REFLECTIONS ON INVESTOR PROTECTION AND CAPITAL MARKET DEVELOPMENT IN TAIWAN
Professor Mak Yuen Teen [1]
Last month, I visited Taiwan as part of a study that the Centre for Investor Protection at the NUS Business School is undertaking on investor protection around the world. The study will cover selected Asian and Western markets, with the objective of identifying investor protection mechanisms that Singapore could consider adopting to strengthen investor protection and rebuild investor confidence.
I was fortunate to be able to meet with board members of the Taiwan Corporate Governance Association (TCGA); senior officials and staff from various departments in Taiwan Stock Exchange (TWSE) and Taipei Exchange (TPEx), including listing examination, listing supervision, strategy and international relations, domestic listing, foreign listing, and corporate governance; and the Chairman and legal affairs department staff from the Securities and Futures Investor Protection Centre (SFIPC).
I wished I had picked a better week as Typhoon Gaemi struck when I was there and all offices and schools were closed for two days. But perhaps it is a reminder that strong governance and investor protection can help capital markets weather any storm.
In this commentary, I share some of the initial reflections from the visit. A detailed report on the Taiwanese market will be included as part of a full report, which I hope will be published next year. I will be working with academics and practitioners from here and around the world on in-depth studies of various markets.
Why Taiwan?
I picked Taiwan as the first market to visit because its SFIPC has developed a formidable reputation over a long period for taking class actions and other actions against those who have harmed investors in the capital market. In fact, on my last visit to Taiwan a few years ago as a speaker at the TCGA Corporate Governance Summit, one of the fellow speakers, the late Justice Randy Holland, the longest-serving Delaware Supreme Court Judge, told me that SFIPC could have become a tad too aggressive. Coming from the U.S. where class actions are almost as popular as fast food, that was a surprise to me.
Taiwan is not the only Asian market that allows class actions. Others such as China and Japan have that too. But as I will share more later, the SFIPC is arguably the only one of its kind in the world in terms of the range of actions and activities it undertakes to protect investors, its independence, and its resourcing.
Another reason for picking Taiwan is that in the latest 2023 Asian Corporate Governance Association (ACGA) ranking, it has caught up with Singapore to be placed joint third.
Investor protection and capital market development
What was interesting in my conversations with the various stakeholders is their recognition of the importance of investor protection in developing a vibrant and sustainable capital market, and the important role that the SFIPC has played in this regard.
I asked whether there was a concern that strong investor protection will discourage companies from listing and individuals from serving as directors – two common pushbacks I hear in Singapore whenever there are proposals to strengthen corporate governance and investor protection. The answers were unanimously no. The directors and stock exchange officials I spoke to clearly felt that investor protection is fundamental to a robust capital market for Taiwan. Several mentioned that the high retail investor participation in the Taiwanese stock market, with retail investors holding 60% of total shares in listed issuers, meant it was imperative that retail investors should be protected.
To my question on how Taiwan had the political will to set up the SFIPC more than 20 years ago through legislation signed by the then President, given that it would likely face resistance from the business community, one remarked that retail investors are voters and the government has to give due regard to their interests and concerns.
“Multi-layer equity market”
Taiwan has what is described as a “multi-layer equity market”. Clearly, much thought has gone into its development and evolution, with different boards complementing each other in supporting growth, fund-raising and trading for different types of companies and those at different stages of development.
There are two centralised exchanges, the Taiwan Stock Exchange (TWSE) and Taipei Exchange (TPEx), each with its own Main Board. Larger companies tend to list on the TWSE while small and mid-cap companies tend to list on TPEx.
Taiwanese law does not allow the stock exchanges to be listed. TWSE was founded in 1962 as a corporate and its shareholders include security firms, banks, firms and a small number of natural person shareholders. As of July 31, 2021, the number of shareholders was 1,308, with 73 legal person shareholders holding 98.46% of the shares. One individual mentioned that the regulator, the Financial Supervisory Commission, frowns on the payment of excessive dividends to shareholders in TWSE. This sounds like a social enterprise.
In contrast, TPEx is a public welfare legal person organisation, a non-profit organisation. Hence, there are no shareholders.
