The primary task of this conference is to communicate and implement the State Council General Office’s Opinions on Further Enhancing the Protection of Legitimate Rights and Interests of Small and Medium-sized Investors in the Capital Market(hereinafter referred to as the “Opinions”) and make arrangements on the protection of small and medium-sized investors. Hereby, I would like to express the following comments.
I. Carefully comprehend the Opinions and elevate awareness
The CPC Central Committee and the State Council have long attached great importance to the protection of small and medium-sized investors. The CSRC always regards this activity as a top priority of its regulatory work and has taken a series of policy measures with positive effects. However, small and medium-sized investors remain at a weak and vulnerable position, lacking awareness of risk and self-protection. Capital market is a venue of public investment and China is home to the largest and most active group of individual investors in the world, with investors of shares, bonds and futures reaching 90 million people and investors of public offering of fund exceeding 60 million people. Of whom, over 99% are small and medium-sized investors with investment volume less than RMB 500,000 yuan, accounting for 14% of China’s urban population. Early after the new term of government took office, Premier Li Keqiang reaffirmed at his press conference the priority of protecting the legitimate rights and interests of investors and especially small and medium-sized investors. In May 2013, at the Seventh Executive Conference of the State Council, he called for the drafting of policies on the protection of small and medium-sized investors. Afterwards, the Opinions on Priorities of Deepening Reform of Economic System in 2013 endorsed by the State Council called for the improvement of policy system for protecting the rights and interests of investors and especially small and medium-sized investors. The Decisions of the Third Plenum of the 18th CPC Congress held in November 2013 clearly indicated that "(we must) optimize the investor reward mechanism of listed companies for the protection of legitimate rights and interests of investors and especially small and medium-sized investors”. The Opinions of the State Council General Office is an important measure to implement the spirit of the Decisions of the Third Plenum of the 18th CPC Congress and a series of relevant arrangements by the State Council, aims to establish a complete policy system for the protection of legitimate rights and interests of small and medium-sized investors for the first time in the journey of China’s capital market development and is a principal guideline for the protection of small and medium-sized investors in the capital market. Protection of small and medium-sized investors is of great significance to safeguarding social equality and justice and the immediate interests of the masses and also an important precondition for the reform, innovation and healthy development of capital market as well. It is also favorable to the transformation of securities and futures regulation. The CSRC and all levels of its leadership and staff must earnestly comprehend the spirit of the Opinions, fully understand the great significance of protecting the legitimate rights and interests of small and medium-sized investors, and carefully carry out their work according to reality. In the interest of ensuring consistent understanding, the nature and matter of protecting small and medium-sized investors should be correctly understood and the following important relationships should be properly approached.
First, we should correctly understand the relationship between the principle of “the same rights for the same shares” and the protection of small and medium-sized investors
"The same rights for the same shares” and “the majority rule” are the basic principles of modern corporate governance, which can be found in Articles 127 and 104 of China’s Company Law. The words of “shares” or “equities” themselves imply equal shares, fair power and equal access to opportunities and interest sharing. “The same rights for the same shares” means that shares of the same type are entitled to the same rights.
In early corporate practices, the principle of the same rights for the same shares is realized through unanimous vote, so that small shareholders have discretionary veto power. This system achieves the principle of the same rights for the same shares in a simple, mechanical and absolute manner. With increasing corporate capital and number of shareholders in the process of a country’s industrialization, however, this system became incompatible with modern society and was finally replaced by the majority rule which enables shareholders with majority voting right to decide on corporate matters, constituting the so-called “control right premium” and “institutional dividend”. This creates conditions and possibilities for controlling shareholders to abuse their control power through their dominant position and infringe upon the legitimate interests of small shareholders. In order to realize the substantive equality of shareholders, some countries and regions have put in place systems to prevent controlling shareholders from abusing their control power. These systems endow controlling shareholders with special fiduciary duties and restrict their rights and behaviors. Fiduciary duties derive from obligations of trustees to their clients under trust law and generally refer to obligations of corporate executives with extensive rights to be responsible for the operation of corporate assets. With growing instances where the rights of small and medium-sized shareholders are damaged by controlling shareholders, both common law and civil law systems have extended the scope of fiduciary duties to controlling shareholders. That is to say, controlling shareholders have the obligation and responsibility to safeguard the interests of other shareholders and corporate interests in addition to their own interests. Meanwhile, there emerged specific mechanisms including cumulative vote, proxy voting and vote solicitation, repurchase rights for dissenting shareholders and representative litigation.
