[Abstract]
The exposure date is of significance in cutting off transaction causation. The specific action of exposure does not need to be comprehensive, complete, and accurate, as long as the information disclosed to the market for the first time is sufficient to serve as a warning for rational investors to re-evaluate relevant securities and guard against investment risks. Where a listed company is able to prove that Plaintiffs’ losses are partly or wholly attributable to other factors unrelated to misrepresentation, the respective impact ratio of such factors on Plaintiffs’ losses can be quantitatively determined by empirically sound methods with the help of professional institutions or personnel.
[Keywords]
Misrepresentation in the securities market, exposure date, causation, loss quantification method
Plaintiff: Xu X Xin.
Plaintiff: Li X Hong.
Plaintiff: Hu X.
Plaintiff: Wang X Jun.
Defendant: Shanghai Potevio Co., Ltd., domiciled in Xuhui District, City of Shanghai.
Legal Representative: General Manager Wang.
Plaintiffs, namely Xu, Li, Hu, and Wang (“Plaintiffs”) filed a lawsuit with Shanghai Financial Court (the “Court”) due to a dispute over liability for misrepresentation in the securities market with Shanghai Potevio Co., Ltd. (“Potevio”).
Plaintiffs alleged that they invested in and traded shares issued by Potevio in reliance on the information disclosure documents of the latter. On January 19, 2017, Potevio released an announcement regarding its receipt of Investigation Notice from China Securities Regulatory Commission (the “CSRC”) for suspected violations of relevant laws and regulations on securities and futures. On January 10, 2018, Potevio released an announcement regarding its receipt of Advance Notice on Administrative Penalty from China Securities Regulatory Commission Shanghai Securities Bureau (hereinafter “CSRC SSB”).On March 24, 2018, Potevio released an announcement regarding its receipt of Administrative Penalty Decision (hereinafter the “Decision”) from CSRC SSB, stating that it was found by CSRC SSB to have inflated its 2014 operating revenue and profit through false trades in order to fill profit gap of the year (with the inflated profit accounting for 73.68% of consolidated total profit in 2014). CSRC SSB identified Potevio’s false representation in the 2014 annual report as information disclosure violations and decided to impose administrative penalties on it. Plaintiffs demanded to hold Potevio liable for civil compensation for its act of misrepresentation identified in the Decision. Plaintiffs alleged that they purchased Potevio shares after the commission date of Potevio’s misrepresentation (March 21, 2014, the date of publication of 2014 annual report) and before the exposure date thereof (January 10, 2018, the date on which Potevio received the Advance Notice on Administrative Penalty), and incurred losses for selling or continuing to hold the shares after the exposure date. Plaintiffs argued that, in accordance with the Securities Law of the People’s Republic of China (hereinafter the “Securities Law”) and the Provisions of the Supreme People’s Court on the Trial of Cases of Civil Compensation Arising out of Misrepresentation in Securities Markets (hereinafter the “Misrepresentation Provisions”), there existed a legal causation between the losses of investment differences, taxes and commissions resulting from Plaintiffs’ trading of Potevio shares and Defendant’s information disclosure tort, and therefore, they requested the Court to order Potevio to assume liabilities for civil compensation.
Defendant Potevio responded that it opposed to Plaintiffs’ claims because:
1. Potevio differed on the exposure date, the base date and the base price claimed by Plaintiffs. After its information disclosure violations on March 21, 2015, Potevio filed an announcement on January 19, 2017 to disclose its receipt of Investigation Notice from CSRC SSB. Since this announcement had sent a warning signal to the securities market and made investors aware of the need to re-evaluate Potevio shares, the date of announcement January 19, 2017 should be recognized as the exposure date of the misrepresentation in this case. With January 19, 2017 as the exposure date, the base date of A shares of Potevio should be March 21, 2017, corresponding to a base price of RMB 31.59, while that of B shares of Potevio should be March 5, 2018, corresponding to a base price of USD 0.792.
2. In this case, Plaintiffs’ purchase of Potevio shares was not triggered by Potevio’s misrepresentation, and therefore there existed no transaction causation between the two. Xu and Wang, two Plaintiffs who purchased Potevio shares from the commission date to the exposure date, continued to up their positions after the exposure of the misrepresentation. For this reason, whether the misrepresentation had occurred did not affect the two investors’ decision-making. What’s more, for two consecutive years, Potevio had disclosed its operating risk, a projected loss of up to RMB 500 million, in its 2015 and 2016 annual reports. Investors who still decided to purchase Potevio shares despite this fact should be presumed to be bottom fishers voluntarily bearing high risks, and thus there was no transaction causation between their losses and Potevio’s misrepresentation. Li and Hu, another two Plaintiffs, did not buy Potevio shares immediately after the commission date. Instead, they did not trade Potevio shares until September 2015 or even after 2016, a point in time when the rise of charging pile concept on the market triggered a surge in Potevio’s share price. Therefore, by purchasing Potevio shares at a high price, the two investors intended to speculate and seek short-term gains, which was utterly unrelated to Potevio’s information disclosure violations on March 21, 2015. Particularly, in view of that Potevio denied the relevance between its operating performance and the charging pile concept in an announcement dated September 10, 2015, and projected loss for the first three quarters of 2015 in another announcement dated October 14, 2015, the two investors’ share purchases were not causally connected to the misrepresentation.
3. Even if Potevio would be held liable for civil compensation, the average buying price should be calculated using the weighted moving average method rather than the ordinary weighted average method proposed by Plaintiffs when they filed the lawsuit. In addition, even if Plaintiffs sustained investment losses, such losses were partly attributable to systemic risks of the securities market and such non-systemic risk factors as Potevio’s deteriorating operational status. Hence, a corresponding proportion of investment losses should be deducted at the time of calculation.
4. Potevio disagreed with Plaintiffs’ claim to count commission loss at the commission rate of 0.1%. Plaintiffs should first prove the existence of commission loss, and with this as a premise, Potevio agreed to compensate the commission loss at the commission rate of 0.03%.
The Court ascertained the following facts in the first instance:
Potevio was an SSE-listed company under A-share ticker symbol of 600680 and B-share ticker symbol of 900930 from October 18, 1993 to May 23, 2019.
