Recently, a number of US-listed Chinese companies have been hit with class action law suits in the US for alleged accounting irregularities. Most of these companies under attack obtained their US listing through a reverse merger, though some went “public” through a conventional IPO.
One of the early steps for companies and their directors and officers is to notify their insurers under their D&O policies of these claims. Insurers will now be asking themselves whether they had priced the risk appropriately and whether this spate of suits is just the tip of the iceberg. They also, rightly, recognise that as Hong Kong will remain the top fund raising centre for Chinese companies, many IPOs will continue to take place here and the troubles faced by Chinese companies in the US may well occur in Hong Kong as well.
Under the Hong Kong Listing Rules, the directors of a company accept responsibility for the information contained in the listing document; in fact, to bring the point home, a statement to that effect is required to be incorporated in the listing document. If the listing document contains any false and misleading information, the directors may be personally liable for investors’ claims under various pieces of legislation as well as in common law.
So far, there have been no significant investor claims in Hong Kong. However, Hong Kong is increasingly a litigious jurisdiction and it will simply be a matter of time before investors take action to recover investment losses. A recent, and somewhat worrying practice, is to use the regulators as a cheap and quick way to exert pressure on companies to settle, hence the claimants file complaints of the provision of false and misleading information with the Securities & Futures Commission (SFC), the Hong Kong Stock Exchange (HKSE) and the Commercial Crime Bureau (CCB). Regulatory investigations, especially if management has to deal with them together with litigation, take up a lot of time and resources and can pose a costly distraction for management.
Recently, we have also seen an increase in the number of investigations carried out by the Audit Investigation Board (AIB) of the Financial Reporting Council (Council). The Council is an independent statutory body set up under the Financial Reporting Council Ordinance (FRCO), which is a fairly new ordinance in Hong Kong, and its passage into law was not without controversy. The role of the Council is to:
- conduct independent investigations into possible auditing and reporting irregularities in relation to listed entities;
- enquire into possible non-compliance with financial reporting requirements of listed entities; and
- require listed entities to rectify any non-compliance identified.
Similar to other Hong Kong regulators, the Council may initiate investigations or enquiries upon receipt of complaints or investigate on its own initiative. However, it has no prosecution powers and therefore will refer cases of auditing or reporting irregularities to the Hong Kong Institute of Certified Public Accountants or to the SFC and SEHK.
In terms of coverage, a typical D&O policy will cover costs arising from administrative, regulatory or official investigations. Therefore, the costs arising from SFC, SEHK, CCB and AIB investigations should all be covered. It is important to engage with legal advisers and insurers as early as possible to pro-actively manage such investigations or litigation.
Up till now, there has been no significant investor claim in Hong Kong. The absence of class action jurisdiction in Hong Kong may be the reason. However, insurers should remain vigilant of investor claims, in particular, the outcome of the investor claim against former directors of CITIC Pacific and investigations by the SFC and CCB in relation to alleged unauthorized forex trading. If an investor is successful with its claim or the regulatory investigation finds wrong-doing on the part of the directors/officers, it may open up a floodgate of new claims.
Although Hong Kong does not have a class action jurisdiction, the Law Reform Commission’s Class Actions Sub-committee published on 5 November 2009 a consultation paper proposing the introduction of a mechanism for multi-party litigation in Hong Kong. While we expect this initiative to be several years away from implementation, insurers need to keep abreast of developments.
Regulators, in their investigations, tend to throw the net wide and it is often the case that a number of senior managers will be in the spotlight at the same time. The regulators are nowadays insisting that each person is separately legally represented, and this in turn leads to increased legal costs. Companies should review their coverage to see if it is adequate and insurers should take this trend into account in pricing and risk assessment.