Protection of small and medium-sized investors is a common practice to prevent the abuse of majority rule and achieve substantive equality of shareholders. It aims to ensure the same rights for the same shares without damaging the principle of equality among shareholders.
Second, we should correctly understand the relationship between “buyer beware” principle and the protection of small and medium-sized investors
"Buyer beware” is a principle of trade that has been followed since the ancient Roman Empire and means that investors should be responsible for the risks of their own investment.
In the context of simple commodity structure, face-to-face transaction between buyers and sellers and equal perception of quality and purpose, the principle of buyer beware becomes an important legal tool to safeguard the order of transaction by preventing dishonesty or default in the process of transaction. With the progress of Industrial Revolution and as remote transaction becomes possible with new means of communication, however, the scope of transaction is no longer confined to spot transaction and the application of new technologies is increasing the professionalization and complexity of commodities. These developments have increased the difficulty for buyers to inspect the quality of goods and properly assess the risks of trading. Gaps of perception on the objects of transaction are widening between buyers and sellers and it is increasingly difficult for buyers to be fully informed. In this sense, the principle of “buyer beware” has caused buyers to undertake all unfavorable results of transaction, which is unfair and unfavorable to social and economic development. Hence, it became evident that sellers should also take responsibilities.
In the 1960s, British judicial precedents began to shift to the principle of “seller beware”, i.e. if a buyer has no opportunity to inspect the goods, the principle of buyer beware shall not apply. In the 1890s, the United States also moved away from the principle of buyer beware. In the face of numerous disputes arising from poor quality of housing properties, US courts began to sympathize with homebuyers and set precedents of not following the principle of buyer beware. If a seller is aware that disclosure of major information will correct buyers’ misperception of goods and non-disclosure thereof constitutes reasonable criteria of unfair transaction not in good faith, refusal to disclose such information is equivalent to fraudulent untruthful statement and shall be subject to the same legal consequences.
Securities trading is different from trading of ordinary commodities. Under the centralized public trading, information is asymmetric between sellers and buyers on a one-to-many and many-to-many basis. While stressing the principle of buyer beware, therefore, sellers must also take responsibilities in the securities market. As US President Roosevelt explained on the 1932 securities bill to the effect that this bill adds a new dimension to the old trading rule of buyer beware: sellers are also responsible, which imposes sellers with the obligation to sufficiently reveal the facts. The US Securities Exchange Commission (SEC) protects small and medium-sized investors under its “shingle theory”. Single theory means that when a broker hangs out a shingle and starts business, it is implied that the broker and its staff have the obligation to represent his or her customers fairly. Occurrence of unfair transaction, i.e. breach of this implicit obligation, constitutes a violation of anti-fraud provisions. In 1985, the British government released a white paper entitled British Financial Services: a New Framework of Investor Protection, which unequivocally declares to the effect that the regulatory framework described by this White Paper moderately highlights the long-standing principle of buyer beware but it recognizes that this principle alone is not enough. In order to increase investor confidence, measures must be taken to reduce fraud and encourage the investment industry to act with the highest possible standards.
Judging by the formulation and implementation of securities law in various countries, a basic experience is that the premise for the application of the principle of buyer beware where investors are responsible for their own profits, losses and risks is that the seller has fulfilled their mandatory obligations of information disclosure and sales suitability and is free from such fraudulent acts as false statement, insider trading and market manipulation. Their mutual responsibilities are complementary and inseparable.
In sum, the protection of small and medium-sized investors is not contradictory with the principle of buyer beware. In addition to the principle of buyer beware, responsibilities on the part of sellers must also be stressed. It must be clarified that the protection of small and medium-sized investors does not mean any assurance that investors will be free from losses. Protection of small and medium-sized investors is a policy system where suitability management system is of primary importance and within the scope of government supervision responsibilities. Enhancing investor education itself is also a protection measure for investors to better protect themselves.