Main Boards
As of June 2024, TWSE’s Main Board had 1,018 listed issuers. The total market capitalisation of these listed issuers was NT$73.398 trillion (US$2.245 trillion). There are few secondary listings, with only 10, in the form of Taiwan Depository Receipts (TDRs). In the case of TPEx, there were 825 listed issuers as of June 2024, with a total market capitalisation of NT$6,804 billion (US$208.14 billion).
There is excellent liquidity and valuations for both the Main Boards of TWSE and TPEx. For the period from January to May 2024, turnover rate in terms of trading value for TWSE and TPEx was 60.14% and 149.37% respectively. In comparison, it was 83.02% for Korea, 51.18% for Tokyo, 46.91% for New York, 48.67% for Nasdaq, 26.24% for Hong Kong, with Singapore at a distant 15.6%. As of May 2024, P/E ratio for TPEx Main Board stocks averaged 30.05 for TPEx, 22.42 for TWSE, 25.74 for New York, 19.9 for Tokyo, 18.52 for Nasdaq, 11.67 for Singapore and 11.47 for Hong Kong.
The listing process on the Main Boards of the two exchanges is similar in terms of each having a review process of about 6 to 7 weeks and another two months in preparation for listing. The exchanges conduct formal document reviews, and in the case of TPEx, it may conduct on-site inspections on a case-by-case basis. They are then reviewed by the Listing Review Committee of the respective exchange, and ratified (TPEx) and approved (TWSE) by the exchange’s board of directors.
Other boards
In 2021, TWSE founded the Taiwan Innovation Board (TIB). This is a separate board aimed at innovative companies, and not a board that is a prelude to listing on the Main Board. Small companies with revenue, biotech companies without revenue and large cap companies without revenue are eligible to apply for listing on the TIB. Earlier in 2013, TWSE also founded the “Gofunding Zone”.
In the case of TPEx, it established the Emerging Stock Board (ESB), an over-the-counter (OTC) market, in 2002 for trading of shares of non-listed companies. There were 324 stocks on the ESB as of June 2024. The ESB is a preliminary market for IPOs, with stocks having to be traded on the ESB for at least six months before they can apply for listing on the Main Board. They were somewhat perplexed when I asked whether companies can move from the Main Board back to the ESB, like companies on the Main Board of the SGX moving back to Catalist. The answer was a clear “no”. For foreign listings, there is an alternative route of being advised by securities firms for at least six months, without having to be traded on ESB.
For issuers, the ESB helps them get used to rules and regulations, enhance their governance and financial structure, gain market awareness, discover price and provide liquidity, and makes it easier to enter the capital market, with no thresholds for capital size, profitability and years of existence. For investors, it provides a legal trading platform for trading shares of non-listed companies, improved transparency, and an earlier investment opportunity for retail investors.
In 2014, TPEx started the Go Incubation Board (GIB) and in 2015, it introduced equity-based crowdfunding. I found the GIB to be particularly fascinating as its purpose, as its name suggests, is to help incubate companies which may then list on the ESB. TPEx uses the term “Integrative Counselling Mechanism” to describe the role of GIB. There is no trading function for the GIB, although companies on it may raise funds. There are 105 companies currently on the GIB. The World Bank has called TPEx “one of the most experienced exchanges incubating SMEs”.
Regulatory approach
Both exchanges operate on a combination of disclosure-based and merit-based approach when it comes to approval of listings.
It would appear that the stock exchanges operate primarily to help companies, especially domestic companies, to grow and raise capital. Although the TWSE has a foreign listing department, I learnt that most foreign listings are actually Taiwanese companies that are incorporated overseas, with truly foreign companies listed on the TWSE in the low single digits. In the case of TPEx, foreign companies comprise of just 30 out of 825 listed issuers on the Mainboard and just 3 out of 324 listings on the ESB.
As mentioned earlier, there are few secondary listings in Taiwan. One interesting rule for secondary listings is that if it wants to delist its TDRs, the controlling shareholders will have to buy out the holders of the TDRs at the higher of the share price and net asset value. This rule was felt to be less important for primary listings as there are other avenues that can be used to deal with unfair delistings in the case of primary listings. In any case, it appears that delistings, while they do happen, are not seen to be an issue in Taiwan at this juncture.
