“Fairness is Around Us” Series—Case Study No. 2 on Investor Protection
Release date:2017-09-30
Case 10
Regulatory Enforcement Advances at Every Level, Thousands of Investors Finally Receive Compensation
In 2012, the Guangdong Securities Regulatory Bureau discovered during routine supervision that Z, the former chairman and general manager of Listed Company A within its jurisdiction, had meticulously constructed a web of vested interests to conceal the fact that Company A had related-party relationships with multiple entities and engaged in related-party transactions; some of these related parties were established by his son. Specifically, Company A’s 2009 annual report, as well as its interim and annual reports for 2010 and 2011, failed to disclose, in accordance with the law, the existence of such related-party relationships and related-party transactions. Moreover, even those related-party transactions that met the threshold for mandatory disclosure were neither submitted to the company’s board of directors for review nor promptly disclosed, thereby violating relevant laws and regulations on information disclosure.
To promptly curb the relevant illegal activities and prevent further losses to the broad investor base, in July 2012 the Guangdong Securities Regulatory Bureau issued an “Administrative Regulatory Measures Decision” to Company A and its former chairman, Mr. Z, issuing a warning to Company A and ordering both the company and Mr. Z to make a public statement. Subsequently, Company A issued an announcement admitting that it had previously failed to disclose related parties and related-party transactions in its information disclosures.
Given the serious nature of Company A’s unlawful conduct, mere administrative regulatory measures would be insufficient as a deterrent; it is therefore necessary to hold the company legally accountable. In October of the same year, the Guangdong Securities Regulatory Bureau decided to formally initiate an investigation into the company. In view of the large number of individuals involved and the extended period over which the violations occurred, the Bureau assembled a highly capable and experienced team, overcame numerous challenges, and accelerated the pace of the investigation, ultimately completing all investigative and adjudicatory proceedings in just over 100 days. In March 2013, the Bureau formally issued an administrative penalty decision against Company A, imposing a warning and a fine of RMB 400,000 on the company, a fine of RMB 150,000 on Z, and corresponding penalties on other senior managers and directly responsible personnel.
Administrative penalties do not mark the end of a listed company’s legal liability. According to the relevant regulations, if a listed company is penalized for unlawful information disclosure, shareholders may file a lawsuit seeking compensation for their investment losses against the company.
Following the announcement of the administrative penalty against Company A, a large number of investors began contacting the Guangdong Securities Regulatory Bureau to seek advice on filing lawsuits to protect their rights. To effectively safeguard investors’ legitimate rights and interests, the Bureau provided professional guidance on litigation and rights protection to more than one hundred investors via telephone and disseminated public-service advisory messages titled “Civil Litigation Is an Important Channel for Investors to Protect Their Rights” through the region’s investor protection mobile information platform, directing investors to seek compensation from the infringers by retaining lawyers or filing lawsuits directly with the courts.
Meanwhile, the Guangdong Bureau promptly notified the relevant courts handling the cases of its administrative penalty decisions, and the two sides engaged in repeated discussions on such matters as the calculation of investor losses, the determination of relevant time points, and the impact of systemic risk. In addition, the Bureau coordinated with professionals from relevant securities firms to develop software for calculating compensation amounts, thereby reducing the workload of loss assessment and providing professional support to facilitate the courts’ smooth adjudication of the cases. Furthermore, the Bureau promptly held talks with A Company’s current senior management, urging the company to proactively cooperate with the courts, resolve shareholders’ claims in a lawful and reasonable manner, and minimize the costs associated with shareholders’ rights protection efforts.
According to an announcement by Company A, from March 2013 to May 2015, more than 2,700 individual investors filed lawsuits in court, seeking cumulative damages totaling RMB 384 million. As of June 2015, among the more than 950 cases that had received final judgments from the courts, Company A was ordered to compensate investors for losses exceeding RMB 60 million.
Comment:
1. In this case, Z long served as the principal decision-maker for the company’s affairs; however, over time, Z gradually relaxed personal standards and harbored a sense of complacency, failing to disclose information that the company was legally required to make public. This conduct not only tarnished A Company’s reputable standing in the capital markets but also resulted in penalties being imposed on the company, Z personally, and other relevant persons held accountable. Furthermore, the court ordered the company to bear substantial compensation liabilities, leaving a lasting mark of untrustworthiness in the securities market—a lesson of profound significance. It is hoped that controlling shareholders and de facto controllers of listed companies, as well as directors, supervisors, and senior management, will take this case as a cautionary example, ensure they are fully aware of and comply with the law, and refrain at all costs from testing the limits of the law; otherwise, they will inevitably face irreparable regret.
