Derivative action or securities arbitration in China: seeking a better alternative to retail shareholder protection

Abstract

There is a large body of law and finance literature suggesting that strong legal protection for investors is the key to a nation’s healthy stock market development and economic growth. Despite remarkable progress in setting up its securities market, China has often been criticized for its underdeveloped regulatory regime. The wide securities fraud scandals in contrast with the paucity of conviction rates are indicative of the fact that public enforcement is inadequate in China. Private enforcement efforts such as securities litigation help address the disconnect between securities regulatory regime and investor compensation. Nevertheless, given the immaturity of China’s current legal and institutional framework, various factors preclude private securities litigation from playing an effective role in China’s market regulation and development. Against the background, this article seeks to explore alternative mechanisms for improvement of private enforcement in China. Having concluded that modeling the US class action system is quite unlikely to work well in the Chinese socio-political and socioeconomic situations, the article explores how the present system of securities fraud litigation should be reformed in order to balance the competing interests of state control, social stability, and minority shareholder protection in the listed companies. In view of the dominance of retail shareholders in the Chinese securities market and drawing on international experience, a cost-effective and accessible securities arbitration scheme is proposed to be established in China for resolving civil compensation claims. It is argued that the professionalism, procedural flexibility, speed, confidentiality, and cost saving features of arbitration could offer much potential as a deterrent and remedial device in addressing the deficiencies of private enforcement of securities regulation during economic transition in China.