Third, we should properly understand the relationship between the principle of voluntary transaction and protection of small and medium-sized investors
The principle of voluntary transaction derives from Roman law. As the saying goes, contract is the fetters between parties. “Contract overrides the law”, i.e. contracts entered into by and between parties on a voluntary basis shall be above the law. With the development of commodity economy and growing complexity of market transaction, restrictions began to be imposed on the principle of voluntary transaction. German Civil Code stipulates to the effect that transactions in violation of legal prohibitions shall be invalid; those in violation of good customs shall be invalid; ……those intentionally harm others in ways against good customs shall be obligated to compensate for the damages caused to others. If a buyer has no opportunities to inspect the goods, the principle of voluntary transaction shall not apply. If a buyer orders goods based on the trust of the seller, the goods shall reasonably satisfy the purpose of the buyer in purchasing the goods. Obviously, the law increasingly tends to protect contractual justice instead of contractual freedom alone.
It is still believed by many that investment transaction is voluntary between two parties and losses are the consequences that should be borne by investors themselves. These views actually reflect lack of investor protection awareness, regulatory inaction and unhealthy equity culture and violate the principle of justice and the spirit of contract.
The capital market upholds the spirit of contract. The spirit of contract includes the freedom, equality, fulfillment and remedy of contract with the key elements of honesty and justice. Securities and futures contracts are usually standardized, highly professional and complex in structure. Hence, the principle of voluntary transaction must be limited in order to protect investors and especially small and medium-sized investors. First, investor suitability management should be in place prior to transaction. Investors without professional investment competencies and risk tolerance cannot be permitted to engage in transactions even if they are voluntary to do so. Second, sellers should take sufficient obligations of explanation and intermediaries should fulfill their due diligence and take obligations as a loyal agent. Third, the post-transaction risk compensation system must be put in place.
Fourth, we should properly understand the relationship between the principle of efficiency and the protection of small and medium-sized investors
There are concerns that protection of small and medium-sized investors and consequent additional restrictive provisions on the part of listed companies, their major shareholders and actual controllers would substantially increase operational cost of listed companies, increase compliance cost of market institutions, hamper market efficiency and even cause a "squeeze-out effect” on listed companies that would instead choose to be listed overseas. These views are a misunderstanding. According to securities market surveys of some countries and regions, investor protection system has significant effects on listed companies and their controlling shareholders in the interest of preventing their misconduct and improving governance of companies. The reason is that if behaviors of controlling shareholders damage the interests of small and medium-sized investors, the interests of the company as a whole will suffer as well. Some studies believe that companies that have no restrictions on affiliated sales and procurement will have much worse performance compared with companies that have such restrictions.
According to the reality of many countries or regions, more investor protection brings about more market innovation, less regulatory intervention, higher market operation efficiency and more sophistication of stock market. On the contrary, negligence of investor protection will result in higher costs of market operation and may undermine market confidence and the basis of trust and compromise the efficiency of the entire market. After the Enron scandal broke out in America, Sarbanes-Oxley Act was introduced in 2004, raising requirements for listed companies. Higher costs inspired market innovation and promoted rapid development of the overall market.
II. Focus on implementation and embody protection of small and medium-sized investors throughout all regulatory activities
It is not easy to promulgate a well drafted document and still less easy to implement it. The key is to focus on implementation.
(I) Review departmental rules and regulations with an orientation of satisfying and protecting small and medium-sized investors
Taking the opportunity of implementing the Opinions and in coordination with reviewing administrative licenses, we should conduct an overall review of the CSRC system’s existing rules and regulations, normative documents and internal work guidelines and revise, supplement, consolidate and improve them according to the requirements of the Opinions. Specific requirements on the protection of small and medium-sized investors should be embedded in all processes and aspects of securities and futures market reform, development and supervision. Securities and futures exchanges, relevant associations and relevant entities under the CSRC’s administration should be urged to revise and improve self-discipline rules, business rules and service procedures according to their respective functions and characteristics and further improve protection of small and medium-sized investors.
(II) Improve investor suitability system and tighten investor suitability management
Suitability management is the first protection for the access of investors in capital market. Currently, there is no special international definition on small and medium-sized investors and the classification of investors is primarily based on the needs of regulatory supervision and market risk management. With the diversification of China’s investor structure, different standards of classification have emerged. Suitability management has been put into place in some areas and for some products but with inconsistent and scattered standards. It is an imperative task to implement rational classification for a complex investor composition and establish consistent investor suitability management regulations.
Investor suitability system in the US is largely related to registration exemption. Take “accredited investors” regarding the exemption of certain securities issuance procedures for instance, under the D Regulation under the US 1933 Securities Act, directional issuance to “accredited investors” is exempted from registration and information disclosure obligations regardless of the number of such investors. However, issuance to small and medium-sized investors is prohibited, otherwise issuers will be held liable. Criteria for eight types of accredited investors are constantly adjusted on a dynamic basis.
