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Earth Research | Key Points of Judicial Decisions in Securities Market Fraud Cases (Part 2)

Publish Time:

Jul 24,2024

Source:

Authors: Zhao Jingyu & Yu Yongxin

Introduction

FOREWORD

Since Since January 22, 2022, Article 4 of the "Several Provisions of the Supreme People's Court on Hearing Civil Compensation Cases for False Statements in the Securities Market" (hereinafter referred to as the "Several Provisions"), which came into effect in China, has made a clear legal determination of such acts.

Legal Articles and Case Analysis of False Statements in the Securities Market

False statements are acts that violate securities laws and regulations. China's current "Securities Law" has clear prohibitions and corresponding legal provisions. These legal provisions have been fully applied and verified in judicial practice, showing China's serious attitude towards false statement behaviors. The following is a detailed explanation of the main legal provisions in the "Securities Law" and related judicial practice cases.

(1) Article 5 of the Securities Law stipulates: The issuance and trading of securities must comply with laws and administrative regulations; fraudulent acts, insider trading, and market manipulation are prohibited.

Judicial Practice Cases: Guo Xiulan v. Everbright Securities Co., Ltd., Shanghai Stock Exchange, and China Financial Futures Exchange Insider Trading Liability Dispute Case (Publicly Reported Case).

On August 16, 2013, Everbright Securities made a massive purchase of stocks due to a system error. Subsequently, the company's executives decided to hedge risks by shorting stock index futures and selling ETFs. During this process, the company secretary of Everbright Securities denied relevant rumors in the market without knowing the truth. Afterwards, Everbright Securities engaged in insider trading and profited, and was identified by the China Securities Regulatory Commission as insider trading and was punished. Some investors suffered losses and filed lawsuits. The court finally ruled that Everbright Securities should bear civil compensation liability. At the same time, an executive involved in this incident appealed against the penalty decision, but the court ultimately upheld the original penalty decision.

Points of Contention:

Whether the trading behavior of the defendant Everbright Securities Company on August 16, 2013 constituted insider trading; if it constituted insider trading, whether it should bear tort liability for the losses of the plaintiff Guo Xiulan, and how to determine the scope of compensation liability;
Whether the defendant SSE and CFFEX failed to properly perform their corresponding supervisory duties, whether there was any corresponding fault, and whether they should bear civil compensation liability for the plaintiff's losses.

Analysis of Points of Contention:

Based on the previous judgments of the China Securities Regulatory Commission and the Beijing First Intermediate People's Court, the court determined that the behavior of Everbright Securities Company on August 16, 2013 constituted insider trading.

Regarding the defense of Everbright Securities Company, the court believed that its wrong order trading in the morning and hedging trading in the afternoon were directly related, and the media reports on the wrong order trading did not clearly state the authenticity and reasons for the trading, so it could not be considered that the insider information had been disclosed.

Regarding the losses of the plaintiff Guo Xiulan, the court inferred the causal relationship between the insider trading behavior and the plaintiff's losses based on the efficient market theory.

Specifically in this case, the court believed that the plaintiff's trading losses in the afternoon were directly related to the insider trading behavior of Everbright Securities Company, so it ruled that Everbright Securities Company should compensate the plaintiff for the trading losses in the afternoon, totaling 11,280 yuan. The plaintiff accused the SSE and CFFEX of inaction in supervision and misleading the market.

However, the court believed that the plaintiff's accusations lacked evidence to support them, and the actions of the SSE and CFFEX in the abnormal trading incident of Everbright Securities Company did not constitute inaction in supervision or misleading the market.

The court emphasized that the SSE and CFFEX, as self-regulatory organizations in the securities and futures markets, are responsible for providing guarantees for transactions, releasing information, and taking necessary regulatory measures under specific conditions.

In this case, the actions of the SSE and CFFEX were in accordance with their regulatory responsibilities, and their independently determined regulatory actions should not bear civil legal liability. Therefore, the court rejected the plaintiff's accusations against the SSE and CFFEX.

(2) Article 29 of the Securities Law stipulates: Securities companies underwriting securities shall verify the authenticity, accuracy, and completeness of the public offering prospectus.

If any false records, misleading statements, or material omissions are found, sales activities shall not be carried out; if sales have already been carried out, sales activities must be stopped immediately, and corrective measures must be taken.

