On April 14, 2023, the General Office of the State Council issued the Opinions on the Reform of the Independent Director System of Listed Companies (hereinafter referred to as the “Opinions”). The Opinions point out that the independent director system, as an important part of the corporate governance structure of listed companies, has played a positive role in promoting the standardized operation of companies, protecting the legitimate rights and interests of minority investors, and driving the development of capital markets. However, with the comprehensive deepening of capital market reforms going further, the existing system can no longer meet the inherent requirements of high-quality capital market development. The Opinions put forward multiple reform measures targeting systemic issues in practice such as unclear positioning, mismatch between responsibilities, powers, and benefits, insufficient supervisory means, and lack of support for performing duties for independent directors.

The Opinions explicitly require adhering to a systemic perspective, balancing the relationship between various corporate governance bodies, coordinating institutional supply and market cultivation, and linking legislation, law enforcement, and judiciary to enhance the systemic, integrated, and coordinated nature of the reform.

Combining the legal practices of capital markets and corporate governance of listed companies, this article analyzes and interprets the relevant legal issues from legislative, law enforcement, and judicial perspectives.

I. Specific Measures in the Opinions on Reforming the Independent Director System of Listed Companies

According to the provisions of the Opinions, the basic positioning of the reform is to treat the independent director system as an important institutional arrangement for corporate governance of listed companies, effectively leveraging their roles in decision-making, supervision, and consultation. This reform requires establishing systematic standards for the status, role, selection, management, and supervision of independent directors to resolve prominent issues that restrict them from playing their roles, thereby enhancing their supervisory efficacy.

The Opinions put forward reform measures in eight aspects, which are outlined as follows:

(I) Systemic issues to be resolved by clarifying the roles and positioning of independent directors

Unclear positioning of independent directors, undefined statutory status and boundary of duties in listed company governance, and insufficient roles in key areas requiring supervision.

(Note: Financial fraud, and controlling shareholders using related-party transactions to harm the interests of listed companies remain prominent issues in China’s capital markets.)

Specific measures to improve the system

1. As members of the board of directors of a listed company, independent directors bear the duties of loyalty and diligence to the listed company and all shareholders, and play roles in participating in decision-making, supervision and balance, and professional consultation within the board, so as to promote better realization of the board’s functions in setting strategies, making decisions, and preventing risks.

>> Interpretation: Clarifying the statutory status and duty boundaries of independent directors in listed company governance.

2. Give more full play to the supervisory role of independent directors. According to the characteristics of independent directors’ independence and expertise, clarify that independent directors should pay special attention to potential major conflict-of-interest matters between the company and its controlling shareholders, actual controllers, directors, and senior executives (hereinafter referred to as “conflict-of-interest matters”), focusing on supervising key areas such as related-party transactions, financial and accounting reports, the appointment and dismissal of directors and senior executives, and remuneration, to prompt board decisions to align with the overall interests of the company, especially protecting the legitimate rights and interests of minority shareholders.

3. Keep independent directors accountable for their supervisory duties, establishing strict performance requirements for their review of potential major conflict-of-interest matters.

>> Interpretation: The supervisory role is the core objective of the independent director system of listed companies. The focus of supervision is directed at potential major conflict-of-interest matters.

4. Promote the revision of the Company Law to improve relevant provisions on independent directors.

>> Interpretation: Improving institutional supply.

(II) Systemic issues to be resolved by strengthening the management of independent directors’ qualifications

Independence is the prominent characteristic and most basic qualification requirement of independent directors. However, there are currently shortcomings in the supervision and management of independent directors’ qualification criteria and identification.

Specific measures to improve the system

1. Independent directors should possess the professional knowledge, work experience, and good personal character necessary to perform their duties.

2. Independent directors must meet independence requirements. Persons having conflicts of interest, such as relatives, shareholdings, employment, or major business dealings with the listed company, its major shareholders, or actual controllers, shall not serve as independent directors.

3. Establish an independent director qualification certification system, clarifying requirements for qualification application, review, and disclosure, and prudently judging whether independent directors to be appointed by listed companies meet the requirements. Securities regulatory agencies must strengthen the organization and supervision of qualification certification.

4. State-owned assets supervision and administration agencies must strengthen supervision over the selection, appointment, and management of independent directors of state-controlled listed companies.

