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Consumer Council Submission on the Proposal to Empower the Securities and Futures Commission to Initiate Derivative Actions

  • 2003.07.01

INTRODUCTION

  1. This paper provides the Consumer Council's views on a consultation paper on the proposal to empower the Securities and Futures Commission (SFC) to initiate derivative actions. The Financial Services and the Treasury Bureau (FSTB) invited the Council to provide comments on the proposal.

THE PROPOSAL

  1. In the current consultation paper, FSTB is proposing that the existing common law derivative action should be replaced by a statutory derivative action, brought by the SFC.
  2. The proposal is to empower the SFC to initiate, without court approval, a derivative action against wrongdoers in relation to a listed company on grounds including:
    • fraud;
    • negligence;
    • default in relation to any legislation; and
    • breach of any fiduciary or statutory duty, where the company is unwilling or unable to do so.
  3. Under the proposal, the SFC would only be empowered to exercise such statutory right where it is in the public interest and in the interest of the company concerned to do so.

COUNCIL COMMENTS

  1. Some concerns have been raised with the proposal in the consultation paper:
    1. One concern is whether it would be appropriate for a regulator to expend investing public's money on private commercial disputes.
    2. Another is whether SFC involvement would result in reduced likelihood of investors taking their own action.
  2. The Council's observations on the above concerns are as follows:
    1. The first concern is commonly raised with regard to the expenditure of public funds. The Council believes focus should be on the objective of the fund, and whether such matters as derivative action should be supported in the public interest. A precedent does exist with Legal Aid, which aims to facilitate access to justice. In addition, the Council's Consumer Legal Action Fund (CLAF) is used to assist persons who would not ordinarily be expected to have the resources to fight a complicated legal battle. If the SFC's derivative action power is used to assist similar cases then an analogy with Legal Aid and the CLAF would stand.
    2. With regard to the second concern, there seems little likelihood of investors taking action even under the current regime, since there is no investor interest group in Hong Kong similar to what exists overseas in Hong Kong. While there was a recent proposal that an investor interest group should be funded (the Hongkong Association of Minority Shareholders 'HAMS' proposal) but this failed to get government or industry support. It would appear that this sort of representative group would be necessary to assist investors who would want to mount an action through the courts. In the absence of such a support group, the prospect of investors taking their own action is remote.

PREVIOUS COUNCIL COMMENTS

  1. The issue of derivative action was previously canvassed in November 2001 in the consultation on Corporate Governance Review, by the Standing Committee on Company Law Reform (SCCLR). In its submission, the Council agreed with the observation that under the common law, a person who suffers loss may find it difficult to seek redress through civil action against a person responsible for causing the loss. It also agreed that there are difficulties involved, for instance, the person generally needs to fit a cause of action into litigation on contract law or tort such as negligence, and may not be aware of his legal position.
  2. In view of this, the Council pledged its support for making derivative action statutory; as it would
    • provide an effective mechanism by which shareholders can protect themselves; and
    • remove uncertainties and provide a more effective means of enforcing directors' duties and other wrongdoing committed in relation to the company.
  3. However, the Council noted that this would be a discretionary power, and given that investors have rights of their own, there may be some circumstances where the SFC either chooses not to exercise that power, or may feel it appropriate to leave the matter to individual investors. This raised a question as to whether those investors would have the resources to fund a court action.
  4. The Council suggested that consideration should therefore also be given to provide investors with access to funds and other assistance for a court action, for example, expanding the scope of the Legal Aid system.

ALTERNATIVE PROPOSALS TO DERIVATIVE ACTION

  1. The recent report by the Expert Group to Review the Operation of the Securities and Futures Markets RegulatoryStructure , in March 2003 also discussed private action by investors. It noted that whilst any initiative to give investors more legal rights to seek remedies is to be welcomed, it was not entirely convinced that statutory derivative actions would be of much practical help to small investors as the actions would need to be paid for by the plaintiff until the case is won and damages are awarded.
  2. The Expert Group also noted that even if a case is won, the damages would go to the company which would still be controlled by the people who caused losses in the first place and that it would be doubtful whether the plaintiff could receive a rightful share of compensation.
  3. Rather than providing the derivative actions, the Expert Group suggested that the Government should look into the feasibility of introducing either
    1. contingency fees based class actions; or
    2. the Australian system of pre-trial hearing in which a judge decides whether the claimant has any reasonable prospect of success, and if he or she does, may order the company to fund the claim.
  4. The Council notes that the Conditional Fees Sub Committee of the Law Reform Commission is examining the application of contingency fees in general.

CONCLUSION

  1. The Council supports the proposal to give the SFC the power to take derivative action on behalf of consumers. The power will be at the SFC's discretion, and if other circumstances arise in the future that provide a suitable environment for investors taking their own action, i.e. a strong investor association or contingency fees, the SFC's discretion can be applied accordingly.