On March 21, 2015, Potevio published its 2014 annual report, in which it disclosed the company’s basic information, accounting data, financial indicators, share capital, shareholders, etc.
On January 19, 2017, Potevio disclosed the Announcement on the Receipt of Investigation Notice from the CSRC, stating that “Potevio received an Investigation Notice from CSRC on January 17, 2017. CSRC decided to initiate an investigation against Potevio for suspected violations of relevant laws and regulations on securities and futures in accordance with the Securities Law”.
On January 10, 2018, Potevio issued an announcement regarding its receipt of Advance Notice on Administrative Penalty from CSRC SSB on January 9, 2018. The particulars of the Advance Notice on Administrative Penalty were: After having completed the investigation on the suspected information disclosure violations of Potevio, CSRC SSB decided to impose administrative penalties on it according to law based on the following violations confirmed: for the purpose of filling the profit gap of 2014 and achieving the profit target of the year, Potevio fabricated two tripartite trades with Shanghai Shengfei Trading Co., Ltd. and Shenzhen Busbar Sci-Tech Development Co., Ltd. from September to November 2014, which resulted in a false increase of RMB 17,831,200 in operating revenue and a false increase of RMB 1,347,300 in total profit; later in November 2014, it reached another tripartite deal with Shanghai Chengyu Energy Technology Co., Ltd. and Shanghai Zhonghan Enterprise Development Co., Ltd., which resulted in a false increase of RMB 24,786,300 in operating revenue and a false increase of RMB 8,636,700 in total profit. For Potevio, the three deals together led to an inflated operating revenue of RMB 42,617,500, as well as an inflated total profit of RMB 9,984,000 for fiscal year 2014, representing 73.68% of its consolidated total profit of RMB 13,549,600 in 2014. It was found after investigation that the said three trades were false trades: the subject matters of the trade contracts were the same, and the contract-signing and payment time was the same or similar; in terms of the process, Potevio sold the goods to external parties and finally repurchased them, which formed a closed loop of trade process and capital transfer; furthermore, all the goods involved were stored in or sent out from a virtual warehouse, and there was no physical transfer of goods. Potevio’s false representation in its 2014 annual report violated the provisions of Article 63 of the Securities Law which provides that “the information as disclosed by issuers and listed companies according to law shall be authentic, accurate and integrate and be free from any false record, misleading statement or major omission”, constituting the act described in Article 193 of the Securities Law that “an issuer, a listed company or any other obligor of information disclosure fails to disclose information according to the relevant provisions or there is any false record, misleading or major omission in the information as disclosed.” Consequently, CSRC SSB decided to order Potevio to make corrections, give it a disciplinary warning, and impose a fine of RMB 400,000.
On March 15, 2018, CSRC SSB issued Administrative Penalty Decision [2018] No. 4, where Potevio’s violations identified were consistent with those identified in the aforesaid Advance Notice on Administrative Penalty. In light of the facts, nature, circumstances and degree of social harm of Potevio’s violations, and in accordance with the provisions of Article 193 (1) of the Securities Law, CSRC SSB decided to order Potevio to make corrections, give it a disciplinary warning, and impose a fine of RMB 400,000.
In this case, Plaintiffs took March 21, 2015 as the commission date of the misrepresentation, to which Potevio had no objection. Plaintiffs Xu, Li, Hu, and Wang all bought Potevio shares after March 21, 2015, and the relevant transaction records were obtained by the Court from China Securities Depository and Clearing Corporation Limited (CSDC).
Besides, it was found that on January 19, 2017, Potevio’s A-share price tumbled 10.01%, corresponding to a cumulative ten-day decline of 13.89%, while its B-share price slumped 7.46%, corresponding to a cumulative ten-day loss of 16.39%.
On January 26, 2017, February 25, 2017, and April 15, 2017, Potevio issued for three consecutive times the Reminding Announcement on Possible Delisting Risk of the Company’s Shares. On March 28, 2017, shares of Potevio were officially under special treatment (ST). On April 22, 2017, Potevio published the Announcement on Delisting Risk Warning and Trading Suspension of the Shares of the Company, warning investors of investment risks, reminding investors that if its 2017 audited net profit continued to be negative, its shares would be likely to be suspended from listing. On April 25, 2017, the shares of Potevio entered delisting risk warning (*ST) status. On January 31, 2018, March 3, 2018, March 20, 2018, April 26, 2018, and April 27, 2018, Potevio issued multiple announcements to warn investors of the risk of listing suspension. Since the days from April 28, 2018 to May 1, 2018 were non-trading days, Potevio’s shares were suspended from trading from May 2, 2018. On May 17, 2019, the Shanghai Stock Exchange (SSE) made a decision to terminate the listing of Potevio’s shares. Subsequently on May 23, 2019, Potevio’s A shares and B shares were delisted from the SSE.
The Court also found that the General Office of the State Council issued the Guiding Opinions on Accelerating the Construction of Electric Vehicle Charging Infrastructure (Guo Ban Fa [2015] No.73) on September 29, 2015, and five ministries and commissions including the Ministry of Finance jointly issued the Notice on Implementing the Incentive Policy for New Energy Vehicle Charging Infrastructure and Strengthening the Promotion and Application of New Energy Vehicles During the 13th Five-Year Plan Period (Cai Jian [2016] No.7) on January 11, 2016. The two documents spurred investor zeal for stocks related to the concepts of new energy vehicles and charging piles. Consequently, Potevio’s A-share price, standing at around RMB 15 in early September 2015, soared to some RMB 32 by early October 2015, further gained later and peaked at RMB 61.72 on November 13, 2015, and after that fluctuated at a high level of about RMB 50 till December 31, 2015. Potevio’s share price headed downward from 2016 and returned again to RMB 30 to RMB 35 by January 19, 2017, or prior to Potevio’s investigation by the CSRC.
