Hong Kong Proposes Class Actions After Investor Concerns

Hong Kong Proposes Class Actions After Bad Share Sale Concerns
Stock traders work at the Hong Kong Stock Exchange in Hong Kong, China. Photographer: Jerome Favre/Bloomberg

Hong Kong, where the securities regulator this month proposed introducing civil liability for banks working on initial share sale prospectuses, may also allow class-action lawsuits to help investors seek damages.

The city’s Law Reform Commission today recommended legislation to allow a group with a common complaint to sue through a representative. The new regime initially will apply to product liability and consumer fraud cases and not to purchasers of securities, the commission said.

Hong Kong currently allows multiparty proceedings under rules the city’s then-chief justice Andrew Li criticized as restrictive and inadequate in 2004. Losing parties must pay all or part of their opponent’s legal fees under Hong Kong law, a deterrent for individual investors seeking damages.

As a result, litigation risk for bankers and companies selling shares in Hong Kong has been relatively low to date, according to Jeff Maddox, a lawyer who had advised on capital raising in Hong Kong, New York and Singapore stock exchanges.

“There’s less than a three percent chance of getting sued after a listing here compared to a 20 to 25 percent chance in the U.S.,” said Maddox, a Hong Kong-based partner at Cadwalader, Wickersham & Taft LLP, citing industry statistics.

Allowing class actions was recommended by a sub-committee of the law commission in 2009 following losses by thousands of investors on notes guaranteed by failed Lehman Brothers Holdings Inc.

Criminal Liability

The need for class actions “most typically arises where a large number of persons have been adversely affected by another’s conduct, but each person’s loss is too small” to make individual litigation viable, the commission said today.

Its final recommendation comes two weeks after the Securities and Futures Commission, Hong Kong’s market regulator, proposed extending criminal and civil liability laws to initial share sale arrangers who sign off on misleading or inaccurate prospectuses.

The SFC said tighter laws are needed to protect investors after finding substandard work by investment banks arranging IPOs. In one case, it alleges that Chinese fabric-maker Hontex International Holdings Co. misled investors in its listings prospectus in 2009.

Buyers of products sold by consumer banks or brokerages will be allowed to seek permission to sue as a class under the proposed new regime, the law commission’s Anthony Neoh said today.

Not Like Facebook

Their lawsuits can be financed by the city’s Consumer Legal Action Fund, with a general government fund recommended when other types of group suits are allowed. Contingency fees and other forms of litigation funding aren’t recommended by the commission, and the type of lawsuits around the Facebook Inc. IPO won’t be covered by the proposed regime initially, he said.

Neoh said the proposals would have to be acted on by the government and declined to speculate on when class actions would actually be allowed or on when they would be extended to cover shareholders of publicly-listed companies.

“Legislation has to be drafted and introduced,” he said.

Civil liability will have a positive influence on the behavior of market participants, SFC Chief Executive Officer Ashley Alder said May 22. That said, the current litigation system can be “off-putting -- in part because of expense,” he said.

There have been no investor lawsuits against Citic Pacific Ltd., which plunged after it announced a potential $2 billion loss on wrong-way bets in 2008, six weeks after directors first learned of the information.

Too Complex

Three retirees tried to pursue the steelmaker and property developer’s former chairman in the small claims tribunal, where parties represent themselves, to avoid the potential legal costs involved in a trial. The case was dismissed on the grounds that it was too complex for the tribunal.

“If Hong Kong were to allow class actions, the risk of facing potential shareholder class-action lawsuits might well be a powerful driver for a change in mindset and behavior in the market,” said Tim Mak, a Hong Kong-based financial services regulatory lawyer at Herbert Smith LLP.

“Some might argue that a class-action system would encourage higher standards of corporate governance and listed-company management behavior,” he said.

“Over and above any potential criminal responsibility, the possibility of being on the receiving end of a class action lawsuit would be an additional risk that market participants would need to take seriously,” Mak said.

Stock Market Boom

This year there have been at least six disputes between accounting firms and mainland Chinese companies, including Boshiwa International Holding Ltd., a Shanghai-based Harry Potter apparel licensee whose auditor resigned in March due to disagreements over financial information.

Hong Kong, which Britain returned to Chinese rule in 1997, has benefited as $159 billion of IPOs by companies from the mainland in the past decade swelled the value of its stock market. First-time sales peaked at $58 billion in 2010 before declining by more than half last year, data compiled by Bloomberg show.

The SFC’s aim with its recent proposals on IPO sponsors is to encourage vigilance not to put bankers in prison, according to Alder.

Gareth Hughes, a Hong Kong-based disputes lawyer at Ashurst LLP said that a group lawsuit regime has been long-awaited and is welcomed.

“That said, the devil is in the detail, not least given the mixed results in other jurisdictions and the scope for abusive claims,” he said. “It may well be some time before such a regime is in place.”

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