Recently, five independent directors of Kangmei Pharmaceutical were sentenced to 369 million yuan of joint and several civil liability by the Guangzhou Intermediate Court of Justice, triggering widespread social repercussions. The mainstream view seems to be that vase directors deserve their crimes, and severe punishment is conducive to making an example of others; "Heavenly priced compensation is not enough to regret, and even to celebrate.". The viewpoint of this article is that under the current system design framework, requiring independent directors to bear sky-high civil compensation may be detrimental to the construction of the independent director system of listed companies in China. In subsequent civil compensation cases, the CSI Small and Medium Investors Service Center may avoid or prudently handle the group of independent directors who are prosecuted. The reasons are as follows.

First, it is not easy to detect financial fraud, especially when the counterfeiter attempts to deliberately conceal it.

For example, in the case of the Muddy Water Shorting of Ruixing Coffee, in order to detect financial fraud and thus short, Muddy Water Company hired 92 full-time and 1418 part-time personnel to video 24/7 in store samples in 53 cities in China, with a total recording time of 11260 hours. The intensity of such due diligence is beyond imagination, even for intermediary agencies or investigation agencies, let alone external directors who receive tens of thousands of yuan in compensation. Even though independent directors have relatively broad legal rights, such as the right to independently hire external auditors and consultants, the above rights cannot be exercised without the company's consent, and the author is not aware of any cases in which they have been exercised.

Secondly, everything has a cost.

Rational economic people usually need to consider inputs and outputs when making decisions. In the case of large investment, implementation can only be possible if the incentive mechanism is sufficiently large. The reason why muddy water companies invest such high costs is precisely because the short selling mechanism can bring huge benefits to them. However, for independent directors, there is insufficient motivation to participate in fraud and detect fraud. The subsidies for independent directors are fixed and not linked to the performance of the company or the stock market, so they lack the motivation to cheat. But vice versa, there is no incentive mechanism in the current system design to detect fraud. The position of independent director itself has some positive incentives, such as expanding social networking, strengthening contacts with the industry, improving social awareness, and obtaining additional subsidy income. However, these positive incentives are limited. When reverse incentives reach a certain level, that is, if they are too lazy to detect fraud and suffer significant risks, they will inevitably compare relevant benefits. Risk averse independent boards of directors make a decision to resign, rather than actively detect fraud, because detecting fraud requires more effort, but does not bring greater benefits, and cannot offset risks.

Thirdly, some research results indicate that, contrary to public perception, the sky-high compensation liability of independent directors does not conform to international practice.

Professor Xing Huiqiang from the School of Law of the Central University of Finance and Economics deeply analyzed the administrative and civil liabilities borne by independent directors of listed companies under the current legal system in the United States in his widely circulated article "How to Investigate the Legal Liability of Independent Directors in the United States". Although the data investigated in this paper has a certain time lag, it still has considerable reference significance. The article points out that, "Statistics from the United States Securities Regulatory Commission (SEC) indicate that during the five years from August 1997 to July 2002, the SEC conducted 227 law enforcement investigations and filed 515 lawsuits, involving 869 parties, 164 of whom were enterprises and 705 individuals. Of these 705 individuals, none were independent directors." After the adoption, the leaders of the SEC have repeatedly threatened to take law enforcement actions against independent directors who have not fulfilled their duty of care to ensure the authenticity of information disclosure. "However," the thunder is loud and the rain is small, "and the SEC focuses on verbal threats, with few real lawsuits being filed.". "Some scholars have made statistics on securities litigation and corporate litigation since the 1980s, and found that most securities litigation cases have been settled through settlement. About 20 cases have actually entered the adjudication phase, with only a few remaining cases where independent directors have become defendants. In the end, only one case has judged that independent directors are responsible. However, this has not led to independent directors paying their own expenses. In the litigation of listed companies in the same period, independent directors have been the sole defendants." "The number of cases prosecuted for breach of fiduciary obligations is similar to that of securities litigation, with only four cases in which the plaintiff won over independent directors, but only one independent director paid for it.". "For many directors, the risk of loss is primarily reputation rather than money." American scholars believe that "this" low reward low risk "mechanism for external directors is appropriate, and neither remuneration nor punishment should be increased." The lack of a system where external directors assume responsibility at their own expense has constituted the best deterrent. ". "Even some American scholars believe that" implementing almost zero liability risk to external directors in multiple countries for decades means that it may be a bad policy to let external directors take greater risks. "

Fourth, skyrocketing compensation may have a cold cicada effect. With other supporting systems unchanged, it is only a reverse incentive to increase liability, which may lead to the expulsion of good coins by bad ones.