Securities companies underwriting securities shall not engage in the following acts:

Conducting false or misleading advertising or other promotional activities to investors;
Soliciting underwriting business through unfair competition;
Other acts that violate the provisions of securities underwriting business.

If a securities company engages in the acts listed in the preceding paragraph and causes losses to other securities underwriting institutions or investors, it shall bear compensation liability in accordance with the law.

(3) Article 78 of the Securities Law stipulates: Issuers and other information disclosure obligors stipulated by laws, administrative regulations, and the State Council's securities regulatory agency shall timely fulfill their information disclosure obligations in accordance with the law.

The information disclosed by information disclosure obligors shall be true, accurate, complete, concise, clear, and easy to understand, and shall not contain any false records, misleading statements, or material omissions. For securities that are publicly issued and traded both domestically and internationally, the information disclosure obligors shall disclose the information disclosed overseas domestically at the same time.

Judicial Practice Cases:

One of the top ten typical cases of investor protection released by the Beijing Financial Court: Exemplary judgment of securities statement liability disputes + diversified resolution mechanism for parallel cases—Wang Mou v. A Joint Stock Limited Company Securities False Statement Liability Dispute Case.

In the "Acquisition Announcement" issued by a joint-stock limited company on February 11, 2015, the equity of a company it planned to acquire and the corresponding energy reserves were incorrectly recorded as more than twice the actual reserves, and the market value of the corresponding energy was also far higher than the actual value. On the day the "Acquisition Announcement" was issued, the company's stock price rose, and the trading volume increased significantly compared to the previous few trading days. The annual reports of the joint-stock company from 2015 to 2018 all contained inflated assets. On November 11, 2021, the Beijing Regulatory Bureau of the China Securities Regulatory Commission issued an "Administrative Penalty Decision" that determined that the joint-stock limited company had inflated the actual energy holdings, corresponding market value, and annual report capital increase. Wang Mou purchased the company's stocks after the implementation of the above false acts and before their disclosure, and because of the above false statement acts, the value of the company's stocks he held depreciated, so he requested the joint-stock limited company to compensate for his investment losses.

Court Ruling:

After trial, the court held that the "Acquisition Announcement" issued by the joint-stock limited company incorrectly recorded the planned energy allocation resources as twice the actual situation, constituting a false statement. This error led to false records in the company's annual reports from 2015 to 2018, seriously misleading investors.

The court, considering various risk factors, ruled that a certain joint-stock company should compensate investor Wang's actual losses, but rejected the part of his claim that was excessively high.

The "Acquisition Announcement" had a significant impact on the assets, rights, and operating results of a certain joint-stock company, and after the announcement was released, the company's stock price rose and trading volume increased significantly, meeting the criteria for materiality.

Key points of this case:

Article 78 of the "Securities Law of the People's Republic of China" clearly stipulates the information disclosure obligations of securities issuers. Listed companies issuing securities shall truthfully disclose material information affecting their business in accordance with the law, protecting investors' right to know. This is the foundation for the healthy development of the securities market. If a listed company makes false statements, it will cause losses to investors' property rights and lead to lawsuits related to securities misrepresentation.

People's courts properly hearing securities dispute cases can further regulate and guide securities market participants to improve disclosure mechanisms and protect investors' legitimate rights and interests in securities market activities in accordance with the law.

(IV) Article 85 of the "Securities Law" stipulates: If an information disclosure obligor fails to disclose information as required, or if the announced securities issuance documents, periodic reports, interim 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 liability for compensation; the controlling shareholder, actual controller, directors, supervisors, senior management personnel, and other directly responsible persons of the issuer, as well as the sponsor, underwriting securities company, and their directly responsible persons, shall bear joint and several liability with the issuer, unless they can prove that they are not at fault.

(V) Article 163 of the "Securities Law" stipulates: Securities service institutions preparing and issuing audit reports and other attestation reports, asset appraisal reports, financial advisory reports, credit rating reports, or legal opinions for securities issuance, listing, trading, and other securities business activities shall exercise due diligence and verify and confirm the authenticity, accuracy, and completeness of the content of the documents and materials on which they rely.

If the documents they prepare or issue contain false records, misleading statements, or major omissions, causing losses to others, they shall bear joint and several liability with the client, unless they can prove that they are not at fault.