During the trial, the Court appointed China Academy of Financial Research affiliated to Shanghai Jiao Tong University (hereinafter the “CAFR”), to assess Plaintiffs’ losses of investment difference arising from Potevio’s misrepresentation. CAFR issued on February 19, 2020 the Assessment Report on the Loss of Securities Investors (hereinafter the “Loss Assessment Report”). In view of that loss assessment involved determination of the commission date, exposure date, base date, and base price, while Plaintiffs and Potevio differed on such dates and price, the Court determined such dates and price first and only then reviewed the loss assessment results based on the two parties’ arguments and challenges with respect to the Loss Assessment Report.
The Court held in the first instance that:
The issues of this case were identified as follows: (I) How to identify the exposure date, base date and base price of Potevio’s misrepresentation; (II) Whether there existed transaction causation between Potevio’s misrepresentation and Plaintiffs’ purchase of Potevio shares; in other words, whether Plaintiffs were induced to purchase the shares in reliance on the misrepresentation; (III) Whether Plaintiffs’ losses were caused by Potevio’s misrepresentation, and whether such losses were wholly or partly attributable to the systemic risks of the securities market and other causative factors; and (IV) How to determine the damages for Plaintiffs’ losses of investment difference, and if there existed systemic risks of the securities market and other causative factors, how to determine their impact on the losses and corresponding amounts to be deducted.
(I) How to identify the exposure date, base date and base price of Potevio’s misrepresentation. The exposure date was meant to send sufficient warning signals to the securities market to remind investors to re-evaluate stocks, and this date carried the function of cutting off transaction causation (that is, investors that purchased shares after the exposure date would not be compensated due to absence of transaction causation). In addition to the timing of the first exposure and the authority of the exposing entity, the determination of the exposure date should also take into account whether the exposure fully revealed investment risks and served as a sufficient warning to investors, in other words, whether the exposure had a substantial impact on securities transactions. On January 19, 2017, Potevio published an announcement regarding its receipt of Investigation Notice from the CSRC, saying that CSRC initiated investigation of it for suspected violations of relevant laws and regulations on securities and futures. On the day of announcement, the share price of Potevio fell by its daily limit, and capital outflowed significantly. Moreover, in the next ten trading days, Potevio recorded a cumulative share price decline of more than 10%. Based on these figures, Potevio’s announcement on being filed for investigation by the CSRC had already sent sufficient warning signals to the securities market and prompted relevant investors to re-evaluate Potevio shares and make new investment decisions. Hence, the Court deemed the claim of Potevio, i.e. taking January 19, 2017 as the exposure date, to be acceptable. In accordance with Article 32 and Article 33 of the Misrepresentation Provisions, with January 19, 2017 as the exposure date, the A-share base date should be March 21, 2017, corresponding to a base price of RMB 31.59, while the B-share base date should be March 5, 2018, corresponding to a base price of USD 0.792.
(II) Whether there existed transaction causation between Potevio’s misrepresentation and Plaintiffs’ purchase of Potevio shares. Pursuant to the principle of “presumed reliance” adopted by Article 18 of the Misrepresentation Provisions, it should be presumed that investors trading shares during the period when the market was affected by the misrepresentation were induced to trading shares in reliance on such misrepresentation, and that their transactions were causally connected to such misrepresentation. Such a principle of presuming transaction causation eliminated the need for investors to prove that they made investment decisions in reliance on the misrepresentation, nor did it require that reliance on the misrepresentation was the only motivation for investors to make investment decisions. Given that the impact of the misrepresentation which induced investors to buy shares was not eliminated before it was exposed, such impact should be deemed as beginning on the commission date of the misrepresentation and ending on the exposure date thereof. Potevio maintained that there should be no “presumed reliance” between Plaintiffs’ previous investment decisions and its information disclosure violations because Plaintiffs continued to purchase Potevio shares in large quantity even after the exposure of the misrepresentation. However, since Potevio’s profit fraud in the 2014 annual report was not revealed until the company was filed for investigation, it could be presumed that before the exposure date, Plaintiffs still purchased shares in reliance on the information disclosed by Potevio. As for Plaintiffs’ buying Potevio shares in large quantity after the exposure date, it was a reasonable choice of Plaintiffs either for the purpose of reducing shareholding costs through purchase of a large number of low-price shares or for the purpose of long-term investment, which was not in conflict with their previous transactions in reliance on the misrepresentation. Moreover, pursuant to Article 18 of the Misrepresentation Provisions, there was no causality between the shares bought by an investor after the exposure date and the misrepresentation. Evidently, the law has taken in account the investors’ continuous share purchases out of various motives after the exposure date, classifying losses therefrom as losses unrelated to the misrepresentation and excluding them from the scope of claims. Potevio also argued that instead of being induced by Potevio’s misrepresentation, certain Plaintiffs purchased Potevio shares intended to profit from the rise of the charging pile concept. However, it is impractical to distinguish investors’ motivations for buying Potevio shares. Since the impact of the misrepresentation which induced investors to buy shares began on the commission date of the misrepresentation and ended on the exposure date thereof, the impact of Potevio’s misrepresentation in its 2014 annual report could not be excluded as investors chose Potevio shares among numerous stocks, even if they were attracted by upward trend of the market amid the tremendous loss projected. Conversely, had Potevio truthfully disclosed true operating conditions in its 2014 annual report, Plaintiffs might have changed their trading decisions due to the consistently poor operating performance of the company. Therefore, the rise of charging pile concept that triggered price surge amid the downturn in Potevio’s operating performance should not be deemed as having cut off the causation between Potevio’s previous misrepresentation and Plaintiffs’ transactions, and the possibility that Plaintiffs had purchased shares based on their expectations rising from the inflated profit should not be ruled out. As for the abnormal rise in the share price catalyzed by the charging pile concept as claimed by Potevio, it should be taken into account in the calculation of investors’ losses.