The fact that the law prohibits the exchanges from being listed and the TPEx being set up as a not-for-profit entity arguably means that the stock exchanges are not focused on making profits. While the exchanges are very focused on getting more companies to grow and list, it does not seem to be at the expense of lowering admission and listing standards. I asked if multi-vote shares (MVS) are allowed, especially given the large number of tech companies listed there and the common argument that such companies prefer MVS. The answer was a clear “no” – one-share-one-vote is fundamental. There are no listings of Special Purpose Acquisition Companies (SPACs) either.
The exchanges are quite involved in reviewing listings, with ratification/approval required by the board of directors of the exchange.
While the statutory regulator has delegated regulatory powers to the stock exchanges – and the exchanges do not have separate regulatory subsidiaries – the stock exchanges’ powers of investigation are quite extensive. They can ask for board meeting minutes and documents to conduct their investigations. Given that they are not driven by commercial goals, the conflicts of interest inherent in a listed exchange which may lead them to compromise their regulatory roles in pursuit of commercial goals are not present. Further, conflicts are managed by limiting the enforcement function of the exchanges.
The exchanges contribute to the funding of the SFIPC and collaborate with the latter, including in relation to SFIPC actions against issuers, directors and others.
SFIPC: a unique investor protection body
The last leg of my trip, pushed back to the morning of the day of my departure because of Typhoon Gaemi, was with the SFIPC. It did not disappoint.
On July 17, 2002, the President of Taiwan promulgated the Securities Investors and Futures Traders Protection Act, which became effective on January 1, 2003. The SFIPC was set up under the Act to provide consultation on the trading of securities and futures as regulated by related laws and regulations; mediation of disputes arising from the trading of securities and futures; and litigation services on behalf of investors. In addition, it manages a protection fund to compensate investors if a securities or commodities firm is unable to do so due to financial difficulties. In terms of legal structure, the SFIPC is a foundation under Taiwan’s legal system.
The investor protection fund was NT$1.031 billion (US$31.54 million) when the SFIPC was established. The donors included TWSE and TPEx and some other organisations such as the securities firms. Moreover, TWSE, TPEx, securities and futures firms are required to contribute to the protection fund each month. The protection fund currently stands at around NT$8 billion (US$244.73 million). The amount of contribution is linked to trading on the markets.
While there are no specific prohibitions against SFIPC receiving any form of funding from listed issuers, it does not accept such funding in order to avoid conflicts.
SFIPC was set up given the growing retail participation and some scandals at that time. The government believed that small investors may face difficulties in protecting themselves.
At that time, a number of markets already had investor protection funds and Taiwan used them as a model. However, there was no model to follow when it came to the setting up of the SFIPC. SFIPC started with taking class actions but over the years, its powers have been expanded. Today, the SFIPC is unique in the world in terms of the range of things it can do. Some other markets have bodies that can take class actions, but not the full suite of things that SFIPC does today, which include class actions/arbitration, disgorgements, derivative suits, discharge suits, and other actions aimed at protecting shareholders’ rights and interests.
Legal actions are taken by the SFIPC’s Legal Affairs Department, which has nearly 20 lawyers. They do not use external legal counsels.
The SFIPC is also very transparent. Its website and annual reports provide extensive information in terms of its structure, activities, specific actions and much more.
Class actions/arbitration
Most class action cases by SFIPC (about 90%) are initiated based on enforcement actions by prosecutors relating to four major kinds of crimes: making false financial statements, producing false prospectuses, influencing share prices illegally, and insider trading.
In about 10% of cases, SFIPC has also launched class action without prosecutors taking action, usually based on cases garnering public attention. Class actions may be filed for any securities investment or futures trading fraud involving 20 or more victims.
Information from enforcement actions by statutory regulators and information from the stock exchanges are important sources of evidence used to initiate such actions. There are also some cases where investors sue on their own by engaging their own lawyers – or join in a lawsuit on their own after SFIPC has started action.
Contingency-fee based class actions are allowed with some exceptions and are permitted for securities-related class actions. However, lawyers cannot solicit for investors to sue.
There is a cap on legal costs if SFIPC loses. SFIPC also pays lower filing fees for court actions.
As of the end of June 2024, the courts have rendered decisions in 195 class action suits launched by SFIPC, with SFIPC being successful in 112 cases, a success rate of 57.43%.
