The casings were made with an industrial gelatin that contained high amounts of the metal chromium, the official China Daily newspaper said, adding the group was detained at a workshop last month.
Police are still investigating where the casings were sold. State media did not report any cases of illness caused by the toxic shells.
The group was led by a 56-year-old man named Pan Bohai, the China Daily said. Pan, who had previously worked at a now-bankrupt pharmaceutical firm that also produced empty capsules, gathered 10 friends to start his own business, the paper said.
The company had been producing the capsules since February, the paper said.
Chinese consumers have become increasingly wary about fake food and pharmaceuticals in the wake of a series of scandals, from re-used “gutter oil” in cooking to cadmium-tainted rice.
The latest scandal mirrors a 2012 incident in which authorities launched investigations into 43 companies for producing chromium-tainted capsules, according to state media reports.
Capsule makers sometimes cut corners by using cheaper industrial gelatin, made with unsafe amounts of the metal chromium, instead of the pricier gelatin made for human consumption.
Authorities last week seized more than 30,000 tonnes of chicken feet, common on restaurant menus, after it was discovered excess hydrogen peroxide was added to the meat. Police detained 38 people involved in the case after raiding nine supplier factories.
In 2008, infant formula tainted by the industrial chemical melamine caused the illness of hundreds of thousands of infants and killed at least six.-Reuters