Judicial Practice Cases:

Kinga Technology Co., Ltd. (hereinafter referred to as "Kinga Technology") is an A-share listed company. Zhou Moumou, a third party to the case, is the chairman of Kinga Technology. Plaintiff Mu Mou is an ordinary investor in the secondary market. Defendant Chen Moumou is an independent director of Kinga Technology. Defendant Lixin Certified Public Accountants (Special General Partnership) (hereinafter referred to as Lixin Firm) is the audit unit for Kinga Technology's 2014 annual financial statements. As determined by the China Securities Regulatory Commission (CSRC), Kinga Technology inflated profits by fabricating customers, forging contracts, forging bank documents, forging material product receipt and dispatch records, and concealing expense expenditures, resulting in an inflated total profit of 80,495,532.4 yuan in its 2014 annual report, which also turned a loss into a profit. Kinga Technology's disclosed 2014 annual report constitutes a major misrepresentation. Zhou Moumou was identified by the CSRC as a directly responsible supervisor, and Chen Moumou was identified by the CSRC as another directly responsible person. During its audit of Kinga Technology's 2014 annual financial statements, Lixin Firm committed violations of professional standards and rules, including failing to implement verification procedures for abnormal bank confirmations obtained, improper confirmation procedures for sales and collections cycles, improper confirmation procedures for accounts receivable, insufficient attention to abnormal situations in major contracts, and improper confirmation procedures for purchases and payments. Based on this, Lixin Firm issued a "standard unqualified audit report." The effective judgment in the case of (2019) Chuan Min Zhong No. 678, Mu Mou v. Kinga Technology Co., Ltd. and Zhou Moumou for securities misrepresentation liability dispute, ruled that Kinga Technology Co., Ltd. should compensate Mu Mou 96,288.23 yuan, and Zhou Moumou should bear joint and several liability. Mu Moumou believes that Lixin Firm, as a professional audit institution, violated audit professional rules and failed to exercise due diligence, and Chen Moumou, as an independent director, failed to fulfill his duty of diligence, both constituting significant faults, and both should bear joint and several liability. Therefore, the case was filed with the court, requesting that Lixin Firm and Chen Moumou be ordered to bear joint and several liability for the 96,288.23 yuan debt owed by Kinga Technology and Zhou Moumou to the plaintiff under the civil judgment of (2019) Chuan Min Zhong No. 678.

Case analysis:

In judicial practice, the criteria for determining the liability of independent directors are inconsistent and urgently need to be addressed.

Although the Kangmei Pharmaceutical case, as a landmark case promoting the reform of China's independent director system, established partial joint and several liability for independent directors, the theoretical basis of partial joint and several liability;

The internal and external relationships of partial joint and several liability;

The distinction between imperfect joint and several liability and partial joint and several liability;

The issue of determining the liability limits for partially responsible parties, among others, needs further clarification to form rules for identifying the legal liability of independent directors and judicial reasoning in securities misrepresentation liability disputes that have theoretical support and practical significance, thereby unifying the judicial criteria for similar cases.

(VI) Judicial Determination of "Inducement to Sell" Type of Misrepresentation – Zhang Mou v. Company A Securities Misrepresentation Liability Case

Basic Case Facts:

On November 23, 2015, Company A's wholly-owned subsidiary, Company Jia, signed a "Partnership Agreement" with Company Yi. Company Jia invested 300 million yuan as a limited partner, and Company Yi invested 500,000 yuan as a general partner, jointly establishing Partnership Bing. On November 27, 2015, Company Jia signed "Supplementary Agreement 1" with Company Ding, stipulating that: within the valid term of the partnership, Company Ding would provide guarantees for the safety of Company Jia's principal funds; Company Ding promised that if Company Jia's subscribed principal investment incurred losses upon the expiration of the partnership or when all partners unanimously agreed to withdraw, Company Ding would compensate for the corresponding losses in an equivalent amount; within the valid term of the partnership, Company Ding promised to ensure Company Jia an annual fixed return of 5% from the date of payment, and if the partnership failed to achieve the aforementioned returns, Company Ding would make up the difference and pay annually. In March 2016, Company Jia, Company Yi, and Partnership Bing signed an "Additional Investment Agreement," agreeing that Company Jia would make an additional investment of 200 million yuan in Partnership Bing. Company Jia and Company Ding signed "Supplementary Agreement 2," which made supplementary agreements regarding Company Jia's additional 200 million yuan, with the agreement content being essentially the same as "Supplementary Agreement 1." On November 29, 2017, Company A announced that relevant personnel from Company Yi and Company Ding had lost contact. On December 15, 2017, Company A announced that it had received an "Investigation Notice" from the Shenzhen Securities Regulatory Bureau. In May 2018, the Shenzhen Securities Regulatory Bureau issued an administrative penalty against Company A, determining that Company A failed to disclose "Supplementary Agreement 1" and "Supplementary Agreement 2," violating relevant provisions of the "Securities Law," and decided to impose administrative penalties on Company A and relevant responsible personnel. Zhang Mou filed a lawsuit with the Shenzhen Intermediate People's Court, claiming losses incurred from previous purchases of Company A's shares, and requested that Company A be ordered to compensate for the losses.