5. Expand sources of outstanding independent directors to adapt to market development needs. Explore the establishment of an independent director information database, and encourage individuals with rich industry experience, corporate management experience, and professional expertise in financial accounting, finance, or law, who hold high reputations in their respective fields, to serve as independent directors.

6. Formulate professional codes of ethics for independent directors, advocating that independent directors shape a good professional image of integrity, fairness, independence, and active performance of duties.

7. Improve the targeting of independent director training, specifying minimum time requirements, and enhancing independent directors’ awareness of compliance.

(III) Systemic issues to be resolved by improving the selection and appointment system of independent directors

Against the background of concentrated shareholding of major shareholders in China’s listed companies and insufficient participation of minority shareholders in corporate governance, there are phenomena of “courtesy directors” and varying qualities of independent directors.

Specific measures to improve the system

1. Optimize nomination mechanisms, supporting the board of directors, the board of supervisors, and eligible shareholders of listed companies in nominating independent directors, and encouraging investor protection institutions and other entities to nominate independent directors in accordance with the law by publicly soliciting shareholder rights.  

2. Establish a nomination recusal mechanism. Nominators of listed companies shall not nominate individuals with whom they have conflicts of interest, or close associates whose circumstances might affect their independent performance of duties, as candidates for independent directors.  

3. The nomination committee of the board of directors shall review the qualifications of candidates, and the listed company shall disclose the qualifications of the nominator, nominee, and candidate before the general meeting of shareholders votes.

4. A cumulative voting system shall be promoted for the election of independent directors at general meetings of shareholders of listed companies, encouraging the implementation of cumulative voting through competitive elections to promote active exercise of shareholder rights by minority investors.

5. Establish a mechanism for periodic testing of the independence of independent directors. Through independent directors’ self-inspection, listed companies’ evaluation, and public information disclosure, ensure that independent directors continue to perform their duties independently without being influenced by the listed company, its major shareholders, or actual controllers. For independent directors who fail to meet independence requirements, listed companies shall immediately suspend their performance of duties and dismiss them according to statutory procedures.

(IV) Systemic issues to be resolved by optimizing the performance of duties of independent directors (Part 1):

The key to independent directors playing their roles is their external independent status. However, this status characteristic leads to a lack of leverage within the company, leaving independent directors without organizational support and often trapping them in a “lone fighter” dilemma.

Specific measures to improve the system

1. Encourage listed companies to optimize the board composition. Independent directors should account for more than one-third of the board of directors of a listed company, and external directors (including independent directors) should hold the majority on the board of state-controlled listed companies.

2. The board of directors of a listed company shall establish an audit committee, entirely composed of non-executive directors, with independent directors holding the majority. The audit committee shall undertake duties such as reviewing company financial information and its disclosure, supervising and evaluating internal and external audit work, and internal control. Significant matters such as financial and accounting reports and their disclosure must be pre-approved by the audit committee before being submitted to the board for review.

3. Gradually promote the establishment of nomination committees and remuneration and appraisal committees dominated by independent directors on the boards of listed companies, responsible for reviewing the appointment, dismissal, and remuneration of directors and senior executives and making recommendations to the board.

>> Interpretation: Building an effective performance platform for independent directors, promoting the transition of independent directors’ performance from individual actions to reliance on organizational structures.

(IV) Systemic issues to be resolved by optimizing the performance of duties of independent directors (Part 2):

Currently, independent directors lack effective pre-approval means. In a board structure where independent directors do not hold the majority, independent directors cannot sway the final decision-making outcome even if they express dissent, which is unfavorable for preventing risks in key areas of capital markets in advance.

Specific measures to improve the system

1. Establish a mechanism for special meetings attended solely by independent directors. Potential major conflict-of-interest matters such as related-party transactions must be pre-approved by the special meetings of independent directors before being submitted to the board of directors for review.

2. Improve disclosure requirements regarding independent directors’ participation in board special committees and special meetings, enhancing the transparency of independent directors’ performance of duties.

3. Improve special powers of independent directors, promoting their reasonable exercise of powers such as independently hiring intermediary agencies and soliciting shareholder rights, to better perform supervisory duties.

4. Sound the communication and exchange mechanism between independent directors and minority investors.

>> Interpretation: Shifting the threshold of supervision forward.

