Abstract
If the performance forecasts early disclosed by a listed company significantly deviate from its final annual report, but the court, after review, determines that the listed company has employed basic assumptions, accounting policies, and other preparation basis that are not manifestly unreasonable, issued adequate risk warnings for important factors, and promptly fulfilled its obligation to correct errors in disclosure, then the listed company does not constitute a misrepresentation.
Basic Facts
A software company (the “defendant” or the “Company”), listed on the STAR market, primarily engages in software sales. The plaintiff is an ordinary STAR market investor. In 2021, the defendant signed seven software sales contracts with a distributor. From March to December 2021, the distributor issued receipts of delivery one after another, and the defendant recognized the revenues from the transactions. According to the Company's annual reports for 2020 and 2021, in terms of revenue recognition methods for key audit matters, the sold software is recognized as software products without installation requirements, whose revenues are recognized when they are delivered and signed for by end customers.
On January 25, 2022, the defendant issued an Announcement of Performance Increase Forecast, forecasting a year-on-year increase of about 50%-70% in operating revenue, net profit attributable to the parent’s owners, and net profit less non-recurring gains and losses attributable to the parent’s owners, for the year 2021. The Announcement also stated that the Company’s primary financial data for 2021 were only preliminary calculations that were not audited by an accounting firm. On February 25, 2022, the defendant published an Announcement of Performance Snapshot, further disclosing the primary financial data for 2021, consistent with the Announcement of Performance Increase Forecast in terms of change. In this Announcement, the Company warned that the primary financial data for 2021 were only preliminary calculations that were not audited by an accounting firm, subject to its officially-disclosed audited 2021 annual report, and investors are advised of the associated investment risks. On April 15, 2022, the defendant issued a Correction Announcement to revise its previously forecasted 2021 performance, forecasting a year-on-year decrease of about 50%-70% in net profit attributable to the parent’s owners and net profit less non-recurring gains and losses attributable to the parent’s owners, for the year 2021. In addition, the Announcement noted that the said performance forecast was not audited by a certified public accountant. The Announcement also explained the reasons for revising the performance forecast and snapshot. To be specific, the correction involved RMB 99.52 million (including tax) worth of sales contracts signed by the Company with a customer (namely the distributor) in 2021. But the distributor’s sale performance had been far from meeting expectations since 2022, resulting in a delay in the contracts’ performance schedule, which means the distributor’s ability to perform was deteriorating. For this reason, upon adequate discussions with its accountant and following the prudence principle, the Company decided to adjust the accounting treatment of the above RMB 99.52 million worth of contracts by deducting RMB 88.07 million from the 2021 operating revenue.
After the disclosure of the Correction Announcement, the CSRC Beijing office and the Shanghai Stock Exchange determined that the Company had failed to prudently recognize revenue and profit, resulting in inaccurate information disclosure, in violation of the Measures for the Administration of Information Disclosure by Listed Companies, Code of Corporate Governance for Listed Companies, and Rules Governing the Listing of Stocks on the Science and Technology Innovation Board of Shanghai Stock Exchange. Therefore, they respectively imposed such measures as issuing order for correction and regulatory warning on the Company and related personnel.
During the trial, the court ascertained that the Company’s annual audit accounting firm communicated with its independent directors and audit committee members in December 2021, February 2022, and April 2022. In particular, the Statement of Financial Audit dated February 24, 2022 stated that the amount of operating revenue in the audited key financial indicators aligned with the Announcement of Performance Snapshot. On April 28, 2022, the Company’s independent directors communicated with the accounting firm with respect to its audit of the performance forecast and snapshot, its objection (if any) to the Company’s revenue recognition principles, and its application of prudence principle in the audit. The accountant noted that it’s normal to use conventional revenue recognition methods Specifically, as demonstrated by multiple factors, the distributor failed to meet its expected targets for operating revenue and business performance, potentially affecting its ability to perform. In addition, it also failed to meet the preset sales schedule under the contracts with the Company. Considering its collection of payments as of December 31, 2021 and deteriorating ability to perform in terms of sale to downstream customers, the accountant did not recognize revenue for the orders concerned based on the prudence principle.
Holding
On July 4, 2023, the Shanghai Financial Court (the “Court”) issued a civil judgment ((2022) Hu 74 Min Chu No. 2814), dismissing all claims of the plaintiff Zhu X. Neither party appealed the first instance judgment, which has become effective.
