Following the rapid development of the Shanghai / Shenzhen Stock Exchange Market (“SSE / SZSE”) and the ChiNext Market (“ChiNext”) in China over recent years, an increasing number of judgments on the issue of misrepresentation relating to securities (e.g. fraudulent listing, fictitious profit etc.) have been reported. Meanwhile, as of 2016, after the “Provisions of the Supreme People’s Court on the Trial of Cases of Civil Compensation Arising out of False Presentation in Securities Markets” (“Misrepresentation Provisions”) entered into force in 2003, more than 110 cases regarding securities misrepresentations have been filed before competent courts in China, of which more than 40 have resulted in judgments. In 2017, the Xintai Electric fraudulent listing case has blazed the trail for securities misrepresentation claims regarding ChiNext listed companies. In this article, we will illustrate the key factors in disputes arising out of securities misrepresentation claims in the Chinese market.
According to the Misrepresentation Provisions, there are three key issues in respect of securities misrepresentation disputes in China:
- Whether the misrepresentation in question is material (“Materiality Test”);
- Whether there is a causal relationship between the misrepresentation and the losses claimed by investors (“Causation Test”); and
- Whether there is any exemption from liability available for defendants (“Exemption”).
Article 6 of the Misrepresentation Provisions provides that “Where an investor files a lawsuit for civil compensation arising from misrepresentation in relation to securities, he shall submit the decision or announcement issued by the regulatory authorities…” In practice, this means that an administrative punishment decision issued by the China Securities Regulatory Commission (“CSRC”) should be enclosed in the Statement of Claim filed before the courts.1 Certain courts have held that the CSRC punishment decision may also be regarded as substantive evidence in ascertaining materiality. In other words, the courts would in principle conclude that the misrepresentation 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 precedent cases that in order to prove securities misrepresentation, the claimant must prove both: (i) that it relied upon the defendant’s allegedly fraudulent conduct in purchasing or selling securities (“transaction causation”); and (ii) that defendant’s conduct caused, at least in part, the claimant’s loss (“loss causation”). The “fraud on the market theory” adopted by the legislators entitles claimants to a rebuttable presumption of the existence of transaction causation, even where they were unaware of the misrepresentation at the time of their purchase or sale. Article 18 of the Misrepresentation 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
The defendants will often attempt to reduce their liability, or successfully defend the claim altogether, by relying on the exemption for systemic risks, as provided under Article 19.4 of the Misrepresentation Provisions. However, no specific qualitative analysis of the provisions has been provided under Chinese law. Therefore, the standards and methods adopted in judicial practice in relation to the provision, vary significantly from court to court, resulting in intense debates on how to ascertain the systemic risks of the securities market and determine the deductible amount on the same basis. In the circumstances, the “systemic advance/decline” of the relevant indices of the securities market (such as the composite index and/or the industrial index of the relevant securities market) and the existence of any “systemic events” of the securities market (such as a global/regional financial crisis or a material change of the domestic policy regarding the relevant industry etc.) are usually regarded as key evidence.
Although the past few years have witnessed an increasing number of cases regarding misrepresentation in relation to securities filed before various Chinese Courts, and certain listed companies and financial institutions have been punished or held liable for misrepresentation, it should be noted that the Chinese securities market is still not as mature as that of certain developed countries, and whether a claim against the party committing securities misrepresentation will be successful largely depends on the factual matrix and the discretion of competent Courts in China.