Abstract
In disputes over liability for misrepresentation of securities traded through market-making on the NEEQ, where securities prices reflect significant information of issuer and investors make investment decisions based on trust in these prices, the “presumption of reliance principle” can be applied to establish the causality of the transactions. Liability of the securities intermediaries should be determined considering factors such as the unique characteristics of the NEEQ market, responsibilities of the parties involved, historical institutional environments, and cost-benefit analyses. If the sponsoring broker failed to prudently verify material details such as financial data before listing, it should bear corresponding liability for investor losses caused by false statements during this pre-listing phase.
Basic Facts
On December 13, 2013, the shares of the defendant, an IT company, were listed for public transfer on the National Equities and Exchange Quotations (NEEQ). A securities company acted as the sponsor and referrer for the listing. A law firm provided legal opinions for the listing, and an accounting firm provided audit services for the semi-annual and annual reports of the company from 2013 to 2016. An appraisal firm offered appraisal opinions for the listing. On August 11, 2017, board of directors of the IT company released the Announcement on Investigation of the Company by the China Securities Regulatory Commission, stating that the company was under investigation for suspected illegal information disclosure. On November 16, 2020, the CSRC Shanghai office imposed administrative penalties on the company, Xu XX, Zhu XX, and Zhuang X. The penalty decision specified that the company had falsely inflated its annual revenue for the first half of 2013 to 2016 in public disclosures. Defendant Zhuang (then head of the accounting firm) and defendant Zhu (then general manager and supervisor) were identified as other direct responsible parties for such misrepresentation. Plaintiff Li XX, having incurred losses from investing in the shares of the IT company, filed a lawsuit seeking joint and several liability for compensation of the losses of investment difference from the IT company, Zhuang X, Zhu XX, and the relevant intermediaries.
Holding
Shanghai Financial Court issued a civil judgment ((2021) Hu 74 Min Chu No. 1368) on June 30, 2023:
(1) Defendant IT company shall compensate plaintiff Li XX for investment losses totaling RMB 1,850,039.01 within ten days of the judgment taking effect;
(2) Defendant Zhu shall bear joint and several liability within a range of 60% for the payment obligations of the IT company as per the first item above;
(3) Defendant Zhuang shall bear joint and several liability within a range of 2% for the payment obligations of the IT company as per the first item above;
(4) Defendant Securities Company shall bear joint and several liability within a range of RMB 20,211.54 for the payment obligations of the IT company as per the first item above;
(5) Defendant Accounting Firm shall bear joint and several liability within a range of RMB 242,502.58 for the payment obligations of the IT company as per the first item above; and
(6) Dismissal of the remaining claims by plaintiff Li XX.
After this first-instance judgment, the accounting firm appealed. On November 15, 2023, the Shanghai High People’s Court issued a civil judgment ((2023) Hu Min Zhong No. 699), dismissing the appeal and upholding the original judgment.
Reasoning
The Shanghai Financial Court opined that in determining causality in market-making transactions on the NEEQ, the “presumption of reliance” principle can be applied. In these transactions, market makers rely on their experience and expertise to gather more information and conduct scientific analysis, ultimately reflected in the listed company's stock price. Investors similarly rely on market prices to make investment decisions, thus the “presumption of reliance” can be applied.
The responsibilities of the sponsoring broker should be differentiated by stage. In this case, a securities company served as the sponsoring broker of the IT company, engaging predominantly in stock listing recommendation and ongoing supervision. The regulatory standards and performance criteria differ between these two business areas. During the pre-listing due diligence phase, the sponsoring broker relied solely on written materials for investigation and failed to employ methods such as client interviews or analytical reviews to verify financial ambiguities. This lack of due diligence merits corresponding liability. For the post-listing ongoing supervision phase, in accordance with the Guidelines for Ongoing Supervision by Sponsoring Brokers on the NEEQ (Trial) (2014), the sponsoring broker’s duties after the company’s listing primarily involved urging and guiding the company to duly perform its disclosure obligations. There was no requirement for validating the financial data in the annual or audit reports or signing or sealing the reports. Hence, the sponsoring broker was not responsible for substantive verification of the financial data. Moreover, given the lengthy supervisory period from listing to delisting on the NEEQ, the Court determined that the sponsoring broker was not liable for misrepresentation during this phase.
Regarding the liability shares among the intermediaries, several factors were considered: 1) Market differences. Different markets have different characteristics such as issuance regulations, intermediaries’ roles, and investor entry thresholds, which must be fully considered; 2) Division of roles and responsibilities. There should be differentiation in fault based on the distinct roles, responsibilities, and levels of management involvement among the parties involved; 3) Historical context. It is necessary to assess liabilities from a historical perspective, taking into proper consideration the legislative and enforcement environment at the time of the misrepresentation; and 4) Costs, benefits, and means. Liability determination should also account for reasonable investigation methods, costs, as well as the relevant professional standards and industry common practices.
Significance
This case is the first nationwide case concerning liability for misrepresentation of securities traded through market-making on the NEEQ, concerning financial fraud by an NEEQ-listed company during its listing and subsequent years, involving various securities service intermediaries before and after the listing. The case explores complex issues, including the nature and application of laws on the NEEQ market, the applicability of the “presumption of reliance” principle to NEEQ market-making transactions, the selection of methods for calculating investor losses in these transactions, the influence of market makers' engagement and withdrawal on loss assessment, the necessity of considering market characteristics and historical institutional environments in determining the respective liability of the securities market participants, the standards for assessing the liability of an NEEQ sponsoring broker at different phases, the standards for determining the fulfillment of due diligence by the accounting firm, the differentiation in liability among intermediaries based on their involvement levels at different phases, and the distribution of investors losses for multiple overlapping misrepresentation.
The judgment is beneficial for promoting the role of securities intermediaries as “gatekeepers”, helping investors to value market information and make rational investment decisions, and promoting the healthy development of the securities intermediary service market.
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