(III) Whether Plaintiffs’ losses were caused by Potevio’s misrepresentation, and whether such losses were wholly or partly attributable to the systemic risks of the securities market and other causative factors. The dispute over liability for misrepresentation is essentially a special kind of dispute concerning damages for tort. Despite that the investors traded shares during the period when the market was affected by the misrepresentation, the price of an individual stock in the securities market was inevitably affected by multiple factors, which aside from the aforesaid misrepresentation, also included other factors like market risks. It was hence neither reasonable nor fair for the misrepresentation maker to bear investors’ losses caused by the rise and fall of share price arising from other factors other than misrepresentation. Therefore, Article 19 of the Misrepresentation Provisions has clearly stipulated that, if it is proved that the losses are in whole or in part caused by the systemic risks of the securities market etc., it should be determined that there is no causation between the misrepresentation and such losses. Pursuant to the said Article, the party liable for misrepresentation would only assume compensation liability for the portion of investors’ losses attributable to the misrepresentation; if there was evidence showing that investors’ losses were contributed by other causative factors, which had a considerable impact on the fluctuations of the share price and were irrelevant to the misrepresentation, such losses should be excluded from the scope of compensation liabilities. Plaintiffs claimed that the word “etc.” in Article 19 of the Misrepresentation Provisions was an ending word for exhaustive enumeration, and that the deductible factors were limited to the “systemic risks of the securities market” identified by the competent authority. The Court deemed such a claim to be unacceptable as it violated the underlying legal principle of tort damages.
(IV) How to determine the damages for Plaintiffs’ losses of investment difference, and if there existed systemic risks of the securities market and other causative factors, how to determine their impact on the losses and corresponding amounts to be deducted. Given that this case involved “other factors” that contributed to investors’ losses and neither party had proposed a reasonable method to calculate the impact of such factors, the Court appointed a professional institution as an assessor.
According to the Loss Assessment Report issued by CAFR on February 19, 2020, Plaintiffs’ losses of investment difference arising from the misrepresentation were assessed following the steps below:
1. Determining the transactions to be incorporated into the scope of loss assessment. The Loss Assessment Report determined such transactions as per the following principles: shares held by an investor on the day immediately before the commission date and shares purchased by him after the exposure date were excluded; all shares purchased by an investor before his securities balance became zero were excluded, because such shares had been sold out before the exposure date, while all share purchases of an investor from the date of the “first qualified purchase”, namely the first purchase following the last time that his securities balance became zero, to the exposure date were counted; for net shares that were purchased from the commission date to the exposure date, both the corresponding shares sold and those held till the base date were counted. Specifically: (1) Plaintiff Xu, who conducted transactions only via his A-share ordinary securities account, executed a buy transaction, his first qualified purchase, on October 28, 2016; Xu held 5,600 shares of Potevio prior to January 19, 2017 and sold all of the above 5,600 shares from January 19, 2017 to March 21, 2017. (2) Plaintiff Li, who conducted transactions only via his B-share securities account, initiated a buy transaction, his first qualified purchase, on January 12, 2016; Li held 2,000 shares of Potevio prior to January 19, 2017 and held the 2,000 shares until after March 5, 2018. (3) Plaintiff Hu, who conducted transactions only via his B-share securities account, executed a buy transaction, his first qualified purchase, on February 29, 2016; Hu held 2,100 shares of Potevio prior to January 19, 2017 and held the 2,100 shares until after March 5, 2018. (4) Plaintiff Wang, who conducted transactions only via his B-share securities account, executed a buy transaction, his first qualified purchase, on March 21, 2016; Wang held 9,900 shares of Potevio prior to January 19, 2017, sold 4,800 shares of them from January 19, 2017 to March 5, 2018, and held the remaining 5,100 shares until after March 5, 2018.
2. Determining the specific calculation method. The Loss Assessment Report applied the method of synchronous comparison of yield curves to calculate losses of investment difference arising from the misrepresentation. The rationale behind this method was the quantitative analysis of various factors that affected share price: the yield curve of Potevio shares formed by other factors other than the misrepresentation was used to compute investors’ simulated loss-profit ratio and accordingly to obtain the simulated investment losses caused by other factors including systemic risks of the securities market; the simulated investment losses were then compared with nominal investment losses formed under the combined influence of all factors including the misrepresentation so as to calculate investors’ losses of investment difference arising from the misrepresentation that is eligible for compensation. The Loss Assessment Report opined that for Potevio, in addition to share price movements brought by market factors, industry factors and style factors of the individual stock itself, its share price fluctuations following the rise of the charging pile concept from 2015 to 2016 and its special treatment (ST) by the SSE due to continuous operating losses in 2017 were also unrelated to its misrepresentation. As a result, based on a quantitative analysis of market factors, industry factors, and style factors of the individual stock (including charging pile concept factor and ST factor), the Loss Assessment Report built a model to calculate the simulated daily rate of return (ROR) of Potevio shares under the influence of other factors other than the misrepresentation. After computing the simulated share price of Potevio, the model then calculated investors’ losses of investment difference arising from the misrepresentation following the three steps below: (1) Calculating the nominal loss-profit ratio. Nominal loss-profit ratio = nominal investment losses / nominal costs of shares purchased × 100%; (2) Calculating the simulated loss-profit ratio. Simulated loss-profit ratio = simulated investment losses / simulated costs of shares purchased × 100%; and (3) Calculating investors’ losses of investment difference arising from the misrepresentation. Amount of losses eligible for compensation = nominal costs of shares purchased × (nominal loss-profit ratio ? simulated loss-profit ratio).
3. Calculating the simulated daily ROR. (1). The quantitative loss calculation model applied a multi-factor method to calculate the simulated daily ROR of Potevio’s A shares. The model incorporated the country factor(s) to reflect the impact of market risks, the industry factor(s) to reflect the impact of the industry, and the style factors to reflect the impact of various fundamental indicators. The nine style factors commonly adopted in multi-factor models were incorporated, including size (large cap vs. small cap in ROR), value (high valuation vs. low valuation in ROR), beta (high degree vs. low degree of reaction to market risks in ROR), earnings (high earnings level vs. low earnings level in ROR), leverage (high leverage vs. low leverage in ROR), growth (fast growth vs. slow growth in sales or earnings in ROR), momentum (outstanding vs. poor historical performance in ROR), volatility (large volatility vs. small volatility of trading in ROR), and liquidity (high turnover rate vs. low turnover rate in ROR). Also, the charging pile concept and the ST factor were added as two style factors given their influence on Potevio. (2). The quantitative loss calculation model computed the simulated daily ROR of B shares using the method of correlation between A shares and B shares. The multi-factor model method, which required a large number of samples to estimate the returns of various factors to reduce the estimation error, was not applicable to B shares due to the small number of B shares of merely around 100 shares. The method of correlation between A shares and B shares leveraged the evident correlation of share price movement between a company’s A shares and B shares. The simulated daily ROR of A shares was first obtained through the multi-factor model method for A shares and then used to construct the simulated daily ROR of B shares based on the correlation between A shares and B shares.
