Analysis of the Far-Reaching Impacts of Listed Companies' Joint Compensation Liability Arising from Illegal Activities of Private Equity Actual Controllers

The Nanjing Intermediate People’s Court’s first-instance judgment ordered Xu Xiang and Xu Changjiang to compensate 23 investors a total of 3.2936 million yuan, and the defendant Wenfeng Stock to bear joint compensation liability. This judgment sets an important judicial precedent:

• Expansion of Joint Liability
  : Extended from direct liable entities to listed companies themselves
• Clarification of Actual Controllers’ Liability
  : Impact of illegal activities by private equity actual controllers on listed companies
• Strengthening of Investor Protection
  : Substantial judicial relief for losses of small and medium investors

After the implementation of the new Securities Law in 2020, major changes have occurred in the investor protection mechanism of China’s capital market:

• Establishment of the special representative litigation system (Kangmei Pharmaceutical case as the first example, with investors awarded 2.459 billion yuan in compensation [1])
• Expansion of the scope of joint liability
• Strengthening of information disclosure obligations
• Clarification of “gatekeeper” liability

• Listed companies must establish stricter mechanisms for identifying and reviewing related party transactions
• The behaviors of actual controllers and controlling shareholders need to be included in a comprehensive monitoring system
• The behavioral norms of external shareholders such as private equity funds have become a key governance focus

• Independent directors must be truly independent and effectively perform their supervisory duties
• The supervisory board needs to strengthen supervision over the behaviors of actual controllers
• The role of the board secretary in checking information disclosure has become more critical

• Shift from “formal compliance” to “substantive compliance”
• Establish a full-process risk early warning mechanism
• Conduct regular compliance training and risk assessments

• The risk of excessive power of actual controllers is highlighted
• Need to optimize the equity balance mechanism
• Protect the rights of small and medium shareholders to participate in corporate governance

• Listed companies need to be more cautious when introducing strategic investors from private equity funds
• Background investigations of actual controllers of private equity funds must be detailed
• Compliance clauses and liability assumptions need to be clearly defined in investment agreements

• Shift from “meeting minimum requirements” to “proactive and full disclosure”
• Higher requirements for disclosure of behaviors of controlling shareholders and actual controllers
• Accuracy and timeliness of risk warnings have become key

• The Kangmei Pharmaceutical case pioneered special representative litigation, with a record 2.459 billion yuan in compensation [1]
• Investors no longer face the dilemma of “winning the lawsuit but not getting the money”
• The collective litigation mechanism has significantly reduced the cost of rights protection

• Investors can claim compensation from both direct liable parties and listed companies at the same time
• Listed companies’ assumption of joint liability increases the guarantee of compensation
• A “multi-party sharing” investor protection mechanism has been formed

• In the Xu Xiang case, criminal liability and civil compensation liability are pursued simultaneously
• Forms a “double-edged sword” deterrent to market violators
• The illegal cost is far higher than the potential benefit

• Full-chain accountability from individual violations to institutional liability
• Listed companies “paying the bill” for the illegal behaviors of actual controllers forms a strong warning
• Promote the market to shift from “post-event punishment” to “pre-event prevention”

• The role of investor protection institutions has become more important
• Development of non-litigation relief mechanisms such as mediation and arbitration
• Effective connection between administrative relief and judicial relief

• Increase investors’ attention to corporate governance of listed companies
• Strengthen investors’ awareness of supervising the behaviors of actual controllers
• Promote rational investment and value investment concepts

• Improvement of the Supreme People’s Court’s judicial interpretation on securities misrepresentation
• Further clarification of the application standards for joint liability
• Accumulation of court experience in hearing securities violation cases

• Listed companies with high governance levels will obtain market premiums
• Rising violation costs prompt companies to actively improve governance levels
• Market resource allocation becomes more optimized

• Responsibilities of sponsor institutions, law firms, and accounting firms are more clearly defined
• The “gatekeeper” mechanism truly plays its role
• The due diligence obligations of intermediary institutions are strengthened

• Big data monitoring of abnormal market transactions
• AI identification of potential violations
• Real-time monitoring of actual controllers’ fund movements

• Information sharing among the CSRC, public security, and judicial organs
• Normalization of cross-departmental joint law enforcement
• Effective connection between administrative supervision and judicial trial

• Adapt to the requirements of the new Securities Law
• Strengthen the behavioral norms of actual controllers
• Improve the protection mechanism for small and medium shareholders

• Regulatory concept centered on information disclosure
• Strict implementation of delisting system
• Market-oriented and rule-of-law reform direction

• Establish a comprehensive risk management and internal control system
• Strengthen supervision over the behaviors of actual controllers and controlling shareholders
• Improve the transparency and quality of information disclosure
• Optimize corporate governance structure and improve the effectiveness of independent directors

• Pay attention to the governance level of listed companies and choose enterprises with standardized operations
• Understand the background and past behavior records of actual controllers
• Actively exercise shareholder rights and participate in corporate governance
• Use legal weapons to safeguard their legitimate rights and interests

• Strengthen compliance management and risk control
• Standardize investment behaviors and avoid market manipulation and insider trading
• Respect the corporate governance structure of listed companies and fulfill fiduciary responsibilities
• Establish a sound internal compliance system

The judgment of the Xu Xiang-Wenfeng Stock case, together with the Kangmei Pharmaceutical special representative litigation case, marks a new stage in investor protection in China’s capital market. By establishing the joint liability of listed companies for the illegal behaviors of actual controllers, this judgment has achieved the following breakthroughs:

1. Corporate Governance Revolution
   : Promote listed companies to shift from “passive compliance” to “active governance” and establish a sound internal control and risk management system.

2. Upgrade of Investor Protection
   : Shift from single administrative punishment to a three-dimensional liability system of “civil + criminal + administrative”, significantly improving the effect of investor relief.

3. Optimization of Market Environment
   : Through increasing illegal costs and expanding liability scope, promote the formation of a “good money drives out bad money” market ecology.

4. Improvement of Regulatory System
   : Promote the formation of a full-chain regulatory mechanism of “pre-event prevention, in-event monitoring, and post-event accountability”.

This case will have a far-reaching impact on the A-share market, promoting the improvement of listed companies’ governance levels, the perfection of investor protection mechanisms, and the optimization of market order, laying a solid foundation for the high-quality development of China’s capital market. In the future, with the accumulation of special representative litigation practice and the unification of judicial judgment standards, the level of rule of law in China’s capital market will be further improved, better serving the real economy and protecting the legitimate rights and interests of investors.

[1] Securities Times - “Kangmei Pharmaceutical Special Representative Litigation First-Instance Judgment: Investors Awarded 2.459 Billion Yuan” and related reports
[2] Relevant announcements and judgment documents of Nanjing Intermediate People’s Court (from image information in search results)
[3] 2020 Securities Law of the People’s Republic of China and related judicial interpretations
[4] Relevant regulations of the CSRC and the Supreme People’s Court on investor protection in the securities market