As mentioned above, some risk averse independent directors may first choose to vote with their feet. The recent turnover trend can be noted. Many listed companies have also announced that due to the resignation of independent directors, the number of independent directors in the company will be lower than the legal requirements, and the company will actively seek qualified replacements. After the labor shortage caused by the turnover tide, either listed companies should increase the treatment of independent directors or purchase additional insurance for independent directors to hedge risks; Either lower the threshold and allow candidates with higher risk tolerance to join. As long as the mandatory requirements of the China Securities Regulatory Commission for the establishment of independent directors remain unchanged, the aforementioned increased costs can actually only be paid for by listed companies and ultimately by investors.

Fifth, the design of the independent director system itself may not even be aimed at detecting financial fraud.

The obligations imposed on independent directors by the Guiding Opinions on the Establishment of an Independent Director System in Listed Companies and the Governance Standards for Listed Companies mainly focus on the protection of the legitimate rights and interests of small and medium-sized shareholders and the independent performance of their duties. Moreover, independent directors are not all financial experts, and according to current regulatory requirements, only at least one accounting professional is required. In addition, independent directors of listed companies are nominated internally rather than appointed externally, so there must be some social overlap with major shareholders and company executives.

The author believes that from the perspective of institutional design, independent directors are similar to what Chairman Mao called "mixing sand". As independent directors are part-time employees, although they receive subsidies, without such subsidies, they will not have any impact on their lives. Therefore, they are bound to be more detached than internal directors. In the case of decentralized ownership, the importance of independent directors is more prominent. The creation of independent directors is intended to alleviate insider control, rather than assume the heavy responsibility of "watchdog". As mentioned earlier, Western countries pursue a "low reward low risk" operating mechanism for independent directors. The essence of this mechanism is: because it is more independent in terms of economy, position, and equity, it will not have too deep interest disputes with listed companies compared to internal directors; Therefore, independent directors should be allowed to bear legal liability risks that match their relatively low returns. The fact that independent directors are required to bear joint and several liabilities only because they have signed the relevant disclosure documents is actually caused by a thinking that form is more important than substance.

Sixth, independent directors also lack solvency.

As an ordinary person, faced with hundreds of millions of yuan of compensation, there is no doubt that it is impossible to pay. Unlike independent directors, other responsible entities are either commercial entities (including underwriters, accounting firms, law firms, rating agencies, and analysis institutions), or actual controllers, major shareholders, and senior managers who obtain higher returns from fraud, with higher solvency. In a situation where China has not yet established a complete personal bankruptcy system, allowing independent directors to bear such a huge amount of joint and several civil compensation for misrepresentation by listed companies is sufficient to cause their ruin. Considering its dual status as an academic, scientific research, and professional, it seems more prudent to seek compensation at sky-high prices. In fact, administrative penalties, including but not limited to confiscation of tenure gains, disqualification, and social exposure, effectively declare "social death" for groups that value high reputation.

To sum up, we believe that the skyrocketing civil claims against independent directors should be deferred. We should also stand at the height of the overall system construction of corporate governance of listed companies, seek truth from facts, and not blame the whole. In subsequent civil compensation cases, the CSI Small and Medium Investors Service Center may avoid or prudently handle suing the special group of independent directors.

However, it should still be pointed out that according to current laws and regulations, there is a considerable legal basis for requiring independent directors to bear civil liability. Therefore, when facing professional risks in the new situation for the independent director group, we suggest that: before taking office, necessary due diligence should be conducted on the company's situation to avoid high-risk companies; During my tenure, I am careful to verify the resolution of bills and consult with other financial and legal personnel when necessary; And may require the company to purchase director's liability insurance; And retain relevant evidence to prove that they did not participate and were unable to know about financial fraud; After the event, professional lawyers were hired to actively defend and strive to minimize losses.

(This article is translated by software translator for reference only.)