Disgorgements
I found disgorgements particularly interesting especially as it is covered by securities law in Taiwan. However, I learnt that it is based on the short-swing profit rule in the U.S., which I must confess I did not know exist. Under this rule, insiders are required to forfeit any trading profit earned from a combined purchase and sale that occurs within a six-month period. This is based on the presumption that insiders have non-public information. I learnt that disgorgement is also practised in other markets like Japan.
In the case of Taiwan, when SFIPC receives information from the stock exchanges of such situations involving a director, supervisor, managerial officer, or shareholder holding more than 10% percent of the company’s shares, they will write to companies to ask them to disgorge profits from these insiders back to the company. If the company does not do so, SFIPC has the right to claim for disgorgement on behalf of the company.
Derivative suits and discharge suits
These are generally initiated from complaints or where there are public revelations about possible breaches of director duties. Discharge suits are used to remove directors from their positions.
As of the end of June 2024, the courts have rendered decisions in 53 derivative suits launched by SFIPC, with SFIPC prevailing in 28 cases, or a success rate of 52.83%. In the case of discharge suits, the courts have rendered decisions in 59 cases, with SFIPC being successful in 40 cases, a success rate of 67.79%.
If a director or a supervisor is sued by SFIPC, they may be dismissed by the court. They would then not be able to join new boards within three years from the date that the judgment or ruling becomes final and this is unappealable. They are also not able to stay in their current boards.
Shareholders’ rights and interests
SFPIC buys 100 shares in each listed company. This gives it the standing of a shareholder. Each year, SFIPC sends hundreds of letters to listed issuers, raising concerns on a range of issues, such as excessive compensation for directors and supervisors, disproportionate dividend policy, and guarantees or excessive loans to others.
It writes to companies, submit proposals, and attends AGMs to exert pressure on companies. But they do not result in lawsuits. There was a view that it does change behaviour in some cases. For excessive compensation, SFIPC’s actions are based on companies making losses but executives getting high remuneration, and benchmarking remuneration against other companies.
Is the SFIPC too aggressive?
I had earlier mentioned that the late Justice Randy Holland had mentioned to me that the SFIPC may have been too aggressive in pursuing actions. SFIPC acknowledged this, saying that there was some pushback in that the law holds all directors accountable and all directors, including independent directors, are assumed to be culpable unless they can prove otherwise. Further, actions were initiated when companies were in financial trouble even though it may be the result of business decisions, not wrongdoing. To address this, SFIPC has introduced a mechanism whereby a panel of advisors will review and allow directors to explain what they have done (based on a detailed set of criteria/actions). Mindful of how such panels may be conflicted, I asked about their composition. No current practising lawyers are on the panels due to concerns about conflicts. They are mostly scholars and reputable directors, such as those on the board of the TCGA. It is yet another illustration of how mindful the SFIPC is about protecting its independence and avoiding conflicts.
Conclusion
What I admire about Taiwan is that it did not do what many other markets (but by no means most markets) did and list their stock exchanges. They created ownership or legal structures that curtailed the incentive to chase profits at the expense of long-term market development, ensured that the exchanges were focused on helping local companies grow and raise capital through a suite of different boards, and put investor protection as a centrepiece of its corporate governance ecosystem,
While there may be contextual differences between Singapore and Taiwan, I think Singapore can learn a lot from Taiwan and other markets which are placing strong emphasis on investor protection. Further research in other markets may identify other investor protection measures that Singapore can consider adopting.
[1] The author is Director of the Centre for Investor Protection at NUS Business School. This article is based a study visit to Taiwan in July 2024 by the author to understand its investor protection and capital market development. The information in this article should be viewed as preliminary, with a detailed report to come following additional research. The author would like to thank Yeh Pinyi, an MBA student in Taiwan, who provided administrative and research support during the visit; his good friend Dr Vincent Chen, CFO of Chunghwa Telecoms, who helped set up the meetings; board members of the Taiwan Corporate Governance Association, and officials from the Taiwan Stock Exchange, Taipei Exchange and the Securities and Futures Investor Protection Centre for their hospitality and openness in answering his questions and sharing information. The article reflects the author’s personal views and interpretations. Any errors in the article are the author’s sole responsibility.