IN Malaysia, the courts have appeared to generally adopt a passive attitude to private securities litigation.

Various obstacles preclude private enforcement from playing a significant role in market regulation.

Questions abound whether legal institutions should be reformed to provide support and strengthen investors’ ability to sue listed companies.

This could become an important governance mechanism, possibly encourage growth in our capital market and help to regulate corporate officials.

Is such an action a viable alternative for minority investors seeking to bring recalcitrant companies to heel?

If such an action can be successfully brought about, will it yield the outcome that investors’ desire and that will impact positively on our capital markets?

China, where investors’ protection was close to zero previously, is now showing progress ..

With the growing number of scandals in Chinese listed companies and the punishments meted out by the China Securities Regulatory Commission (CSRC) – warnings, fines or business suspensions – seen as inadequate.

It did nothing to compensate equity holders who bought shares in good faith only to see them plummet in value once wrongdoing was uncovered, so an amendment was made to China’s securities law.

Effective 2020, they allowed investors – especially individuals – more protection and exposed listed companies found guilty of wrongdoing to the risk of having to pay significant damages.

It also puts the managers and their intermediaries at risk of being held liable for paying compensation.

Individuals can now collectively sue companies for losses suffered as a result of corporate wrongdoing and be compensated collectively.

The cases covered include disclosure of false information, insider trading and market manipulation on Chinese mainland stock markets.

Unlike the American securities class action system – which is mainly driven by lawyers and can be open to abuse by law firms and plaintiffs motivated solely by money – the amendments to China’s securities law were designed around public interest and investor protection.

The litigation must meet three criteria:

1) an administrative penalty has already been issued against the listed issuer

2) the case has had a negative impact on society

3) the listed company has the financial means to pay compensation to the investors.

The criteria set appears consistent with the principles set in the Smith and Others v Cardiff Corporation [1953] 2 All ER 1373; [1954] 1 QB 210 where the Court of Appeal held that to bring a representative action it must be shown: first, that all the members of the class had a common interest; secondly, that they all had a common grievance; and thirdly, that the relief was in its nature beneficial to them all.

Once an action started, other shareholders do not have to apply to join the group of plaintiffs, as they are automatically included if they fit the criteria.

Meanwhile, they do not have to pay court fees in advance to have the case processed, or pay legal fees.

Following this amendment, Kangmei Pharmaceutical, once a stock market darling and one of China’s biggest publicly traded drugmakers – upon the approval by the courts of its bankruptcy reorganisation plan, in which five investors will be injecting ¥6.5 billion (RM4.3 billion) of fresh funds into the company and ensuring it is capable of paying the compensation – was ordered by another court in another ruling later, to pay ¥2.46 billion to more than 50,000 shareholders, who lost money because of a massive ¥88.6 billion fraud, in the form of shares, trust products or cash from the fresh funds.

Most importantly, the later court also ruled that in the event the company could not pay, five independent board directors shared partial liability of the shortfall in compensation, with three held responsible for 10% each and two for up to 5% each.

Pressure is now growing in China on intermediaries such as accountants, advisers and underwriters because of their role in scandals that have rocked the stock markets.

The Kangmei ruling has put them on notice that they will not be allowed to escape the consequences of their actions.

In our country, substantial procedural loopholes have impeded minority shareholders’ remedies, making it difficult for individual plaintiffs to file suits in the courts.

To begin with, class action suits – or representative actions in our country derived from Order 15, rule 12(1) of the Rules of Court 2012 – are not often seen in our courts.

By nature, we are not a litigious society and it is not common to have individual investors who suffered as a result of false statements and market manipulation to seek a legal remedy through the courts.

Delays in proceedings and skyrocketing costs in initiating litigation are also some of the factors that have disincentivised investors from relying upon the civil liability regime for enforcing their compensation claims.

The growth of our capital market hinges upon the regulatory process rather than the courts through the Securities Commission (SC), which has broad remedial powers for securities law violations and is solely instrumental in formulating policies and regulations governing capital markets and operating through the power of sanctioning various market players.

Such an approach tends to target issuer companies and intermediaries involved in the capital markets so as to deter wrongdoing. The regulatory mechanism is aimed much less, if at all, at compensating investor losses.

The common thread that runs through the powers of the SC is that they are targeted at wrongdoers. It appears that SC’s aim in imposing these measures is to prevent the commission or continuation of violations by the errant parties.

The element missing in this scheme of things is the compensation of investors who may have suffered losses. SC’s regulatory focus is on the violators rather than the victims.

Although adjudication and criminal prosecution powers are available to SC, it is only the adjudicatory mechanism that has been successfully utilised in securities law violations to hand down penalties.

For criminal prosecution, SC’s track record appears patchy. SC might argue otherwise.

Although the SC has issued several consent orders, there has been some criticism that the consent order mechanism was operated in an ad hoc manner and that it lacked transparency.

A dichotomy exists between so-called protection available to investors in the primary markets, ie prospectus disclosures, and the secondary markets, ie continuous disclosures.

While the existing laws places significant emphasis on primary market disclosures, it is considerably weak for secondary market disclosures, wherein investors may have to rely on more general protective measures and enforcement mechanisms.

The judiciary has not played a vital role in the development of our capital market through the imposition of civil liability upon issuer companies or the compensation of investors for losses due to misstatements.

Despite the existence of substantial rules for civil liability and compensation and the presence of an elaborate court system, the associated conditions for the judiciary to make an impact on investor protection are conspicuous by their absence.

Considering the inadequacy of judicial enforcement, it is easy to understand why securities fraud remains in existence to date.

In developed markets, the strong role of the judiciary is seen as key in ensuring liquid and vibrant capital markets.

There is no single instance of an issuer having been ordered by our courts to pay a significant amount in compensation to investors for incorrect or misleading disclosures.

As the arbiter of disputes between investors and issuer companies, the courts should perform the role of remedying the grievances of investors and impose civil liability on issuers, their directors and capital market intermediaries and award compensation to redress investor losses.

In the country’s corporate structure for listed companies, power of ownership is normally concentrated in the controlling shareholders who, generally are the founding members or families of the entities through various mechanisms such as cross holdings, pyramid structures and tunnelling.

This often led to greater benefits to the controlling shareholders who tunnel and misappropriate assets and resources out of companies at the cost of the minority shareholders.

Given the prevalence of concentrated shareholding and the somewhat extensive role played by controlling shareholders, the express recognition of their liability would augur for the benefit of the affected investors in case of misstatements, fraud etc.

Given that controlling shareholders may themselves be corporate entities with financial resources, it confers a better chance of recovery for suing investors.

Managed carefully, having access to and a growing preference for representative actions might not be a bad thing for the country.

Some would even argue that it provides more checks and balances for listed companies here.

Sound investment decisions can only be made when there is full disclosure of accurate information.

Shareholders, especially the minority and individual, should not suffer and incur losses due to poor corporate governance, breach of fiduciary duties, or a failure of good faith, fair dealing or loyalty in the companies in which they invest.

Hopefully, one day, some lawyers with the necessary entrepreneurial spirit and technical ability will come out to assist the minority investors to mount large scale securities litigation and drive the development of securities class actions in the country.

Changes made to the securities law whereby instead of requiring minority shareholders to prove reliance, it is presumed that market prices reflect all available information and does not require the shareholders to prove reliance on the specific statement independently. – February 19, 2022.

* FLK reads The Malaysian Insight.

* This is the opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insight. Article may be edited for brevity and clarity.