The first Securities Law of the PRC come into effect on 1 July 1999, and has since undergone five amendments. The latest revision came into effect on 1 March 2020. It is more striking than all previous revisions, with many highlights. For instance, the new version officially launches a registration-based IPO system, lowers the prerequisite for issuing shares from “sustained profitability” to “sustainable operation ability”, strengthens information disclosure and investor protection, implements the presumed fault liability, introduces a representative litigation system, and adopts heftier fines for rule breakers.
The introduction of a registration-based IPO system, and the scrapping of the requirement of “sustained profitability” for new listings will attract more companies to finance through the capital market, and it is foreseeable that the number of China’s A-share listed companies will surge.
The registration system is also applicable to the public issuance of securities by listed companies during M&A transactions. This not only saves time and simplifies procedures, but also encourages listed companies to use M&A to achieve resource integration more often. With the implementation of the latest Securities Law revisions, it is expected that more M&A transactions will take place in the A-share market.
Inevitably, disputes will be triggered, due to insufficient information disclosure or failure to fulfill performance commitments, etc., and some may run into hundreds of millions, or even billions. For these huge M&A disputes, arbitration is undoubtedly needed for a fair and efficient settlement.
Meanwhile, since such M&A disputes involve listed companies, the progress of the cases will undoubtedly affect stock transactions. How to properly co-ordinate the information disclosure requirements for listed companies and the confidentiality requirements of arbitration is an issue that arbitration colleagues need to consider.
Article 95 of the Securities Law introduces a representative litigation system, which is similar to “class action”. It is beneficial for investors to monitor listed companies, improve the efficiency of judicial resources, and better protect small and medium investors.
The first paragraph of article 54 of the Civil Procedure Law stipulates that where there are multiple persons comprising one party to a lawsuit, but the number of persons is not confirmed at the time of filing the lawsuit, the court may issue a public announcement and notify the rights holders to register with the court within a stipulated period.
Article 95 of the Securities Law introduces the above-mentioned litigation system into securities civil compensation proceedings. Although the representative litigation system was already stipulated by the Civil Procedure Law in 2007, it was not until 13 March 2020 that the representative litigation system was first applied, by Hangzhou Intermediate People’s Court in a series of disputes on liability for false statements of securities between bond investors of “15 Wuyang Bonds” “15 Wuyang 02” and Wuyang Construction Group. This is the first representative lawsuit for securities civil compensation since the implementation of the Civil Procedure Law and the newly revised Securities Law.
Class action in the securities market is a powerful weapon for investor protection. However, just as every coin has two sides, it may also destroy some listed companies that are operating normally. For example, Robbins Geller Rudman & Dowd and Pomerantz initiated a class action lawsuit against Alibaba, in which the law firms accused Alibaba of publishing false and misleading information about the company’s business operations, financial outlook, and investigations by regulatory authorities. In the end, Alibaba paid US$250 million as a condition for settlement. However, Alibaba responded that it believed that it had nothing to do with the accuracy of information disclosure and management transparency.
The author believes that in order to respond to representative litigation, and reduce the risk of malicious litigation, general counsels should gradually include arbitration more broadly in their vision. Taking the US as an example, when class action prevailed, many in-house lawyers began to combine arbitration clauses with class action injunctions to avoid class action.
According to a survey by The New York Times, Verizon has 125 million registered users. Nevertheless, from 2010 to 2014, Verizon faced only 65 consumer arbitration cases in total. Similarly, Time Warner Cable, with 15 million users, has only 7 arbitration cases. It shows that choosing arbitration will greatly reduce the risk of class action.
For China, as early as 2004, the Legislative Affairs Office of the State Council and the China Securities Regulatory Commission (CSRC) jointly issued the Notice on Doing Well the Arbitration of Securities and Futures Contract Disputes, encouraging securities issuers, securities companies, securities investment consulting agencies, fund issuers, fund management companies, fund custodian institutions, listed companies and other entities to choose arbitration to resolve their securities disputes with each other, and with their clients.
However, because of the diversity, complexity and extensive nature of securities disputes, arbitration has not yet become the mainstream choice for resolving securities disputes in practice. The author understands that with the implementation of the representative litigation system, more and more listed companies and fund companies will include arbitration clauses in their contracts with investors. As far as Chinese arbitration is concerned, whether to introduce a representative litigation system into the arbitration rules is also a question worth studying.
The latest Securities Law upholds deregulation, strengthens supervision, facilitates financing, and strengthens information disclosure. For this purpose, a new chapter was added to the law with provisions on information disclosure. Almost every enterprise that is about to launch an IPO has several PE investment institutions behind it. For investment at the pre-IPO stage, PE investment institutions generally sign a VAM (valuation adjustment mechanism) agreement with the target company. In the past, in order to maintain the stability of the equity and control of listed companies, the CSRC required companies to be listed, to clean up the VAM agreement before reporting. In response to regulatory requirements, PE investment institutions and companies often do not terminate the VAM agreement, but sign a non-disclosure “drawer agreement” to stipulate that the VAM agreement continues to be valid.
On 14 May 2020, Sihui Fuji Electronics Technology, which signed a VAM agreement with its investors, successfully passed the CSRC review. This landmark case suggests that market practice has begun to be officially recognized by regulatory agencies. In the past, in an arbitration case where the PE investment agency required the actual controller of the company to repurchase its investment based on the VAM agreement, the arbitrators always haddifferent opinions on how to determine the validity of the termination agreement of the VAM agreement and the “drawer agreement” between the parties.
Some arbitrators even thought that the “drawer agreement” should be invalid due to the parties’ intention to maliciously evade supervision. In the past few years, the author has represented many PE investment institutions in handling arbitration cases concerning investment exits.
In almost every case, the target companies defend on the grounds that the “drawer agreement” is invalid, and request the arbitral tribunal to apply the publicly disclosed termination agreement to hear the case. It is believed that with the promulgation of the latest Securities Law and the implementation of new review standards, the arbitral tribunal will have a more consistent point of view when hearing PE investment exit arbitration cases.
Overall, the implementation of the new Securities Law will promote the further development of China’s arbitration business. However, how China’s arbitration institutions adjust the arbitration rules to adapt to the opportunities and challenges brought about by the revised Securities Law, such as the representative litigation system, is worthy of in-depth exploration by arbitration colleagues.
Kevin Xie is an arbitrator of the China International Economic and Trade Arbitration Commission, and a senior partner of DeHeng Law Offices
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