The final assessment results of the Loss Assessment Report were as follows: For Plaintiff Xu, the loss of investment difference arising from the misrepresentation was RMB 7,561.34; for Plaintiff Li, USD 1,480.96; for Plaintiff Hu, USD 1,621.99; and for Plaintiff Wang, USD 8,616.63. At the trial, CAFR designated loss assessors Li and Li X chao to appear for interrogation, and they offered detailed explanation for the methods, rationales and logics of the calculation under the Loss Assessment Report and were interrogated by Plaintiffs, Potevio and the Court.
Potevio admitted the logics and methods of the calculation under the Loss Assessment Report by and large but challenged the simulations for B shares, alleging that:
Firstly, the Loss Assessment Report failed to take listing suspension as an additional deduction factor for Potevio’s B shares, which was unreasonable. For an individual share in ST status, listing suspension was not a certain event, and for investors, whether a company that had suffered losses for two consecutive years would usher in a turnaround or a continuous loss leading to listing suspension in the third year was an unforeseeable contingent event. After Potevio warned the risk of listing suspension for the first time, its share price fell by daily limit for eight consecutive trading days. This fact manifested the market’s strong reaction to Potevio’s warning of listing suspension risk. Therefore, listing suspension, as an operating risk unrelated to the misrepresentation, should be considered in the calculation of the simulated ROR of B shares.
Secondly, the simulated B-share price in the Loss Assessment Report did not accurately reflect the continuous impact of ST and *ST factors on B-share price after March 21, 2017, the base date of A shares. According to Appendix 2 of the Loss Assessment Report, the simulated B-share price on April 25, 2017, the official date on which Potevio entered *ST status, lost 0.4% and 1.9% from the previous two trading days, respectively, which was inconsistent with Potevio’s actual share price decline.
To sum up, considering that B shares had a later base date than A shares and were under the continuous impact of operating risk factors such as ST factor, *ST factor and listing suspension, listing suspension should be added as an additional factor to the model to calculate the simulated ROR, so that the trend of simulated B-share price could reflect the continuous impact of ST factor and *ST factor, and that the compensation rate for B-share investors was not too high.
After the trial, in response to the list of constituent stocks in ST status submitted by CAFR, Potevio expressed supplementary opinions, asserting that the data calculated as per the list could not accurately reflect the impact of listing suspension on its share prices because samples with the same situation as Potevio on the list accounted for less than 10%. Potevio held that an equal number of stocks in ST, *ST and listing suspension status should be selected into the list for even distribution, and that when selecting stocks in listing suspension status, stocks that were later resumed for listing should be removed while stocks that were later delisted should be retained.
The loss assessors responded to Potevio’s challenge as follows during the interrogation: The impact of Potevio’s listing suspension had been considered through the style factors in the calculation model. Since in practice, listed companies that warned the risk of listing suspension were usually caught in long-term poor performance, the impact of this factor had been partially included in the two style factors of value and earnings in the calculation model. Additionally, the ST factor added to the calculation model, which covered all stocks in ST and *ST status during the same period, had automatically incorporated stock samples that issued a risk warning for listing suspension due to unimproved performance after their *ST status, and such samples would exist for a long time on different trading days. Therefore, the risk of listing suspension was contained in the long-term cumulative impact of ST and *ST factors. As for Potevio’s allegation regarding the consecutive limit-down of shares after the announcement on listing suspension, the impact had been allocated evenly over the entire time period after its ST and *ST status in the calculation model through the above method. Under such a circumstance, the addition of an extra factor for Potevio’s warning announcement on listing suspension would result in double deductions. Likewise, the deviation between Potevio’s actual decline and simulated decline on the day when the company officially entered a ST status was also attributed to the fact that the ST and *ST factors in the calculation model, including both companies that just entered ST status and companies that had been in ST status for a period of time, reflected the average impact of a basket of ST and *ST stocks as samples. In contrast to Potevio’s allegation that the continuous impact of ST and *ST factors on B-share price after the A-share base date on March 21, 2017 was not considered, the short-term share price volatility arising from the ST and *ST factors had been absorbed through the long-term influences of ST and *ST factors in the calculation model.
As for Potevio’s challenge on the selection of constituent stocks in ST status in the calculation model, the loss assessors responded as follows: the ST factor of the model reflected the impact of various factors, such as poor management, ST, *ST and listing suspension risk, through long-term stock price adjustments, and it was an equilibrium estimate of the influence of ST and *ST factors on the companies’ share prices in the entire A-share market. Seeing that it is impossible to infer at a specific trading day which company in ST or *ST status would issue a warning of listing suspension risk, artificial selection and control by screening constituent stocks of each previous trading day based on information known afterwards would introduce additional model errors and in turn affect the accuracy of calculation.
In light of both parties’ opinions on the Loss Assessment Report and the response of the loss assessors, the Court affirmed as follows:
First, in terms of the calculation method of the loss of investment difference, according to the Misrepresentation Provisions, the loss of investment difference of an investor is calculated by multiplying the difference between the average price of securities purchased and the average price of securities actually sold or the base price by the number of securities held by the investor. Where an investor executes more than one buy and sale transactions, multiple methods are available to calculate the average buying price and the loss of investment difference. In this case, the Loss Assessment Report applied the weighted moving average method to calculate the average buying price after the first qualified purchase, i.e. for each qualified buy transaction, the sum of the cost for shares newly purchased and the holding cost for shares previously purchased was divided by the current number of shares held. For the above calculation method, Plaintiffs, though with no objection, deemed it to be cumbersome, proposing the FIFO + ordinary weighted average method as a simpler one.
The selection of a loss calculation method would directly affect the fairness and rationality of loss identification. The weighted moving average method after the first qualified purchase used by the Loss Assessment Report, was favored in judicial practice, as it would make the calculation of holding cost per share more comprehensive and objective and could better reflect investors’ real investment costs. Therefore, the method was endorsed by the Court.
