China’s corporate law and securities regulation have undergone a series of legislative reforms over the past decade to enhance investor protection and foster market competition.

The comprehensive reform of the People’s Republic of China (PRC) Securities Law in 2019 marked a significant shift in the country’s initial public offering (IPO) system, transitioning from an approval-based regime to a registration-based one. This change removed the requirement for substantial review by the China Securities Regulatory Commission (CSRC), the securities market’s watchdog. In practice, however, the reform has been implemented incrementally, extending to cover all mainland stock exchanges – the Beijing Stock Exchange, the Shanghai Stock Exchange, and the Shenzhen Stock Exchange – by 2023. This progression reflects the Chinese authorities’ consistently prudent approach towards financial markets liberalization.

Within this regulatory framework, the information disclosure regime and accountability system have emerged as crucial mechanisms for enabling investors to make informed investment decisions and for fostering an integrated and efficient financial market. Accordingly, the revised PRC Company Law and PRC Securities Law are anticipated to play complementary roles in establishing a so-called “regulatory-contractual mixed paradigm” accountability system for IPO misrepresentation.

In a new paper, we examine whether the reforms to the PRC Company Law in 2023 facilitate a shift in China’s accountability system for IPO misrepresentation from a regulatory to a contractual paradigm. This exploration is grounded in an analysis of China’s existing accountability system and its limitations. Below, we present our key findings:

Investors’ Difficulties in Claiming IPO Misrepresentation under the Existing Accountability System

China’s current accountability system for IPO misrepresentation adopts a “reverse onus” approach, imposing strict liability on information disclosure obligors. This seeks to alleviate the evidentiary burden borne by investors, given their disadvantaged position in the market. Under this framework, once a misrepresentation is identified in a prospectus, investors who purchase relevant shares between the misrepresentation date and its correction date and subsequently incur losses can claim compensation. Obligors can only escape liability by demonstrating a break in the causation chain between their misconduct and the investors’ losses, regardless of their subjective intent.

However, investors continue to face challenges in identifying misrepresentations and determining the scope of proper defendants, particularly following the removal of administrative preconditions. Courts may also dismiss claims based on a subjective assessment of whether the misrepresentation is “significant enough,” which introduces uncertainty and inconsistency.

The introduction of China’s Special Securities Representation Action (SSRA) and the involvement of investor protection institutions in assisting private lawsuits represent a legal response to these challenges. However, systemic barriers—such as passive judicial attitudes, protracted negotiations, the absence of contingency fees, and complex initiation procedures—render investor compensation inefficient. This raises a critical question: Can individuals effectively use private lawsuits to protect their interests?

Strengthened Liability on Information Disclosure Obligors in the 2023 Company Law

The recent reforms to the PRC Company Law have strengthened the corporate accountability system in three key ways, offering potentially promising avenues for enhanced investor protection: (1) reaffirming and clarifying directors’ duties, specifically their duties of loyalty and diligence; (2) imposing more explicit liabilities on de facto corporate operators, including shadow directors, de facto directors, senior managers, and actual controllers; and (3) expanding the liability of directors and senior managers to third parties, enabling aggrieved investors, including both current and former shareholders, to initiate private actions in cases of misrepresentation.

Our paper employs a black-letter methodology to examine these revised rules in the context of IPOs. While the reforms provide a basis for claims, achieving the intended protections remains challenging. This difficulty arises from the rules’ broad applicability across diverse scenarios, which can inadvertently overlook the specific characteristics of the parties involved. Notably, the evidentiary burden placed on aggrieved investors, particularly retail investors, remains disproportionately high. Without special provisions—such as a presumption of fault for information disclosure obligors—these investors face significant obstacles in seeking just compensation.

Reflection on the Way Forward: A Regulatory and Contractual Mixed Accountability System

In IPO misrepresentation cases, investors may pursue claims against issuers under contract law by establishing either (1) a fault in contract formation or (2) a breach of contract, without needing to prove the materiality of the fault. However, holding non-signatory parties accountable through mechanisms such as piercing the corporate veil or derivative actions raises both substantive justice and procedural challenges.

The recent amendments to the Company Law, while progressive, still place substantial evidentiary burdens on private litigants, underscoring the need for continued regulatory intervention. Administrative remedies, such as “buyback” and “advance compensation,” have emerged as efficient compensation mechanisms. Although the buyback method is rarely used, advance compensation—where the obligor provides compensation prior to litigation—has gained widespread adoption. This mechanism effectively transforms potential tort claims into contractual arrangements between information disclosure obligors and affected investors, with the CSRC ensuring the enforceability of these agreements.

China’s existing accountability framework reflects the distinct characteristics of the state’s involvement in the stock market, which are expected to persist given retail investors’ relative lack of sophistication, the prevalence of politically connected firms, and the administrative, paternalistic leadership style. Nonetheless, significant progress has been made by Chinese authorities in liberalizing the public stock market through a more market-oriented regulatory approach, particularly with respect to directors’ and senior managers’ responsibilities towards third parties and the explicit liabilities of controlling shareholders or actual controllers introduced by the Company Law revisions.

In the future, while aggrieved investors may initiate private suits, increased participation from legal professionals will be essential in such cases. Furthermore, regulators should prioritize streamlining the processes for initiating class actions. These reforms, from both regulatory and contractual perspectives, would not only enhance enforcement mechanisms but also promote a more active and empowered investor community in addressing and preventing corporate misconduct.

This post comes to us from Lerong Lu, a reader in law, and Jiujing Ye, a PhD candidate and visiting lecturer, at The Dickson Poon School of Law, King’s College London. It is based on their recent paper, “China’s 2023 Company Law Reform: Shifting the Accountability System for IPO Misrepresentation from Regulatory to Contractual Paradigms?,” available here. A version of this post appeared on the Oxford Business Law Blog here.