Reasoning
The Court opined that major deviations did exist between the Company’s disclosed predictive information and its actual operating results. To be specific, both the Announcement of Performance Increase Forecast and the Announcement of Performance Snapshot forecasted a year-on-year increase of around 50% in net profit attributable to the parent's owners for the previous year, but the disclosed annual report showed a year-on-year decrease of about 50%. But to establish whether the Company committed securities misrepresentation, it is also necessary to assess the case from the perspectives of the three exceptions under Article 6 of the Several Provisions of the Supreme People’s Court on Trial of Civil Compensation Cases Arising from Misrepresentation in the Securities Market.
First, whether the basis of accounting preparation for the Company’s operating revenue and net profit disclosed in the Announcement of Performance Increase Forecast and Announcement of Performance Snapshot was manifestly unreasonable. In this case, the revenue from the sales contracts was derecognized mainly because the accountant decided doing so out of prudence principle and based on its investigations and interviews after an onsite audit of the Company, during which the accountant identified the distributor’s (namely buyer to the contracts) worsened ability to perform and lower-than-expected collection of payments. According to the facts of this case, the software sales transactions in question were genuine; the Company delivered the software as agreed and acquired the corresponding accounts receivable. Therefore, it is a normal accounting practice for the Company to recognize the contract revenue based on the rights and obligations under the contracts, customary accounting principles, and general operating procedures. Moreover, the Company presented evidence showing its recognition of revenue also took into account the software’s attributes, end users’ needs and capabilities, previous collection of payments, and other commercial expectations. Although the said accounting treatment was adjusted by the accountant citing the “principle of prudence,” this case does not involve an issue that “the employed basis of accounting preparation was manifestly unreasonable.”
Second, whether the Announcement of Performance Increase Forecast and the Announcement of Performance Snapshot provided adequate risk warnings for significant factors affecting the forecasts. In terms of the facts, at the release of the two announcements, the Company may not have anticipated the risk that revenue from the sales contracts could not be recognized. Specifically, the adjustments to the financial data in this case were mainly related to changes in accounting treatment. These changes were made partly to reflect the customer's ability to perform and collection of payments, and partly out of the accountant’s consideration of the prudence principle. From another perspective, as the accounting treatment for the same matter is not unique, the direct deduction of the operating revenue in question is just one accounting approach and does not exclude others. In view of the above, it is demanding and against objective facts to require the Company to specifically highlight the progress of the sales contracts to the public as a critical factor at the release of the two announcements.
Third, whether the Company promptly fulfilled its obligation to correct when a material change occurred in the assumptions for preparing the Announcement of Performance Increase Forecast and the Announcement of Performance Snapshot. According to multiple evidence, the annual audit was initiated on site in January 2022. During the on-site audit, the accountant focused on software sales revenue as a key indicator and examined sales contracts with the distributor. The accounting firm finally decided a deduction of revenue after investigations, which comprise coordinated evidence collection, repeated interviews, and acquisition of downstream customer orders. As the investigations were delayed due to involving trade secrets, the accountant officially requested a correction from the Company on April 14, 2022. And the Company issued a Correction Announcement on April 15, 2022. Therefore, it is determined that the Company had promptly fulfilled its correction obligations.
In conclusion, although the Announcement of Performance Increase Forecast and the Announcement of Performance Snapshot issued by the Company are predicative information, where the disclosed performance data were significantly deviated from the final annual report, the Company has employed basic assumptions, accounting policies, and other preparation basis that are not manifestly unreasonable, issued adequate risk warnings for important factors, and promptly fulfilled its obligation to correct errors in disclosure. Therefore, it is determined that the Company did not commit a misrepresentation.
Significance
In the securities market, profit forecasts, development plans, and other predictive information are disclosed by an issuer on a voluntary basis. Unlike statements on facts that are objective and established, predictive information is inherently uncertain and risky. As a result, according to the Several Provisions of the Supreme People’s Court on Trial of Civil Compensation Cases Arising from Misrepresentation in the Securities Market, major deviations between predictive information and actual operating results do not constitute misrepresentation, except for three exceptions. As securities regulators intensify supervision over predictive information, major judicial issues have emerged as to how to determine whether predictive information significantly deviated from actual operating results constitutes misrepresentation, and as to whether an issuer is liable for civil compensation for receiving regulatory actions. This case is a representative example where deviations exist between the performance forecasts and the actual data disclosed in the annual report. The Court fully reviewed the disclosure process of the financial predictive information concerned from the perspectives of the three exceptions. Having ascertained that the disclosure adequately revealed risks without misleading, the Court ruled that the issuer, acting in good faith, was exempt from civil compensation, thus distinguishing major deviations in predictive information from misrepresentation. This case establishes judicial review standards for similar cases, playing a positive part in guiding the relevant adjudication process.
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