Second, the method used to count losses caused by other factors such as systemic risks of the securities market is not clearly prescribed in the Misrepresentation Provisions. The Loss Assessment Report applied a calculation method that comprehensively took into account various common factors affecting the sustainability of share price, including not only the broader market factor and the industry factor, but also the style factors of Potevio (size, value, beta, earnings, leverage, growth, momentum, volatility, and liquidity) as well as the ST factor and the charging pile concept factor that were added to measure the influence ST status, *ST status and charging pile concept.
Compared to the method of simply comparing the share price change of Potevio with industry performance over a selected period of time, this method quantified various factors affecting share price, effectively separated the misrepresentation from other factors affecting share price, and was thus more fact-based and accurate and more in line with the legislative purpose and judicial practice requirements with respect to loss calculation in misrepresentation cases. The amount of investors’ losses of investment difference arising from the misrepresentation in this case were determined according to the Loss Assessment Report, that is, for Plaintiff Xu, the loss of investment difference arising from the misrepresentation was RMB 7,561.34; for Plaintiff Li, USD 1,480.96; for Plaintiff Hu, USD 1,621.99; and for Plaintiff Wang, USD 8,616.63.
In addition, pursuant to Article 30 of the Misrepresentation Provisions, aside from the aforesaid loss of investment difference, Potevio should also be liable for compensation for the commission, stamp duty, and related interest on the loss of investment difference. In this case, Plaintiffs claimed that Potevio should compensate the loss of commission and stamp duty at 0.1% of the loss of investment difference. The Court endorsed Plaintiffs’ claim for stamp duty, since Potevio acknowledged that stamp duty fell within the scope of compensation and had no objection to the calculation standards claimed by Plaintiffs. With regard to the claim for commission, Plaintiffs had no burden of proof for the existence of commission, as their trading of shares through the securities companies with which they opened accounts would definitely generate commissions; yet seeing that Plaintiffs did not provide evidence to prove the specific percentage at which their commissions were charged, the Court determined a compensation rate of 0.03% at its discretion with reference to the current general commission charging standard of securities companies. Investors who traded shares via their B-share securities accounts incurred USD losses, and they demanded Potevio to pay them in RMB after converting the USD losses at the USD/RMB exchange rate on the B-share base date recognized by the Court. Upon inquiry, the USD - RMB middle rate obtained in the inter-bank foreign exchange market was 6.3431 on March 5, 2018, the B-share base date. This was confirmed by the Court given the absence of objection from Potevio.
Pursuant to Article 69 of the Securities Law of the People’s Republic of China and Articles 17, 18, 19, 20, 30, 31, 32 and 33 of the Provisions of the Supreme People’s Court on the Trial of Cases of Civil Compensation Arising out of Misrepresentation in Securities Markets, the Court entered a judgement on April 17, 2020 as follows:
I. Defendant Potevio shall pay a compensation of RMB 7,571.17 to Plaintiff Xu;
II. Defendant Potevio shall pay a compensation of RMB 9,406.06 to Plaintiff Li;
III. Defendant Potevio shall pay a compensation of RMB 10,301.83 to Plaintiff Hu;
IV. Defendant Potevio shall pay a compensation of RMB 54,727.19 to Plaintiff Wang.
Appellant Potevio refused to accept the judgment of first instance and appealed to Shanghai High People’s Court, alleging that:
1. It was clearly inappropriate to directly connect the losses claimed by Plaintiffs to the misrepresentation, because after all, Potevio had gone through several stages including performance inflation, ST, *ST, listing suspension, and delisting. Amid the extreme volatility of China’s capital market in recent years, the causes for Plaintiffs’ losses were exceedingly complicated and thus should not be totally passed on to listed companies. Otherwise, an unbearable burden would be placed on the operation of listed companies.
2. The basic concept of exercising caution to guard against investment risks should be established among investors. Investors must be clearly aware of investment risks and be ready to withstand investment losses.
3. Seventeen years have passed since the Misrepresentation Provisions were promulgated by the Supreme People’s Court. This period witnessed tremendous changes in the internal and external environment of China’s capital market, and therefore the judicial system should respond to these changes in a timely manner.
4. The judgment of the first instance wrongly established a causation between Plaintiffs’ investment losses with the misrepresentation for the following reasons:
(1) The judgment of first instance mistakenly interpreted the “presumption of reliance” as a “strict liability”. The view of the judgement that there was transaction causation as long as an investor purchased Potevio shares before the exposure date run counter to legal provisions and the spirit of legislation. The book Understanding and Application of Judicial Interpretations on Trial of Cases of Misrepresentation in the Securities Market explicitly states that the “presumed reliance” is a kind of “defensible reliance”. Therefore, Potevio should be given an opportunity to prove that Plaintiffs’ investment decisions were not entirely in reliance on the misrepresentation but were affected by other investment motives including speculation, bottom fishing, and short-term speculation.
(2) In the defense against “presumed reliance”, the three criteria of transaction records, transaction time, and transaction background could be used to verify whether there as transaction causation. In terms of transaction records, Plaintiffs Xu and Wang continued to purchase a large number of Potevio shares after the exposure date; such fact indicated that the exposure did not exert any influence on their decision-making. In terms of transaction time, the first buy transactions of the two investors occurred more than half a year and even more than one and a half years after the commission date, and thus obviously their purchases were not in reliance on the misrepresentation. Therefore, the court should deny the transaction causation between the two investors’ losses and the misrepresentation.
Plaintiffs Li and Hu ignored the fact Appellant had projected a loss of RMB 28 million in an announcement in October 2015 and bought additional shares when the share price went up for the purpose of speculation. Particularly, Plaintiff Li had only one transaction record, which occurred in January 2016, nearly one year after the commission date of the misrepresentation; Plaintiff Hu traded Potevio shares from October 2015 to July 2016. All the buy transactions of Hu occurred during the rise of the charging pile concept on the market, and he conducted additional purchases after making a profit from the 2,000 shares purchased for the first time. The act of selling after gaining short-term profit clearly showed that the intention of Hu was to profit from Potevio’s share price rise. Clearly, Li and Hu were not induced by Potevio’s earnings prospects to purchase Potevio shares. Therefore, the court should rule that there was no transaction causation between the two investors’ losses and the misrepresentation.
