China government-backed class actions take aim at corporate fraud – with limits

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SHANGHAI/HONG KONG (Reuters) – China wants its army of mom-and-pop investors to take corporate fraudsters to task with landmark class action lawsuits, but heavy government involvement means they are not likely to be as common as in other legal systems, lawyers and investors said.

The legal framework, which follows a series of scandals and official vows to crack down on corporate malfeasance, is the latest move to deepen and improve capital markets in China, where 80% of trading is conducted by retail investors.

Under the new class-action mechanism, which began on July 31, a Chinese government-affiliated body, the China Securities Investor Service Centre (CSISC), will sue on behalf of all individual investors in a company.

The CSISC said it would initially select “typical, major cases with wicked social impact and exemplary significance”. Investors and lawyers say that could result in other cases falling by the wayside.

“I think it’s going to be complicated … because if a company is very strongly backed, for example, by the local government, do you dare bring a class-action suit against it?” said Marcia Ellis, Hong Kong-based Partner at Morrison & Forester.

Although corporate fraud is not uncommon in China, retail investors have historically had little chance to make their voices heard. Small investors often likened legal action to ants fighting elephants.

Gao Jianlu, a retail investor in southwest China, said the new class-action framework made it cheaper and easier to sue listed companies.

“Bosses of listed companies will lose their shirts and never rise again,” Gao wrote in his blog on the trading community site

Accounting fraud at firms including Kangmei Pharmaceutical and Kangde Xin Composite Material Group risk damaging investors’ trust in China’s financial markets, Yi Huiman, China’s top securities regulator, said in May.

Individual investors have sued these companies, and others, under the existing investor-protection rules, but individual cases typically fail to catch courts’ attention, while compensation is often negligible, even for major fraud.


China’s stock market plays an increasingly important role in financing cash-starved companies in a slowing economy and amid rising tensions with the United States.

Investors fear that China’s shift toward a disclosure-based initial public offering of shares system, in which companies must meet fewer thresholds to list, could result in more fraudulent companies.

But even with the new framework, class-action lawsuits “won’t be used as extensively in China as they are in the U.S.,” activist investor Xu Caiyuan said.

Under the new litigation process, either the courts or a regulator must find that a company has broken the rules, or the company must admit wrongdoing, before a class-action lawsuit can be launched.

In addition, class-action suits launched by individuals, not the CSISC, can only include investors who opt in, reducing the number of plaintiffs and the size of the claim.

Yang Seng, a lawyer who has collected claims on 150 cases of corporate fraud during the past two years, said this would sideline lawyers who had been the most active under the previous system.

“I don’t think we’ll see a large wave of class-action lawsuits,” he said.