of the lawful rights and interests of shareholders and
investors.
(Beijing
Review November 29, 2001)