Chinese brothers Tang Wanxin and Tang Wanli were among the world's most successful tomato farmers. Between 1986 and 2004, they built their tomato company, D'Long International Ltd., into a behemoth on the Shanghai and Shenzhen stock exchanges. The conglomerate invested heavily in hundreds of industrial and financial services companies.
Although the Tangs may have been farmers when they started D'Long, they were no ordinary farmers.
"The Tangs were well-connected with the old school government and the banking industry, so they had access to political clout and financing," says Robert Kwauk, a partner at Blake Cassels & Graydon's Beijing office.
In other words, the Tangs had the power and connections that kept them out of the law's reach in the chaotic world of Chinese securities regulation.
That was until recently.
On Jan. 19, just two weeks after China's newly amended securities law took effect, a court in the Hubei Province began hearing charges against Tang Wanxin and six senior managers at D'Long. The government charged the defendants with illegally raising more than $5.6 billion from the public between 2001 and 2004. It implicates 2,500 organizations and 32,000 individuals. The China Securities Regulatory Commission (CSRC) has hailed the case as "a turning point in China's securities market."
Although the case is technically a criminal enforcement action, observers have noted the proximity between the news of the new securities law and the charges against individuals previously regarded as above the law.
"The fact that people as well-connected as Tang and his associates are not immune shows that the government now has the will to make the securities system work as it should," Kwauk says.
But others doubt that the government will make much progress.
"No matter what changes the Chinese make, the difficulty with their securities laws has always been the lack of enforcement power residing in the CSRC," says Xiaoyu Greg Liu, an associate in the Hong Kong office of Paul Weiss Rifkind Wharton & Garrison.
Until the new amendments came into force, the only sanctions available to the CSRC were public reprimands, denying future listing applications and revoking the professional registration of offenders. But even these limited powers have been circumscribed by market conditions: the Chinese markets reached eight-year lows last year and there wasn't a single new listing in 2005. In other words, there wasn't anything for the CSRC to deny.
The amendments address some of these problems. Article 180 of the new law gives the CSRC power to freeze funds, securities and other assets involved in illegal securities transactions if there is danger that those under investigation will transfer or conceal the assets. The law also gives the commission similar seizure powers if they believe those under investigation might tamper or destroy evidence.
"Previously only judges, criminal prosecutors and the police could exercise such powers," says Allen Zhong, a securities lawyer with the Beijing office of Clifford Chance.
The CSRC responded quickly to its new powers, issuing guidelines right after the government passed the amendments. Liu, though, is still critical of the new enforcement measures.
"The CSRC still will not have subpoena powers, which means that its ability to prevent abuse will be limited since it will not be able to access information until someone is charged or a company collapses," he says.
Liu argues that this is what happened in the D'Long scenario, where the company's complicated structure left authorities in the dark until it collapsed under pressure from creditors.
Also suspect is the CSRC's capacity to take advantage of its new powers.
"It's not a question of just changing the law," says Doug Markel, a partner with Freshfields Bruckhaus Deringer in Beijing. "China needs better enforcement."
While there has been no official signal that the government intends to beef up the commission, the CSRC has stepped up securities enforcement. Chinese officials arrested more than 30 top executives at Chinese listed companies in 2005. The CSRC also has been pressing ahead with tougher rules for securities brokerages.
And quite apart from regulatory enforcement, the new law embraces other mechanisms for protecting investors.
"The new law reinforces the liability of officers and directors by holding them responsible for the content of public filings," says Carmen Chang, who heads Wilson Sonsini Goodrich & Rosati's China practice.
Similarly, the new law makes investment-consulting firms liable for false or misleading information disseminated through the media. The amendments also require the CSRC to set up a company to manage, invest and apply the monies in an investor-protection fund to compensate creditors and investors who have been affected by the closure or liquidation of securities companies. The CSRC has yet to establish the size of the fund and the mechanics of compensation.
"The mere enactment of these measures, regardless of the ultimate form of the regulations or the effectiveness of enforcement, represents a milestone in the evolution of Chinese securities law to a Western model," Kwauk says.
Some observers suggests that Americans, of all people, should recognize the process and give the Chinese credit for it.
According to Morris DeFeo, a corporate securities partner with Crowell & Moring in Washington, D.C., the current state of the securities market in China is reminiscent of the U.S. securities environment just before the Great Depression.
"A lot of the bad things that are happening in China--loose treatment of deposits by banks, unlimited lending against securities, and rampant speculation in securities--is similar to conditions that precipitated the Great Depression and gave rise to commercial and corporate finance regulation," DeFeo says. "Both the Securities Act of 1933 and the Securities Exchange Act of 1934 were outgrowths of rife market problems."
In other words, creating a regulatory structure that would eliminate destabilizing practices was the first step to rectifying market problems in the U.S. As DeFeo sees it, the Chinese are doing the same thing.
"And they're going to have to endure the same evolutionary cycle that we did," he says. "It all won't happen in one fell swoop."