China’s 2023 Company Law Reform: Towards a Mixed Regulatory and Contractual Accountability System for IPO Misrepresentation

China’s corporate law and securities regulation have undergone a series of legislative reforms over the past decade to enhance investor protection and foster market competition.

The comprehensive reform of the People’s Republic of China (PRC) Securities Law in 2019 marked a significant shift in the country’s Initial Public Offering (IPO) system, transitioning from an approval-based to a registration-based regime. This change removed the requirement for substantial review by the China Securities Regulatory Commission (CSRC), the securities market’s watchdog. In practice, however, the reform has been implemented incrementally, extending to cover all mainland stock exchanges—the Beijing Stock Exchange, the Shanghai Stock Exchange, and the Shenzhen Stock Exchange—by 2023. This progression reflects the Chinese authorities’ consistently prudent approach towards financial markets liberalization.

Within this regulatory framework, the information disclosure regime and accountability system have emerged as crucial mechanisms for enabling investors to make informed investment decisions and for fostering an integrated and efficient financial market. Accordingly, the revised PRC Company Law and PRC Securities Law are anticipated to play complementary roles in establishing a so-called ‘regulatory-contractual mixed paradigm’ accountability system for IPO misrepresentation.

In our paper, we examine whether the reforms to the PRC Company Law in 2023 facilitate a shift in China’s accountability system for IPO misrepresentation from a regulatory to a contractual paradigm. This exploration is grounded in an analysis of China’s existing accountability system and its limitations. Below, we present our key findings:

I. Investors’ Difficulties in Claiming IPO Misrepresentation under the Existing Accountability System

China’s current accountability system for IPO misrepresentation adopts a ‘reverse onus’ approach, imposing strict liability on information disclosure obligors. This seeks to alleviate the evidentiary burden borne by investors, given their disadvantaged position in the market. Under this framework, once a misrepresentation is identified in a prospectus, investors who purchase relevant shares between the misrepresentation date and its correction date and subsequently incur losses can claim compensation. Obligors can only escape liability by demonstrating a break in the causation chain between their misconduct and the investors’ losses, regardless of their subjective intent.

However, investors continue facing challenges in identifying misrepresentations and determining the scope of proper defendants, given the removal of administrative preconditions in 2022.  ‘Significance’ is a criterion for courts to establish causation between misrepresentation and investors’ losses, which was previously based on the existence of administrative penalties before 2022. Although, the supreme court of China have interpreted ‘significance’ through two opposing dimensions: (1) the misrepresentation contains information required to be disclosed under securities regulations, and (2) the misrepresentation has not resulted in material changes to the relevant securities’ trading prices and volumes. Courts may also dismiss claims based on a subjective assessment of whether price and volume changes is ‘material enough,’ which introduces uncertainty and inconsistency.

The introduction of China’s Special Securities Representation Action (SSRA) and the involvement of investor protection institutions in assisting private lawsuits represent a legal response to these challenges. However, systemic barriers—such as passive judicial attitudes, protracted negotiations, the absence of contingency fees, and complex initiation procedures—render investor compensation inefficient. This raises a critical question: can individuals effectively utilize private lawsuits to protect their interests?

II. Strengthened Liability on Information Disclosure Obligors in the 2023 Company Law

The recent reforms to the PRC Company Law have strengthened the corporate accountability system in three key dimensions, offering potentially promising avenues for enhanced investor protection: (1) reaffirming and clarifying directors' duties, specifically their duties of loyalty and diligence; (2) imposing more explicit liabilities on de facto corporate operators, including shadow directors, de facto directors, senior managers, and actual controllers; and (3) expanding the liability of directors and senior managers to third parties, enabling aggrieved investors, including both current and former shareholders, to initiate private actions in cases of misrepresentation.

Our paper employs a black-letter methodology to examine these revised rules in the context of IPOs. While the reforms provide a basis for claims, achieving the intended protections remains challenging. This difficulty arises from the rules’ broad applicability across diverse scenarios, which can inadvertently overlook the specific characteristics of the parties involved. Notably, the evidentiary burden placed on aggrieved investors, particularly retail investors, remains disproportionately high. Without special provisions—such as a presumption of fault for information disclosure obligors—these investors face significant obstacles in seeking just compensation.

III. Reflection on the Way Forward: A Regulatory and Contractual Mixed Accountability System

In IPO misrepresentation cases, investors may pursue claims against issuers under contract law by establishing either (1) a fault in contract formation, or (2) a breach of contract, without needing to prove the materiality of the fault. However, holding non-signatory parties accountable through mechanisms such as piercing the corporate veil or derivative actions raises both substantive justice and procedural challenges.

The recent amendments to the Company Law, while progressive, still place substantial evidentiary burdens on private litigants, underscoring the need for continued regulatory intervention. Administrative remedies outlined in the Securities Law 2019, such as ‘Buyback’ and ‘Advance Compensation’ mechanisms, have provided with efficient compensation routes, which are discussed in detail in our paper. Although the buyback method, which allows securities issuers to repurchase securities at their original price from affected investors, is rarely utilized, advance compensation—where the obligor provides compensation enabling compensatory payments to investors prior to litigation—has gained widespread adoption since 2019. This mechanism effectively transforms potential tort claims into contractual arrangements between information disclosure obligors and affected investors, with the CSRC ensuring the enforceability of these agreements.

China’s existing accountability framework reflects the distinct characteristics of the state’s involvement in the stock market, which are expected to persist given the relative immaturity of retail investors, the prevalence of politically connected firms, and the administrative, paternalistic leadership style. Nonetheless, significant progress has been made by Chinese authorities in liberalizing the public stock market through a more market-oriented regulatory approach, particularly with respect to directors’ and senior managers’ responsibilities towards third parties and the explicit liabilities of controlling shareholders or actual controllers introduced by the Company Law revisions.

In the future, while aggrieved investors may initiate private suits, increased participation from legal professionals will be essential in such cases. Furthermore, regulators should prioritize streamlining the processes for initiating class actions. These reforms, from both regulatory and contractual perspectives, would not only enhance enforcement mechanisms but also promote a more active and empowered investor community in addressing and preventing corporate misconduct.

The authors’ complete paper can be found here.

Dr Lerong Lu is a Reader in Law at the Dickson Poon School of Law, King’s College London.

Jiujing Ye is a PhD Candidate & Visiting Lecturer at the Dickson Poon School of Law, King’s College London.