(V) Systemic issues to be resolved by strengthening performance support for independent directors

Insufficient support for independent directors in performing their duties.

Specific measures to improve the system

1. Sound the performance support mechanism for independent directors of listed companies. Listed companies shall provide necessary conditions for independent directors to perform duties in terms of organization, personnel, resources, information, and funding, ensuring that independent directors fully perform their duties according to law.

2. Encourage listed companies to push independent directors to participate in advance in research, demonstration, and other phases of major and complex projects, promoting the effective integration of independent directors’ performance with the company’s internal decision-making processes.

3. Implement the performance support responsibilities of listed companies and related entities toward independent directors, enriching the regulatory means of securities regulatory agencies, and strengthening supervision over listed companies and related entities that fail to cooperate with or obstruct independent directors in performing their duties.

4. Clear communication channels between independent directors and securities regulatory agencies and stock exchanges, sounding the relief mechanism for independent directors when their performance of duties is restricted.

>> Interpretation: The external identity of independent directors determines that they do not participate in daily operation and management, creating information asymmetry, and their performance of duties relies on the cooperation and assistance of the company. Providing necessary support and conditions is essential to make up for the limitations of their external identity.

5. Encourage listed companies to purchase directors’ liability insurance (D&O insurance) for independent directors, supporting insurance companies in developing relevant liability insurance businesses that meet the needs of listed companies, to reduce the risks of independent directors in performing their duties normally.

>> Interpretation: Reducing the risks of independent directors performing their duties normally.

(VI) Systemic issues to be resolved by strictly supervising and managing the performance of independent directors

Insufficient supervisory means, incentives, and constraint mechanisms for independent directors’ performance.

Specific measures to improve the system

1. Tighten and implement independent directors’ performance responsibilities, further regulating their daily performance behaviors. Specify minimum working hours, require the keeping of work records and regular debriefing, determine a reasonable limit on the number of listed companies in which an independent director can concurrently hold office, and strengthen the input of independent directors in performing duties.

2. Securities regulatory agencies and stock exchanges shall increase supervision over independent directors’ performance through on-site inspections, off-site regulation, and self-regulatory management, urging independent directors to perform duties with diligence.

3. Leverage the role of self-regulatory organizations, continuously optimizing self-management and services, and strengthening professional standards and performance support for independent directors.

4. Improve the performance evaluation system for independent directors, researching the establishment of evaluation standards covering scientific decision-making, supervisory effectiveness, and advice-offering. State-owned assets supervision and administration agencies shall strengthen tracking and guidance regarding the performance of independent directors of state-controlled listed companies.

5. Establish a reputation incentive and constraint mechanism for independent directors, incorporating performance records into capital market integrity archives, promoting both positive incentives and negative warnings, and enhancing independent directors’ sense of professional identity and honor.

>> Interpretation: Strengthening supervision to urge independent directors to perform their duties with diligence.

(VII) Systemic issues to be resolved by sounding the responsibility constraint mechanism for independent directors

Mismatch of powers, responsibilities, and benefits for independent directors, along with an incomplete accountability system.

Specific measures to improve the system

1. Adhere to “zero tolerance” in cracking down on securities laws and regulations violations, increasing accountability for independent directors who fail to perform duties. Where independent directors fail to perform statutory duties diligently, thereby harming the legitimate rights and interests of the company or shareholders, accountability shall be strictly pursued in accordance with the law.

2. In accordance with the principle of matching powers, responsibilities, and benefits, and taking into account both the director status and external identity of independent directors, clarify that independent directors and non-independent directors bear joint but distinct legal liabilities. On the basis of directors’ statutory liability for board resolutions and information disclosure, promote the targeted establishment of determination standards for independent directors’ administrative and civil liabilities, reflecting proportional punishment and precise accountability.

3. Combining independent directors’ subjective fault, their role in the decision-making process, the channels through which they obtain information, and the measures they take to verify information, rationally determine the form, proportion, and amount of civil compensation liability borne by independent directors, to achieve organic unity of legal and social effects.

4. Promote the revision of relevant laws and regulations, building a complete responsibility system for independent directors.

(VIII) Systemic issues to be resolved by improving a coordinated and efficient internal and external supervision system

An incomplete internal and external supervision system.

