High liability vs low benefit: Companies see an exodus of independent directors

With huge fines levied on executives and directors of Kangmei Pharmaceutical Co as a deterrent, China has seen a "resignation wave" of independent directors of listed companies.

The Intermediate People's Court of Foshan, south China's Guangdong Province, recently ruled that a number of Kangmei executives and their external accountants were responsible for fabricating its financial statements.

The court ordered them to pay nearly 2.5 billion yuan (US$391 million) to more than 52,000 investors as compensation for their losses on the company's stock.

Shanghai-listed Kangmei's five independent directors are each liable for between 5 percent and 10 percent of the amount, equivalent to 123 million yuan to 246 million yuan, according to an exchange filing.

As shown in the 2020 financial report of the company, the five independent directors received monthly salaries of around 10,000 yuan, and four of the five directors are all university professors. The penalty is hundreds of times their annual salary under 200,000 yuan.

The comparatively low benefit with high levels of liability has driven many independent directors to quit their seats on the boards of listed companies.

Public companies' notices showed that by November 25, more than 30 independent directors have handed in resignation since the court ruling on November 12.

Of note, the number for this 14-day period is close to that in the whole month of October, while it has seen another increase to more than 40 by Monday.

This also gave rise to a heated discussion about the system of independent directors, such as the nomination and appointment, as well as their duties and liability.

An independent director refers to a member of a board of directors who does not have a material or pecuniary relationship with company or related persons, except sitting fees. They do not own shares in the company, and are not involved with the day-to-day operations of the company.

The system of appointing independent directors leaves some drawbacks to consider. One example is the risk of information asymmetry as independent directors are generally less informed about the company than the management team. In addition, they may not have the requisite skills and knowledge to be an effective board member.

Gui Haoming, chief marketing analyst of SWS Research, a fully licensed securities research institute, pointed out that the candidates for independent directors are mainly nominated by major shareholders, which at the beginning leaves a question mark on whether the independent directors are really independent at all.

Shen Meng, director of Xiangsong Capital, said the joint and severe liability of the independent directors in the Kangmei case is the loss caused to the investors by their failure to fulfill their duty, and has no relevance to their salary and benefits they received.

The ruling of this case is conducive to purify the accumulated drawbacks in the current poor system of independent director in the A-share market, Shen said.

Previously, the China Securities Regulatory Commission found Kangmei was engaged in intentional and systematic financial cheating worth 30 billion yuan between 2016 and 2018. It levied a fine of 600,000 yuan on the company in May 2020, along with penalties on 21 responsible people, saying "toxic tumors" in capital markets must be eradicated swiftly, and relentlessly.

Then in April this year, the China Securities Investor Service Center, a government-affiliated body, sued Kangmei on behalf of more than 50 individual investors, the country's first class-action lawsuit against a listed company.

The defendants include former Kangmei Chairman Ma Xingtian and his wife, former deputy general manager Qiu Xiwei and financial chief Zhuang Yiqing. The court found that they deliberately organized, plotted and implemented the financial fraud and should be 100 percent liable for losses to investors. An additional 13 executives were ruled partially responsible for the losses.

The case was a landmark in the history of China's capital market, which is of great significance in helping deepen the reform and healthy development of China's capital market and safeguard the legitimate rights and interests of investors, the CSRC said.

In future, the commission will, based on the experience of this case, promote the improvement of the system and mechanism of class action, and support the investor protection institutions to further optimize the process of case assessment, decision-making and implementation, it pledged.