The system of qualified investors has a short history in China’s capital market with very different thresholds and insufficient consideration of supporting systems. We should carefully review our experience, establish a standard system of investor classification standards and implement consistent investor suitability management criteria in order to provide suitable products and services to appropriate investors. Meanwhile, suitability management responsibilities of market operation and service institutions should be identified and requirements on self-discipline rules should be improved.
(III) Optimize investor return mechanism and increase investment value
Access to investment return is a legitimate right of small and medium-sized investors for their investment participation. Currently, the share of cash dividend of Chinese listed companies in their net profit is roughly 25%, which is significantly below the 40% level of sophisticated markets, with average annualized dividend ratio below 2%. For the problems of limited level, means and awareness of investor return, the Opinions has proposed systematic institutional arrangements to optimize return mechanism and calls for the establishment of comprehensive investor return systems such as cash dividend, share repurchase and scrip dividend scheme, with a view to optimizing investment return environment. Listed companies and intermediary service institutions should be urged to firmly establish the awareness of shareholder return in order to change the situation of limited overall level and lack of standardization and transparency of investment return.
Companies should be urged to revise their articles of associations to strengthen dividend distribution commitments and disclosure and bring into full play the role of honesty supervision system. Equity dilution and commitment requirements for IPO, refinancing and M&A should be implemented in a comprehensive manner. We should: develop regulatory arrangements on share repurchase when share price is below net assets per share; improve review and information disclosure systems and implement regulatory support policy measures and regulatory support policy measures for companies with stable cash dividend distribution; give play to the role of professional institutions such as fund management companies in participating in corporate governance and improving investor return; vigorously develop products of payment on term and of absolute return and support money market fund innovation; and further leverage the role of custodians to supervise the fulfillment of dividend distribution commitments by fund managers.
(IV) Ensure the rights of investors to participate and know and facilitate the exercise of rights by small and medium-sized investors
The Opinions has identified a series of arrangements to facilitate the exercise of rights by investors, which vigorously support comprehensive assurance of the rights of investors to know, participate and supervise and promote the improvement of corporate governance. We should: comprehensively evaluate and improve securities issuance, sustained corporate operation, M&A and information disclosure standards for various types of products; develop and implement voluntary and concise information disclosure rules; improve information disclosure quality; spell out detailed disclosure and commitment responsibilities; and establish a consistent information disclosure platform for the convenience of small and medium-sized investors to access information and expose abnormal disclosure and dishonest acts. For abnormal information, derivative information, commitments, abnormal share price changes and market concerns, we should enhance concurrent monitoring and inspection and make real-time regulatory response. Also the development of a consistent account system for public offering of fund shall be enhanced for the convenience of investors’ inquiry.
We should also promulgate consistent regulatory requirements on the implementation of separate vote counting for small and medium-sized shareholders, overall online voting, cumulative voting system and vote solicitation; formulate guidelines on the third-party witness of voting at shareholders’ meetings; develop standard procedures for small and medium-sized investors to propose removal of directors; improve requirements on the avoidance of conflict of interest; increase corporate governance responsibilities, identify obligations of controlling shareholders, actual controllers and directors and senior executives; enhance compliance supervision and public announcement obligations of shareholder’s meeting, board meeting and major corporate decisions; and provide infrastructure support to the voting of fund holders supported by industry basic platform development.
(V) Enhance compensation for and assistance to small and medium-sized investors and enhance protection of their rights and interests in a proactive manner
We should be committed to creating harmonious investor relations by developing various types of dispute settlement mechanisms; support market players to engage in dispute settlement and professional mediation and support such services as public-interest litigation and contingent fee; establish consistent and clear complaint handling criteria and requirements; urge market players to take primary responsibilities of complaint handling; improve customer complaint and dispute settlement mechanisms; attach importance to leveraging the role of self-discipline organizations and provide professional services, consultation and relief for the protection of small and medium-sized investors; improve risk provisioning system for securities, fund and futures companies; advance the establishment of a risk provisioning fund for violations of listed companies; evaluate the establishment of securities issuance sponsorship warranty fund system; encourage professional liability insurance and market exit insurance for intermediary institutions; and comprehensively elevate professional standardization and awareness of responsibility.
