An Active Financial Centre Can Do Without Private Shareholder Actions

The market of a successful financial centre must be efficient, orderly and fair, which requires that investor protection rules be well written and effectively enforced. Such enforcement can be brought forward by private actors, public bodies or a combination of both. While a substantial literature exists promoting privately driven enforcement of investor protection rules, there is a growing consensus that enforcement action by public bodies is likely to be more important for most markets than privately initiated litigation. The paper discussed here and authored by me and Paul Cheuk, ‘Hong Kong’s Public Enforcement Model of Investor Protection’, presents data showing that Hong Kong exemplifies this point.

In Hong Kong, public authorities carry almost the entire burden of enforcing corporate and securities laws. This appears to work well. During the last decade Hong Kong has repeatedly been the world’s leading financial centre for initial public offerings (‘IPOs’), and done so without scandal or crisis. The market functions at a high level of quality globally despite operating in an environment where most companies are foreign-incorporated – often originating from jurisdictions with reputations for governance that are middling at best – and trading takes place in multiple currencies. Thus, Hong Kong maintains an orderly market although it lacks both the ex ante control that comes from shaping governance standards through domestic company law and an active market in lawyer-driven private shareholder actions.

This paper evaluates 10 years of hand-collected data on every type of enforcement action for investor protection laws in Hong Kong. The paper adds substance to the debate on the determinants of effective corporate and securities law enforcement by fully examining the legal and institutional contexts of enforcement and quantifying its outputs. First, the paper explains Hong Kong’s key laws for corporate and securities regulation and the available procedures for private and public actions. It then examines the powers and competencies of the relevant supervisory authorities, including the Securities and Futures Commission, the Companies Registry, the Official Receiver and the Stock Exchange of Hong Kong, which has a quasi-public role in regulating the market. Finally, using publicly available data evaluated by reading all published decisions filed under each action and supplemented through interviews with agency staff, the paper presents Hong Kong’s enforcement ‘inputs’ (funding and staffing) and ‘outputs’ (actions and sanctions) for the main public enforcers.

The data shows that privately initiated derivative and unfair prejudice actions have been, with only a couple of exceptions, insignificant both numerically and in terms of the importance of the respective actions for the market, so that corporate and securities law enforcement is predominantly in the hands of public bodies. Moreover, increased use of the action to disqualify directors (ie, prevent them from continuing in the role of executive management for a term of years) means that the persons committing misconduct themselves pay for their actions, rather than passing the cost on to the company (and the shareholders) through D&O liability insurance.

These findings are significant beyond Hong Kong for several reasons. First, because Hong Kong law is largely modeled on that of the UK, and also uses the English rule for funding litigation, it invites quantitative analyses in the UK and other UK-origin jurisdictions. Second, because Hong Kong’s public enforcement model is tasked with disciplining an environment in which over 85% of listed companies are foreign-incorporated, controlling shareholders and complex corporate groups are common, and a great deal of the corporate activity takes place outside of the jurisdiction, it provides a test case addressing problems more challenging than in the US, where foreign securities and the law are prophylactically isolated from the US markets via American Depositary Receipts and most operational activity occurs on US soil. Third, Hong Kong topped the IPO rankings for much of the period we measure, which provides a robust proxy for market strength.

Hong Kong’s public enforcement model presents good evidence of public enforcement protecting investment where the threat of private actions is minimal. Such evidence assists both established and developing economies form objective judgements on the preferred model for market regulation.

David C. Donald is a Professor at the Faculty of Law of The Chinese University of Hong Kong.