Tuesday, February 15, 2011
A former student just passed along an interesting article on the problems US investors face in bringing actions under US securities laws against Chinese companies listed in US stock markets. I recommend it. I want to add a few points that aren't made in the article, though.
- The defendant in these suits is not always a Chinese company. In the example given in the article, the defendant, LDK Solar Co., Ltd., is actually a Cayman Islands corporation. Of course, it is in substance a Chinese company: it was set up with the sole purpose of holding the equity in a Chinese firm and then listing its shares abroad. But it is organized under the corporate law of the Cayman Islands, and that at times will make a difference.
- The defendant is not - or need not be - always a company. If there's fraud going on, there are fraudsters. The problems that apply in suing a company may not apply in suing a person, and of course vice versa. While a single person's wealth may not be enough to compensate defrauded investors, the prospect of a large adverse US judgment might be a deterrent to the many wealthy individuals in China who contemplate travel to, or property ownership in, the United States or any other jurisdiction that enforces US judgments. Thus, plaintiffs are not completely without leverage.
- If the defendant company is organized under Chinese law, it almost certainly has a provision in its Articles of Association calling for all shareholder disputes with the company or its management to be settled through arbitration. In other words, shareholders have agreed by contract never to sue in court.
- This provision is required by China's Securities Regulatory Commission in its Mandatory Provisions of Articles of Association of Companies Seeking Overseas Listing (到境外上市公司章程必备条款). [CORRECTION 20 Feb. 2011: The provision is required only in companies listing in Hong Kong; thanks to Joseph Wang for kindly pointing this out. It is allowed and I believe encouraged in companies listing elsewhere. The provision in fact appears in the Articles of at least some companies listed on US exchanges, and of course it would appear in the Articles of Chinese companies listed in Hong Kong that also issued shares or ADRs elsewhere.] The Provisions were promulgated in 1994 and, amazingly, are still in effect; the provision on arbitration was, to the best of my knowledge, intended to favor shareholders because the general opinion of Chinese courts at that time, even among Chinese government officials, was low. I don't know if the CSRC realized it was purporting to shut shareholders out of foreign courts as well. In effect, the rule makes US-style securities class actions impossible. The strength of the US-style class action is not only that it aggregates a number of small claims not worth suing over on their own, but also that it makes settlement possible, because non-parties can (contrary to the usual rule of civil procedure) be bound by the judgment. That can't happen in arbitration.
- "Wait," I hear you saying. "Are you kidding? Surely a company can't avoid the reach of federal securities law so easily!" And indeed, maybe not. I've often wondered what a US court would do if a Chinese defendant in a securities suit raised this provision as a defense. I tend to think it would find the provision void as against public policy. I once tried to verify this intuition when looking at an actual federal class action against a Chinese company organized under Chinese law but listed in the US. I went on Edgar and found the defendant's Articles of Association. I verified that they had the provision in question. I then looked at the briefs in the case and found the name of the lawyer and firm who handled the defense. And I emailed him to ask if he would be able to tell me whether this provision had been raised as a defense, and if not, why not. Never heard back. Coincidentally, shortly thereafter I had some friendly dealings with another partner in his firm. I asked that person to check with the lawyer in question to see if my email had been received and whether he felt comfortable answering it. Back came the answer: email received, but he'd rather not respond, even if only to say that he'd rather not respond. So I'll never know whether they declined to raise the arbitration provision as a matter of litigation strategy, or whether they just didn't notice it.
- Although I haven't researched the question systematically, I don't recall ever hearing of the arbitration provision being raised as a defense when US-listed Chinese companies are sued, and no lawyer or SEC person I've talked to has ever heard of this being done, either. So I think it remains merely an interesting theoretical question.
- Investors can't exactly say they weren't warned. I've looked in the "Risk Factors" section of a number of prospectuses of Chinese companies listing in the US, and my recollection is that they are typically pretty open about the possibility that the controlling shareholder may act against the interests of other shareholders or the company, and there's not a lot anyone will be able to do about it under anyone's law. The prospectus for the company mentioned in this article, LDK Solar, is no exception, warning investors as follows:
You will have limited ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them.
We are incorporated in the Cayman Islands and conduct substantially all of our operations in China through our wholly owned subsidiary established in China. Most of our current directors and officers also reside outside the United States. Substantially all of our assets and the assets of those persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States, in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the applicable securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities” in this prospectus.
But as we know, nobody ever reads the Risk Factors!