Specific measures to improve the system

1. Establish and sound an internal supervision system coordinated with independent directors’ supervision, forming a listed company internal supervision mechanism with comprehensive coverage, distinct focuses, and organic interaction, comprehensively upgrading the level of corporate governance.

2. Promote and accelerate the establishment and improvement of law enforcement and judicial systems and mechanisms for strictly cracking down on securities crimes in accordance with the law, effectively leveraging the supervisory roles of securities service agencies and social public opinion, to form a strong supervisory synergy over entities such as listed companies, their controlling shareholders, and actual controllers.

3. Sound the supervision mechanism for state-owned enterprises with Chinese characteristics, promoting the coordinated connection of discipline inspection and supervision, inspection supervision, state-owned assets regulation, audit supervision, financial supervision, and social supervision, to further improve the overall effectiveness of supervision over state-controlled listed companies.

>> Interpretation: Establishing a coordinated internal and external supervision system.

As can be seen from the above reform measures, the Opinions directly address the prominent issues in practice and propose a series of comprehensive solutions.

II. Analysis of the Impact of the Reform of the Independent Director System on Legislation

The Opinions have clearly stated that this reform aims to optimize the existing independent director system of listed companies and build an independent director system that fits China’s national conditions. Therefore, this reform will inevitably bring about far-reaching impacts on institutional supply, including at the legislative level.

(A) Promoting the revision of fundamental laws such as the Company Law

First, the Opinions explicitly require promoting the revision of laws such as the Company Law, improving relevant regulations on independent directors, and clarifying basic statutory provisions such as the setup and responsibility of independent directors.

From the perspective of the Company Law itself, Article 122 of the current Company Law stipulates: “A listed company shall establish independent directors, and the specific measures shall be prescribed by the State Council.”

Currently, China is in the process of revising the Company Law. The Company Law (Draft Revision for Second Review) (hereinafter referred to as the “Second Review Draft”) revised the above-mentioned article of the current *Company Law and added other provisions. Among them, Article 121 of the Second Review Draft provides: “A joint stock limited company may, in accordance with the provisions of its articles of association, establish an audit committee within the board of directors… The audit committee mentioned in the preceding paragraph shall be composed of three or more directors, with independent directors accounting for the majority, and at least one independent director shall be an accounting professional. An independent director shall not hold any office in the company other than director, and shall not have any relationship with the company that might affect their independent and objective judgment.” Article 136 provides: “A listed company shall establish independent directors, and the specific administrative measures shall be prescribed by the securities regulatory agency of the State Council.” In addition, Article 190 of the Second Review Draft improves provisions on directors’ liabilities, clarifying that where a director causes damage to others in the performance of duties, the company shall bear compensation liability; where the director has intent or gross negligence, the director shall also bear joint and several liability. Article 192 also provides for directors’ liability insurance: “A company may purchase liability insurance for directors during their term of office for the compensation liability they bear due to the performance of corporate duties. After the company purchases or renews liability insurance for directors, the board of directors shall report to the general meeting of shareholders on the insured amount, coverage, and insurance rates of the liability insurance.”

It is clear from these revisions alone that the amendment of the Company Law will undoubtedly respond to the legislative requirements of this reform.

(B) Promoting the formulation and revision of supporting regulations

Currently, in addition to the Company Law and the Securities Law, supporting systems also stipulate contents involving independent directors of listed companies, including but not limited to the Rules for Independent Directors of Listed Companies, Detailed Rules for the Implementation of Training for Independent Directors of Listed Companies, Guidelines for the Articles of Association of Listed Companies, Rules for General Meetings of Shareholders of Listed Companies, Interim Provisions on the Administration of Public Solicitation of Shareholder Rights of Listed Companies, Code of Corporate Governance for Listed Companies, etc.

As far as this reform is concerned, the Opinions explicitly require that the institutional supply must be perfected, which includes: improving the system of independent directors of listed companies, formulating administrative regulations on the supervision of listed companies, and implementing institutional measures such as the positioning, selection, performance methods, performance support, and administrative regulation of independent directors. Improve the supporting rules of securities regulatory agencies and stock exchanges, and refine the specific requirements of each link of the independent director system of listed companies to build a scientifically sound and interconnected rule system. Meanwhile, the Opinions also require state-owned assets supervision and administration agencies and financial regulatory departments to coordinate the independent director system with corporate governance regulations for state-controlled and financial listed companies.

