Chinese companies race to shield executives from investor lawsuits

Chinese companies are rushing to protect their executives from potential lawsuits as Beijing deepens its crackdown on corporate misbehaviour.

A record number of listed companies in the world’s second-biggest economy have said this year that they will buy insurance policies intended to shield against the possibility of directors and officers being sued by shareholders or customers.

That has come as China’s stock market regulator has stepped up efforts to root out corporate malfeasance, disciplining an all-time high of nearly 300 companies in the first four months of the year for reasons including accounting fraud and insider trading.

A spotlight has again been thrown on the governance of Chinese companies in recent weeks following the scandal involving alleged fraud at Luckin Coffee, the New York-listed coffee chain touted as China’s answer to Starbucks.

In March, a securities law tightening corporate disclosure standards and making it easier for investors to sue company directors took effect.

“China’s corporate executives are facing significantly higher risks . . . because of the regulatory overhaul,” said Jiang Xiangyu, a securities lawyer in Shanghai. “They badly need tools to deal with uncertainties.”

Public records show that 72 companies listed in Shanghai and Shenzhen have announced plans this year to buy directors’ and officers’ liability insurance, known as D&O. That is compared with just 23 in the whole of 2019.

Under the rules introduced in March, Chinese companies face much more severe penalties for fraud such as those related to initial public offerings. They also allow individual investors to band together and sue listed companies.

“The new regulation is giving investors a stronger incentive to protect their rights by going to court,” said Liu Chengwei, a partner at Global Law Office in Beijing. 

“Our executives are facing too much risk because of the new security law,” said an executive at Shenzhen-listed GCL Energy Technology, a clean energy company that has taken out D&O insurance. “We want to relieve their pressure.”

The trend has benefited insurers in China. An executive at US-based Chubb said the number of inquiries for D&O insurance from Chinese clients had jumped by 50 per cent this year. “There is a growing demand for controlling management risks,” the executive said.

However, observers have raised concerns that Chinese companies’ purchases of D&O insurance merely provide cover for continued bad behaviour. Almost half of the new D&O policies taken out this year are by companies that have been fined or publicly criticised by regulators over the past 12 months.

Global Top E-Commerce, a Shanxi province-based online retailer that purchased a D&O policy in April, has previously been accused by Shenzhen’s stock exchange of insider trading and overstating its profits. “We want to protect our management,” said a Global Top executive.

But insurers point out that such a strategy is unlikely to pay off, as D&O policies generally do not pay out when intentional malfeasance is found to be to blame. Insurers may also become wary of extending this coverage in future.

“No one will write you a policy” if they suspect poor corporate governance is taking place, said the chief representative of a European insurance company in Shanghai. “D&O insurance won’t make a bad company safer.”

Additional reporting by Xinning Liu in Beijing

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