New Guidance on Corporate Governance

Llinks Law Office

On January 7 2002, the China Securities Regulatory Commission (CSRC) and the State Economic and Trade Commission jointly issued the Listed Company Governance Guidelines (the Guidelines).

Proxy Solicitation Mechanism

According to Article 65 of 1993's Administration of the Issuing and Trading of Shares Tentative Regulations, shareholders may authorize third parties to exercise the right of consent and voting, and if anyone has collected the consent and voting rights from more than 25 shareholders, the CSRC regulations on information disclosure and reporting shall be observed. Except for the above, no other detailed prescriptions can be found before the promulgation of the Guidelines. According to Article 10 of the Guidelines, there are only three kinds of persons qualified for collecting the shareholders' meeting voting rights from the shareholders: i) members of the board of directors; ii) independent directors; and iii) shareholders who satisfy certain conditions. In other jurisdictions, such as the US, this voting-right collection system can be called the Proxy Solicitation Mechanism. It should be noted that the Guidelines require that the Proxy Solicitation be done without any consideration of value. To enforce such a mechanism, the Guidelines need further clarification on such issues as what "the shareholders that satisfy certain conditions" means and whether the proxy is revocable or not.

Independence from Controlling Shareholders

For historical reasons, the state is still the largest shareholder in many listed companies. The result, an excessively concentrated shareholding structure, often entails a lack of representation of minority shareholders. In addition, affiliated transactions between listed companies and their controlling shareholders are common, sometimes with severe conflicts of interest to the detriment of minority shareholders. All these factors have made it difficult for listed companies to achieve independence from their controlling shareholders. For the first time, the Guidelines clearly and systematically clarify the nature of independence of the listed companies and provide the relevant principles. According to Section Two of Part Two of the Guidelines, listed companies shall be separated or independent from their controlling shareholders in terms of personnel, assets, finance, organization and business (the Five Separation Principle). In accordance with the CSRC requirements, this principle is also applicable to companies applying for an IPO.

Cumulative Voting

For the first time the concept of "cumulative voting" appears in PRC laws and regulations. Cumulative voting, a voting method in contrast with straight voting, is a technique whereby minority shareholders concentrate all their votes on one or more individual directors in the hope that they are elected. When cumulative voting is applied, the number of the nominees of the board of directors is multiplied by the total number of voting shares, though this is not clearly stated in the Guidelines. The result of this multiplication equals the total number of votes a shareholder has, and all the votes may concentrate on one or more nominees for the board of directors. It is highly encouraged for listed companies to adopt cumulative voting in the election of directors. However, it should be noted that, if the controlling shareholder(s) hold(s) more than 30% of the total shares in the listed company, it is necessary that the cumulative voting method be adopted to elect directors. According to the existing laws and regulations, directors of companies can be divided into two types: inside and independent directors. Since inside directors usually represent interests of specific shareholder(s), the cumulative voting for the election of inside directors is undoubtedly required to ensure minority shareholder representation on the board of directors. On the other hand, independent directors normally do not represent any specific shareholders, and it is usually believed that there is no need of cumulative voting for election of independent directors. On this issue, the Guidelines do not give a clear answer. Within some companies, inside directors are further divided into executive directors and non-executive directors. However, in case of one election for both executive and non-executive directors, or for both inside and independent directors, how does the cumulative voting system work? The Guidelines are also silent on this issue.

System of Independent Directors

On August 16 2001 the CSRC issued the Establishment of Independent Director Systems by Listed Companies Guiding Opinion (the Guiding Opinion). Article 50 of the Guidelines reiterates the Guiding Opinion in that an independent director has a fiduciary duty and a duty of diligence for the listed company and all its shareholders. In addition to the provisions in the Guiding Opinion such as the required qualifications, the election procedure and the duties of independent directors, the Guidelines make the following provisions in respect of independent directors' rights. First, independent directors can solicit proxies at the shareholders' meeting. Moreover, Article 52 of the Guidelines provides that, if a listed company establishes an auditing committee, a nomination committee or a remuneration and assessment committee under the board of directors, both the majority members and the conveners of such committees shall be independent director(s), and at least one independent director in the auditing committee shall be a professional accountant.

Deficiencies and Conflicts

The Guidelines, as the first set of rules in the PRC covering almost all aspects of listed company governance, undoubtedly represent a milestone in the country's history of corporate governance. However, to guide corporate governance, the Guidelines are to some extent unsatisfactory for lack of detailed regulations on company meetings, especially board meetings and the committee system. In addition, further clarification and specification needs to be made concerning such issues as proxy solicitation, cumulative voting and other newly introduced or essential systems prescribed by the Guidelines. The present PRC Company Law (中华人民共和国公司法) does not contain any provisions on cumulative voting. Therefore, it remains unclear whether PRC courts will recognize the Guidelines' provisions on cumulative voting in the event a dispute on the validity of the election of directors arises in the process of implementing the Guidelines (though the CSRC will supervise listed companies in accordance with the Guidelines).

By Charles Qin

Llinks Law Office,

Shanghai