To implement the Opinions, on the day they were issued, the China Securities Regulatory Commission (CSRC) released the Notice on Soliciting Public Opinions on the Administrative Measures for Independent Directors of Listed Companies (Draft for Public Comments), seeking feedback from society.

From the above situation, it is foreseeable that this reform will simultaneously drive the formulation and revision of a series of supporting systems.

In summary, the reform of the independent director system of listed companies will have a significant impact on China’s future legislation and the formulation and improvement of supporting systems.

III. Analysis of the Impact of the Reform of the Independent Director System on Administrative Enforcement

In terms of administrative enforcement, the current Securities Law (2019 Revision) stipulates corresponding administrative legal liabilities for securities violations in Chapter XIII.

From the content of the Opinions, the reform of the independent director system is likely to have the following impacts on administrative regulation and enforcement.

(A) The enforcement system for cracking down on securities violations and crimes will be more robust

The eighth reform measure of the Opinions explicitly points out the need to accelerate the establishment and improvement of enforcement and judicial systems and mechanisms for strictly cracking down on securities crimes in accordance with the law, forming a strong supervisory synergy over entities such as listed companies, their controlling shareholders, and actual controllers. In the Administrative Measures for Independent Directors of Listed Companies (Draft for Public Comments) issued recently by the CSRC, supervisory measures and legal responsibilities for independent directors have been explicitly stipulated.

(B) Securities regulatory agencies may increase supervision over independent directors’ performance of duties

The seventh reform measure of the Opinions explicitly proposes that securities regulatory agencies should increase supervision over independent directors’ performance through on-site inspections, off-site regulation, and self-regulatory management, urging independent directors to perform duties with diligence.

(C) The principle of matching power and responsibility will be more reflected when determining independent directors’ administrative liability

The Opinions require that, in accordance with the principle of matching powers, responsibilities, and benefits, and taking into account both the director status and external identity of independent directors, clarify that independent directors and non-independent directors bear joint but distinct legal liabilities. On the basis of directors’ statutory liability for board resolutions and information disclosure, promote the targeted establishment of determination standards for independent directors’ administrative liability, reflecting proportional punishment and precise accountability. In fact, the Administrative Measures for Independent Directors of Listed Companies (Draft for Public Comments) released recently by the CSRC already reflects this spirit of matching powers and responsibilities.

IV. Analysis of the Impact of the Reform of the Independent Director System on Judiciary

In recent years, the civil compensation liability of independent directors in securities misrepresentation liability disputes has attracted significant attention. Especially after independent directors were ruled to bear joint and several liability in the Kangmei Pharmaceutical case, a wave of resignations of independent directors occurred among listed companies, and the liability of independent directors became a hot topic.

(A) Outline of current regulations on the determination of independent directors’ compensation liability

The existing system stipulates the circumstances and exemptions under which independent directors bear civil compensation liability. This article outlines the main contents of relevant laws, judicial interpretations, and judicial documents as follows:

In 2016, in its Reply to Recommendation No. 6393 of the Fourth Session of the Twelfth National People’s Congress, the Supreme People’s Court emphasized the trade-off between investor protection and capital formation. The Reply mentioned: “According to the provisions of Article 69 and Article 173 of the Securities Law, any person who plays a role in information disclosure documents shall bear legal liability for false information disclosure, and all tortfeasors shall bear joint and several liability… We believe… if the civil liability system leans too heavily toward protecting investors, the harsh liability system might bring a chilling effect on accountants, external directors, and independent directors, hindering capital formation. Therefore, among the defendants in a securities tort, fair liability sharing should reflect the legal policies of performing respective duties, distinguishing internal and external subjects, matching punishment to fault, and matching responsibility to assets, to achieve fairness in liability sharing among tortfeasors. In institutional design, we must adhere to the principle of consistency between liability and the nature of conduct and the degree of fault (balancing leniency and severity) to prevent overly harsh or severe outcomes, and provide for defense matters for exemption.”