Judgment Result:

On June 4, 2019, the Shenzhen Intermediate People's Court made a civil judgment (2018) Yue 03 Min Chu 1519, determining that Supplementary Agreements 1 and 2 mainly provided guarantees for the principal and annual 5% fixed income that Ding Company invested in the partnership of Party A and Party C. A Company's failure to disclose these two agreements in a timely manner constituted favorable news, and A Company's delay in announcing this favorable news constituted a misleading omission, but would not induce investors to make positive investment decisions. There is no causal relationship between the investors' investment transactions and A Company's false statement behavior.

The decline in A Company's stock price is mainly attributed to the company's own non-systematic risk factors caused by the disappearance of relevant personnel from Ding Company and Yi Company, and not caused by false statements. There is no causal relationship between the investors' investment losses and A Company's false statement behavior.

Therefore, the first-instance judgment: The lawsuit of Zhang Mou was dismissed. After Zhang Mou appealed against the first-instance judgment, the Guangdong High Court dismissed the appeal and upheld the original judgment.

Typical Significance of This Case:

As a model judgment in a series of cases involving securities false statement liability disputes of A Company, this case is pioneering in its distinction between misleading omission and misleading statements, its exploration of the causal relationship between false statement infringement and damage results, and its "two-pronged approach" to transactional causality and loss causality. It provides valuable experience for the trial practice of misleading omission securities false statement cases and the revision and improvement of relevant judicial interpretations, and has strong guiding significance and typical significance.

Damage Compensation for False Statements

Regarding damage compensation, the Supreme People's Court's "Several Provisions" establishes the calculation method for compensation for false statements. The calculation of the amount of damages is a difficult point in securities dispute cases.

At present, China's judicial practice mainly relies on the "Several Provisions." Articles 25 to 28 of the "Several Provisions" have limited the compensation losses of investors.

Due to the relatively short development time of China's securities market, market regulation is constantly being improved. The "Securities Law of the People's Republic of China," which came into effect on March 1, 2020, further improves the quality of financial information disclosure by market entities to standardize securities issuance and trading behavior, protect the legitimate rights and interests of investors, maintain social and economic order and the public interest, and promote the development of the socialist market economy.

However, in judicial practice, cases involving civil liability disputes over false statements still mainly rely on the "Several Provisions." To adapt to the needs of the development of the securities market, the relevant system of civil liability for false statements has been further improved.

Author Introduction

Zhao Jingyu

Zhao JingYu

Heilongjiang Dadi Law Firm

Partner

Zhao Jingyu, a master's degree graduate in administrative law from China University of Political Science and Law, is a partner at Heilongjiang Dadi Law Firm, Director of the First Management Personnel Guidance Working Committee of Heilongjiang Provincial Bankruptcy Administrator Association, Vice Director of the Legal Counsel Committee of Heilongjiang Provincial Overseas Chinese Federation, Vice Director of the Reward, Punishment and Practice Mediation Committee of the Sixth Harbin Lawyers Association, Expert of the Expert Pool for Competitive Allocation of Local Government Bond Funds of Heilongjiang Provincial Department of Finance, and Vice Chairman of Harbin Association of New Social Strata.

Yu Yongxin

Heilongjiang Dadi Law Firm

Lawyer

Yu Yongxin, a member of the Communist Party of China, has long focused on civil and commercial cases and case enforcement. Adhering to the professional ethics of "fairness first, upholding justice, pursuing professionalism, and upholding integrity," he always upholds his values. With his profound legal expertise and rich practical experience, he has provided high-quality legal services to numerous clients. In his work, he treats people sincerely, is committed to upholding the dignity of the law, strives to protect the legitimate rights and interests of the parties, and works hard to ensure that every case receives a fair and just outcome.

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