(3) After the commission date, the share price of Potevio did not surge due to the misrepresentation. Instead, the overall trend of the share of Potevio as a small-cap stock was consistent with the broader market and industry indices. Since October 2015, Potevio had repeatedly disclosed unfavorable operating information. The amount of losses disclosed first enlarged from RMB 28 million to nearly RMB 100 million and then jumped to RMB 470 million as recorded in the 2016 annual report. In comparison, the amount of losses disclosed was 47 times the amount of inflated profit of RMB 9.98 million. Under such a circumstance, even if the misrepresentation produced any inducing impact, the impact had been offset by the successive announcements on operating losses. Plaintiffs who continued to buy Potevio shares after these poor operating results were disclosed had long ceased to make investment decisions based on Potevio’s operating conditions. On the contrary, their decisions, being utterly unrelated to whether Potevio’s profit was inflated or whether its performance was good or bad, essentially amounted to “investment despite knowing the existence of misrepresentation.”.
(4) Even if, at the very worst, there existed transaction causation, the strength of causation between investment decisions and the misrepresentation for different investors should be distinguished. The compensation rate for investors who had obvious motive of bottom fishing (ignoring the impact of the exposure of the misrepresentation) or speculation should be further lowered to mitigate Potevio’s liability for compensation.
5. The charging pile concept leading to share price surge identified in the judgement of first instance was by its nature, a deduction factor to be taken account in the loss calculation process, which shall not be confused with the factor to be taken account in deciding the proportion of liability and establishing the transaction causation.
6. The wrong selection of constituent stocks in ST status in the Loss Assessment Report resulted in an excessively high compensation rate for B-share investors. According to the securities market’s usual response to a small-cap company’s continuous occurrence of ST, *ST and listing suspension within one year, the loss assessors determined that Potevio’s simulated share price fluctuated around RMB 20 (instead of falling significantly), which was not in line with real trading scenarios and economic laws. The reasons are as follows:
(1) After comparing the simulated loss ratio with nominal loss ratio of investors in the Loss Assessment Report issued by CAFR, Appellant found that the compensation rate for A-share investors was 40%-60% of the nominal losses, while that for B-share investors was as high as 75-85% of investors’ nominal losses. Considering the evident correlation of share price movement between a listed company’s A shares and B shares, there should not be such a big gap between the compensation rates for A-share and B-share investors. B shares of Potevio should not be treated differently just because they were traded in a foreign currency, and the compensation rate for B-share investors should not be significantly higher than that for A-share investors.
(2) The method of “constituent stocks in ST status” and linear regression could not accurately reflect the impact of listing suspension on the share price of Potevio. Out of the around 70 constituent stocks in ST status on the list, less than ten samples, or totally five to six samples, underwent actual listing suspension/delisting as Potevio did, including Ingenious Ene-Carbon New Materials Group, Shenji Group Kunming Machine Tool, Chengdu Huaze Cobalt & Nickel Material, and Ji Lin Ji En Nickel Industry. Because of the mismatching in the number of samples, the dramatic impact of the listing suspension on the stock market was not fairly reflected. After Potevio unveiled the first announcement regarding its listing suspension on January 31, 2018, less than 30 trading days from the B-share base date, Potevio’s share price was struck a heavy blow, plummeting by the daily limit on each trading day over a week. Such an intense correction of share price, which was caused by the date of announcement on listing suspension and the base date being particularly close, was not embodied in the long-term adjustment method of linear regression. The listing suspension factor had an impact ratio of at least 16.65% on Potevio’s share price decline according to the estimate of Appellant, and it should be excluded from loss calculation.
(3) The simulated B-share price failed to accurately reflect the continuous impact of ST and *ST factors on Potevio’s B-share price after March 21, 2017. According to Appendix 2 of the Loss Assessment Report, the simulated B-share price on April 25, 2017, the official date on which Potevio entered *ST status, was USD 0.890, lost 0.4% and 1.9% from the previous two simulated trading days on April 24, 2017 and April 21, 2017, respectively. However, the actual A-share price on April 25, 2017, the official date on which Potevio entered *ST status, fell 4.9% from the previous trading day on April 21, 2017 (A-share trading was suspended on April 24, 2017 due to official implementation of ST); the actual A-share price dived 10.66% on the 30th trading day after Potevio entered *ST status; and the actual A-share price declined 5.30% on the trading day when the turnover rate reached 100% after Potevio entered *ST status. It can be concluded from these figures that the simulated B-share price in the Loss Assessment Report failed to reflect the continuous impact of ST and *ST factors on Potevio’s B-share price.
(4) The B-share base date was delayed by a full year or so compared with A-share base date. In Appellant’s view, the one year taken to absorb the impact of the exposure of the misrepresentation was too long and therefore unreasonable. Under a circumstance that the B-share base date was unreasonably postponed due to requirements of legal systems, the systemic risks and market risks that needed to be deducted from the commission date to the base date of B shares should be particularly given adequate consideration, so as to ascertain the actual responsibilities of the misrepresentation maker.
(5) Applying the relative proportion method and the bubble squeeze method, Appellant calculated the compensation rate for B-share investors, which was around 25-35% of investors’ nominal losses. Therefore, in the opinion of Potevio, even assuming there was transaction causation between investors’ losses and Potevio’s misrepresentation, the compensation rate for B-share investors should be significantly lower than that for A-share investors.
Appellees Xu, Li, Hu, and Wang argued that in the judgement of first instance, the facts found were clear and the application of law was correct, and requested the court of second instance to dismiss the appeal and affirm the judgment of the first instance.
In the trial of second instance, Shanghai High People’s Court affirmed the facts found by the court of first instance.
In addition, Shanghai High People’s Court found that (1) Xu purchased 7,000 shares of Potevio from the commission date to the exposure date and another 118,200 shares of Potevio on or after the exposure date; (2) Wang purchased 28,000 shares of Potevio from the commission date to the exposure date and another 12,000 shares of Potevio on or after the exposure date.