Article 85 of the Securities Law (2019 Revision) provides: “Where an information disclosure obligor fails to disclose information in accordance with regulations, or the disclosed securities issuance documents, periodic reports, temporary reports, and other information disclosure materials contain false records, misleading statements, or major omissions, causing losses to investors in securities transactions, the information disclosure obligor shall bear compensation liability; directors and other personnel of the issuer shall bear joint and several compensation liability with the issuer, unless they can prove that they are not at fault.”

In July 2020, the Supreme People’s Court issued the Minutes of the National Courts’ Symposium on the Trial of Bond Dispute Cases. Article 27 explicitly stipulates that directors can be exempted if they have no fault: “Where the controlling shareholders, actual controllers, directors, supervisors, senior executives, or persons performing equivalent duties of the issuer produce or issue information disclosure documents containing false records, misleading statements, or major omissions that are sufficient to affect investors’ judgment on the issuer’s solvency, they shall bear joint and several compensation liability with the issuer for the losses of bondholders and bond investors, unless they can prove that they are not at fault.” Article 28 further clarifies the methods and standards for fault determination.

In January 2022, the Supreme People’s Court issued the Several Provisions on Hearing Civil Compensation Cases of Misrepresentations in the Securities Market, which further clarifies the standards for determining the fault of independent directors, namely: where independent directors can prove one of the circumstances in Paragraph 1 of Article 16 of the Provisions, the people’s court shall determine that they are not at fault.

As can be seen from the above provisions, regarding securities misrepresentation liability disputes, the existing system stipulates the circumstances under which independent directors should bear joint and several compensation liability, but independent directors can be exempted if they have no fault.

(B) The impact of the Opinions on the determination of independent directors’ civil liability

The implementation of the Opinions is likely to have the following impacts on the determination of listed company independent directors’ civil liability in securities misrepresentation liability dispute cases.

First, from the perspective of legal application, the rule system based on which independent directors’ liability is determined will be more complete.

The seventh measure of the Opinions requires sounding the responsibility constraint mechanism for independent directors, promoting the revision of relevant laws and regulations, and building a complete responsibility system for independent directors. In fact, as mentioned above, the ongoing revision of the Company Law and its supporting rules has already responded to the requirements of this reform. Therefore, in terms of legal application, the rule system based on which independent directors’ liability is determined is expected to be further improved.

Second, in terms of liability determination, the pursuit of accountability for independent directors who fail to perform duties diligently may be intensified.

The seventh reform measure of the Opinions has explicitly pointed out the need to adhere to “zero tolerance” in cracking down on securities violations, increasing accountability for independent directors who fail to perform duties diligently. Where independent directors fail to perform statutory duties diligently, thereby harming the legitimate rights and interests of the company or shareholders, accountability shall be strictly pursued in accordance with the law. Therefore, it cannot be ruled out that at the judicial level, the intensity of pursuing accountability for independent directors’ non-performance or diligent-less performance of duties may increase.

Finally, in judicial practice, more attention will likely be paid to the principle of matching powers and responsibilities, seeking proportional liability and precise accountability.

On one hand, the Opinions explicitly propose that, in accordance with the principle of matching powers, responsibilities, and benefits, and taking into account both the director status and external identity of independent directors, clarify that independent directors and non-independent directors bear joint but distinct legal liabilities. On the basis of directors’ statutory liability for board resolutions and information disclosure, promote the targeted establishment of determination standards for independent directors’ civil liability, reflecting proportional punishment and precise accountability. On the other hand, the Opinions also explicitly stipulate that, combining independent directors’ subjective fault, their role in the decision-making process, the channels through which they obtain information, and the measures they take to verify information, rationally determine the form, proportion, and amount of civil compensation liability borne by independent directors, to achieve organic unity of legal and social effects. Therefore, in future judicial practice, with the implementation of the Opinions, the determination of independent directors’ liability will become more precise.

V. Conclusion and Outlook

Against the backdrop of the comprehensive implementation of the registration-based IPO system in China’s capital markets, and especially under the realistic background of heated discussions on independent directors’ liability triggered by the Kangmei Pharmaceutical case, the issuance of the Opinions on the Reform of the Independent Director System of Listed Companies holds milestone significance. It is expected that the above reform measures will effectively promote the standardized operation of listed companies, protect the legitimate rights and interests of minority investors, and drive the capital markets to go further along the path of high-quality development.