2. The purpose of establishing a disclosure regime for related-party transactions of listed companies is to promote fair trading and prevent controlling shareholders, actual controllers, directors, supervisors, and senior management from using such transactions to transfer benefits. A salient feature of this case is that certain related-party transactions were conducted between the listed company and a company established by the chairman’s son. By concealing the existence of the related-party relationship and the related-party transaction itself, the perpetrators engaged in backroom dealings, making it exceedingly difficult to ensure the fairness and impartiality of the relevant commercial transactions. Upon discovering these violations, the regulatory authorities promptly halted the unlawful conduct, imposed penalties on those held accountable, delivered a stern warning to the wrongdoers, and thereby safeguarded the legitimate rights and interests of investors.
Case 11
Continuously refine the equity structure and collectively select director candidates.
In early May 2012, Company C issued an announcement stating that its “overdue” chairman would formally step down at the annual general meeting on May 25, and that the company’s board of directors would undergo a re-election, with cumulative voting to be used for the election of director seats.
The company promptly notified its largest shareholder and major institutional investors, urging them to actively nominate director candidates. Subsequently, the de facto controller, through the controlling shareholder, put forward four nominees, including Mr. Y, who had previously held positions in banks and government agencies and had recently been appointed president of the controlling shareholder; the other three nominees have all served at the company for many years. At the same time, a QFII and a public mutual fund jointly recommended their own director candidates. Media outlets widely predict that, upon election, Mr. Y will be nominated as the company’s general manager, thereby becoming the new leader of the firm.
The participation of institutional investors in the governance of Company C stems from the company’s sustained efforts since 2005 to optimize its equity structure, thereby enhancing the voice and influence of institutional investors. First, the company has fundamentally addressed the issue of single-shareholder dominance: the controlling shareholder’s stake has gradually declined from 50.28% prior to the shareholding reform to 19.45% at the end of 2011, marking a transition from absolute to relative control. Second, the company has brought in downstream distributors as strategic investors by transferring a 10% stake held by the controlling shareholder to ten core regional sales companies, thereby aligning the interests of the company with those of its distributors. Third, the company has implemented an equity incentive plan, under which the controlling shareholder has allocated 4.23% of the shares to executive officers, middle-level managers, and key business personnel. These measures have aligned the interests of the company, all classes of shareholders, and management, attracting substantial long-term holdings from both institutional and individual investors. As a result, the company’s market capitalization increased by a factor of 12.3 between 2005 and 2012.
At the shareholders’ meeting on May 25, the majority of minority and medium-sized shareholders voiced the same concern: “The controlling shareholder holds only 19% of the shares yet has nominated half of the board members. Moreover, the newly appointed executive, Mr. Y, has no experience in corporate management and is unfamiliar with the company’s business; how can he possibly handle the role of Managing Director upon taking office?”
As expected, in the subsequent board election vote, investors actively exercised their voting rights and overwhelmingly cast their ballots for the director candidates recommended by institutional investors. The nominated candidate ultimately secured a landslide victory with 113% of the votes, while Candidate Y, proposed by the controlling shareholder, received only 36.6% approval and was thus rejected. Following the vote, the company’s de facto controller demonstrated a strong commitment to the rule of law and a forward-looking, open-minded approach, stating unequivocally: “We respect the resolution passed at this shareholders’ meeting and are confident that the newly elected board will duly fulfill its rights and obligations.”
Comment:
1. Company C has a diversified equity structure, under which the various shareholders engage in mutual consultation and rationally express their views on major decisions such as executive appointments, profit distribution, and investment and financing, thereby gradually establishing a sound governance mechanism.
2. Listed companies shall, in accordance with the law, establish a fair and reasonable voting mechanism that is designed to reflect the wishes of small and medium-sized investors. Company C has stipulated in its articles of association that the election of directors shall be conducted using a cumulative voting system, thereby creating conditions for small and medium-sized investors to exercise greater influence in the decision-making process.
3. The controlling shareholder of a listed company shall recognize that, although it is the single largest shareholder in terms of shareholding, it does not hold an absolute controlling interest when viewed in light of the overall distribution of the company’s shares. Therefore, the major shareholder should respect and safeguard the independence of the listed company’s operations and governance, and respect investors’ ultimate decision on the company’s proposals.
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