Upon the rapid development of Shanghai / Shenzhen Stock Exchange Market (SSE / SZSE) and the ChiNext Market (ChiNext) in China over recent years, increasing number of case precedents regarding mis-representation on securities (e.g. fraudulent listing, fictitious profit etc) have been reported. Meanwhile, After the "Provisions of the Supreme People's Court on Trial of Cases on Compensation for Arising out of False Presentation in Securities Market (Mis-representation Provisions) entered into force in 2003, more than 110 cases regarding mis-representation on securities have been filed before competent courts in China as of 2016, among which more than 40 judgements have been made. Additionally, in 2017, the Xin Tai Electrical fraudulent listing case has blazed the trial for mis-representation on securities regarding CHINEXT listed company. In the circumstances, this newsletter will briefly illustrate the key factors in disputes arising out of mis-representation on securities in the Chinese security market.
According to the said Mis-representation Provisions, arguably there are three key issues regarding disputes arising out of mis-representation on securities in China:
- whether the mis-representation in question is material (Materiality Test);
- whether there is causal relationship between the mis-representation and the losses claimed by investors (Causation Test);
- whether there is any exemption of liability available for defendants (Exemption).
Article 6 of the Mis-representation Provisions provides that "Where an investor files a lawsuit for civil compensation arising from mis-representation on securities, he shall submit the decision or announcement issued by the regulatory authorities…" In this respect, for any claims regarding mis-representation on securities, an administrative punishment decision issued by the China Securities Regulatory Commission (CSRC) should in principle be enclosed in the Statement of Claim filed before the courts1. It is further held by certain courts that the CSRC punishment decision would not only constitute a prerequisite legal document for filing a claim, but also be regarded as substantive evidence in ascertaining the materiality. In other words, the courts would in principle opine that the mis-representation at issue is material if the relevant parties have been punished by the CSRC.
In China, it is widely agreed by the academia and held in various decided case precedents that in order to ascertain mis-representation on securities, the claimants must plead and prove both (i) that it relied upon defendant's allegedly fraudulent conduct in purchasing or selling securities (transaction causation), and (ii) that defendant’s conduct caused, at least in part, plaintiff’s loss (loss causation). With regard to transaction causation, the "fraud on the market theory" adopted by the legislators entitles claimants to a rebuttable presumption of the existence of transaction causation (e.g., that they relied upon alleged mis-representation) even where they were unaware of the mis-representation at the time of their purchase or sale. In this regard, Article 18 of the Mis-representation Provisions clearly sets out the standards for determining transaction causation. However, the criteria for ascertaining loss causation are yet to be further clarified under Chinese law.
Exemption – systemic risks
As opposed to the said tests, whilst the defendants would often attempt to reduce or exempt their liability by relying on the systemic risks as provided under Article 19.4 of the Mis-representation Provisions, no specific statutory criteria regarding qualitative analysis of the same have been provided under Chinese law. In the circumstances, the standards and methods in ascertaining systemic risks adopted in judicial practice vary significantly from court to court, which results in intensive debates regarding how to ascertain the systemic risks of the securities market and determine the deductible amount on basis of the same. This being the case, the "systemic advance/ decline" of the relevant indices of the security market (e.g. the composite index and/or the industrial index of the relevant security market) and the existence of certain "systemic event" of the security market (e.g. global / regional financial crisis, material change of the domestic policy regarding the relevant industry etc.) are usually regarded as key evidence in ascertaining the systemic risks of the security market.
Although the past few years have witnessed increasing number of cases regarding mis-representation on securities filed before various Chinese Courts and certain listed companies and financial institutions have been punished / held liable for mis-representation, it should be noted that the Chinese security market is still not as mature as that of certain developed countries, and whether a claim against the party committing mis-representation on securities will be successful would largely depend on the factual matrix and the discretion of competent Courts in China.