Improve the system that obligates infringers to take the initiative to compensate investors and establish regulatory mandatory repurchase system and mandatory performance system for breach of commitments. Investigate and punish violations of information disclosure in all forms and crack down on all types of infringement activities. Accelerate the development of credibility database. Establish a violation case reporting system. Develop and implement administrative reconciliation pilot programs.
(VI) Enhance education of small and medium-sized investors, improve protection organization system, and establish a long-term working mechanism
We should develop an overall plan on investor education, enhance education of small and medium-sized investors, popularize investment knowledge, issue warnings, assist them in increasing risk awareness and self-protection competencies, warn them against listening to rumors, following the herd and speculating in new shares, small-cap shares and underperforming shares. Urge securities and futures operation institutions to include investor education into all processes of account opening, transaction, marketing and customer services.
Protection of small and medium-sized investors is a long-term task and systematic project. It requires overall coordination and mobilization of resources and strengths from all sides to form synergy and development of integrated systems of legal protection, regulatory protection, self-discipline protection, market protection and self-protection. We should enhance communication and information sharing with relevant ministries and commissions of the State Council and local government and jointly safeguard the rights and interests of investors. Supported by two inter-ministerial joint meeting mechanisms for standard operation of listed companies and crackdown on illegal securities and futures activities, efforts should be made to explore the establishment of a comprehensive communication and coordination mechanism for safeguarding the rights and interests of small and medium-sized investors. Improve the environment favorable for small and medium-sized investors to exercise and safeguard their rights and access remedy services, and increase resource input from all relevant sides. Enhance international exchange and cooperation on investor protection.
III. Enhance organizational leadership and implement work responsibilities
(I) Enhance learning and publicity organization
All agencies and departments of the CSRC shall organize the learning of the Opinions to fully understand its significance and spirit and requirements on various activities. Adopt effective methods such as lecturing and special training sessions among the CSRC system’s cadres and market players to carefully learn about the Opinions and bring their thinking and action in line with the requirements of the Opinions. Meanwhile, investor communication and interpretation should be carried out in various forms for them to be aware of their rights and exercise their rights by law.
(II) Focus on task breakdown and fulfillment of responsibility
Competent departments of the CSRC should establish investor protection standards and improve regulatory policies and the CSRC’s Investor Protection Bureau should enhance coordination. Regulatory and audit departments should embed the protection of small and medium-sized investors into all processes of daily regulatory operation, inspection and law enforcement. Regional offices of the CSRC should continue deepening the development of responsibility system in their respective jurisdictions, implement the requirements of the Opinions, as well as innovate the forms and methods of their work in light of the characteristics of investors in their jurisdictions and reality. Exchanges and industry associations should improve the self-discipline rules for the assurance and services of investor protection and improve the insurance awareness and competence of member entities. All agencies under the CSRC’s administration should improve business rules and service procedures and enrich the scope of services in line with the requirements of the Opinions and the overall arrangements of the CSRC. All entities of the CSRC system should identify and report new situations and problems confronting the protection of small and medium-sized investors and propose their opinions and suggestions on regulatory improvement. Market operation and service institutions and intermediary institutions should perform due diligence obligations for investors and customers, enhance responsibility awareness, and improve the level of professional service. Small and medium-sized investors should enhance learning, increase their risk awareness and establish the concept of rational investment.
(III) Enhance overall coordination, inspection and evaluation
Implementation of the Opinions is a long-term and unremitting task. We should focus on overall coordination, balance short-term and long-term tasks, highlight priorities and review, and make improvements in a timely manner. Various entities and departments should draft implementation programs, identify timelines, enhance regulatory cooperation, and develop investor protection coordination functions in the entire system and industry. The CSRC’s Investor Protection Bureau should play its role, follow up on the implementation of the Opinions on a dynamic basis, and establish a supervision mechanism. Through implementation of the Opinions, we should establish supervision, inspection and evaluation mechanisms, carry out the satisfaction survey and evaluation of the work of protection of small and medium-sized investors, and take regulatory actions against activities that infringe upon the rights and interests of investors discovered in the process of inspection. The status of investor protection should be incorporated into the classification and evaluation of securities and futures operation and service institutions and a monitoring, patrol inspection and spot check mechanism for investor protection should be established. The evaluation of investor protection activities by regional offices and agencies under the CSRC’s administration should be well organized to ensure that protection of the legitimate rights and interests of small and medium-sized investors becomes an important basis for evaluating the effectiveness of regulatory work.