Shanghai High People’s Court held in the second instance that:
The issues of the second instance were identified as follows: (I) Whether there was causation between the misrepresentation and the losses suffered by investors; and (II) Whether there were mistakes in loss assessment.
(I) Whether there was causation between the misrepresentation and the losses suffered by investors. Article 18 and Article 19 of the Misrepresentation Provisions have set out specific and clear provisions on the causation between the misrepresentation and the investor losses. Potevio defended against the causation on the grounds that the Misrepresentation Provisions were promulgated a long time ago and the circumstances had changed. Such defense was rejected by the court since the Misrepresentation Provisions were still in effect. Article 18 of the Misrepresentation Provisions stipulates the specific circumstances under which causation can be presumed. As long as some of the securities purchased by the four Appellees met the circumstances stipulated in Article 18, it should be presumed that there was causation between the misrepresentation and the harmful consequences. Potevio could not overturn the above presumption unless it was able to present evidence to prove the existence of the five circumstances listed in Article 19 of the Misrepresentation Provisions. After the exposure of the misrepresentation, Potevio’s share price fell by daily limit on that very day. The share purchase decisions of Xu and Wang after the exposure date shall be deemed as having taken into account factors such as exposure of the misrepresentation and share price decline. But prior to the exposure date, it was impractical for them to incorporate into their decisions factors that had not yet occurred. Factors affecting decision-making, such as market environment, share price and company growth, varied with the purchase time, and thus it should not be presumed based on future transaction behaviors that buy transactions prior to the exposure date were not affected by the misrepresentation. Hence, grounds of Appellant in this regard contradicted common sense and were held unacceptable. Once the misrepresentation occurred, it would lead to a share price bubble, and would continue to affect subsequent share price formation until it was exposed. This is why Article 18 of the Misrepresentation Provisions ignored the time interval from the commission date to the exposure date. The share purchases of Li and Hu came after Potevio’s announcement on loss projection, and therefore their decisions shall be deemed as having taken into account the loss projection. However, it should be noted that since the prices at which they purchased shares contained bubbles caused by the misrepresentation, a de facto causal connection was formed between their losses incurred from selling these shares after the exposure date and the act of misrepresentation. Similarly, despite that the first share purchases of Xu and Wang occurred half a year and even one year after the commission date, the existence of causation should be affirmed. Potevio’s grounds of appeal with regard to this issue completely denied the existence of share price bubble caused by the misrepresentation and were contrary to common sense. As a result, they were not accepted by the court.
(II) Whether there were mistakes in loss assessment. On account of the fact that the Misrepresentation Provisions stipulate the method for determining the base date without providing any exceptions for such circumstances as poor liquidity and insufficient turnover rate, it was not improper for the original judgement to determine the base date according to the provisions. Potevio’s view that the time interval between the B-share base date and the exposure date was too long lacked a legal basis and was not accepted either. The formation of share prices, the rise and fall of the stock market, and investor losses were attributable to multiple factors. The longer the time interval between the purchase date and the base date, the greater the possibility that the share price would be affected by systemic risks, industry risks and other factors, and the more difficult it would be to identify the losses. For the purpose of assessment of the losses caused by the misrepresentation, as irreversible price deviation had occurred, none of the post-event calculation methods available could completely restore the market environment and situations at the time of transaction in order to realize precise calculation. Moreover, the greater the number of investors involved in litigation triggered by the misrepresentation, the higher the litigation cost of accurately calculating the losses of each investor would be. Therefore, to pursue relative accuracy and fairness, a relatively reasonable solution was to adopt a simple, easy, efficient and low-litigation-cost loss determination method. The multi-factor model method employed in the Loss Assessment Report was extremely professional and complicated in calculation methods: in terms of the influencing factors adopted in the formula, the model designers incorporated 11 factors such as size, beta, charging pile concept, and ST and offered specific reasons for the inclusion of each factor, which fully demonstrated that they possessed profound and professional knowledge of the securities market, finance, and economics; in terms of data of the model, the collection and entry of data needed for calculation, including data of investors trading Potevio shares and historical trading data of a large number of reference stocks, required extremely professional accounting knowledge and computational programming techniques. Additionally, in terms of educational and professional background, most of the five members of the assessment team had master’s or doctor’s degrees in finance, accounting and financial economics and computer science, and had teaching and research experience in related fields as well. Their respective professionalism determined that the Loss Assessment Report they jointly contributed to were more empirically sound and reliable than the opinions of just one or two experts.
The securities sector is highly specialized, and the calculation of losses arising from misrepresentation in the securities market involve economics, finance, accounting, mathematics, computer programming, and other disciplines and fields. Appointing a professional and neutral third party to issue the Loss Assessment Report was more in line with procedural justice and substantive justice. As a consequence, Potevio’s ground of appeal that its proposal was more reasonable was not accepted. Before adopting the Loss Assessment Report, the court of first instance reviewed the basic information and professional experience of CAFR and the five loss assessors and heard the opinions of both parties and the supplementary explanations of loss assessors. With regard to Potevio’s challenge against not separately considering the impact of listing suspension, loss assessors had responded that this factor had been measured through the value, earnings and ST factors and that the addition of listing suspension factor would lead to repeated deduction. The responses of loss assessors were obviously more convincing, and thus it was not improper that the court of first instance did not support Potevio’s challenge. Since in this case, neither party had presented evidence to prove that the loss assessors’ responses lacked fairness, soundness and authority, the court of first instance’s determination of the losses by referring to the Loss Assessment Report satisfied the fundamental requirements of due process. It must be admitted that the power of science is limited. Our understanding of the world depends on the social needs for science and advancements in technology, and further research will undoubtedly leads to new understanding. Nevertheless, the Loss Assessment Report already represents the most sound, economic, and efficient way currently available with regard to this matter and meets the high probability standard required in a civil litigation. It was reasonable for the court of first instance to determine investor losses according to the report. As a result, Potevio’s grounds of appeal in this regard were held untenable.
In accordance with Article 170(1)(1) of the Civil Procedural Law of the People’s Republic of China, Shanghai High People’s Court rendered the following judgment on June 11, 2020:
The appeal is dismissed and the judgment of the first instance is affirmed.
This Judgment is final.
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