(This article was first published on China Law & Practice, authorised reprint)
Siyuan Liu and Feng Zhao of Jingtian & Gongcheng highlight some key opportunities – and compliance risks – for foreign-invested securities companies in China.
The Measures for the Administration of Foreign-invested Securities Companies (外商投资证券公司管理办法, the "Measures") promulgated by the China Securities Regulatory Commission (CSRC) on April 28 2018 provide various opportunities for foreign-funded securities companies (FSCs) to develop their businesses in China. These include permitting foreign investors’ control over FSCs, expanding FSCs’ scope of business and further raising requirements on foreign investors’ qualifications. The implementation of the Measures not only further opens the Chinese financial market, but should also introduce well-respected foreign financial institutions into the country, both of which are hoped to facilitate further positive and smooth operation and development of the Chinese securities market.
In recent years, the CSRC has significantly strengthened its supervision and enforcement of the Chinese securities market, raised compliance requirements for all market participants, and dealt firmly with violations of applicable securities laws, regulation or rules. It is important that FSCs which plan to enter the Chinese securities market have a comprehensive and accurate understanding of such compliance requirements as well as the CSRC’s enforcement practice.
A number of the most significant compliance risks which FSCs might encounter in their operations in China are summarized below, based on a review of past securities compliance risks and a deep reading of enforcement cases.
1 MAJOR SECURITIES COMPLIANCE RISKS FOR FSCS
1. Insider trading
As provided in Article 76 of the PRC Securities Law (中华人民共和国证券法), individuals with access to inside information, or individuals unlawfully obtaining such inside information, must not in any way trade relevant securities, divulge such inside information to others or advise others to trade such securities before the inside information is legally disclosed to the public.
While forming their advice on securities investments, the FSC’s personnel (in particular their analysts) might come across, whether intentionally or not, undisclosed information, or even inside information, during their research into listed companies and their meetings with senior executives. These people – or even the FSC itself – might be found to have violated insider trading rules if such inside information is disclosed to others, or if they or their company’s department of securities proprietary engages in securities trading by taking advantage of such inside information.
If insider trading is proven, an FSC or its personnel could be subject to administrative penalties, such as warnings, disposal of securities, confiscation of illegal proceeds, or a fine of one to five times of the value of the illegal proceeds. Where the circumstances are serious, the FSC or its individual personnel might also be permanently banned from operating in the Chinese securities market, or could even find themselves subject to criminal proceedings.
2. Manipulation of the securities market
As stipulated in Article 77 of the PRC Securities Law, manipulation of the securities market refers to any of the following behaviors: (1) manipulating securities prices or trading volumes by, independently or in collusion with others, jointly or successively trading such securities to one’s advantage in terms of funding, shareholding or obtaining information; (2) affecting securities prices or trading volumes by collaborating with others in securities trading at an agreed time or price and by an agreed method; (3) affecting securities prices or trading volumes by trading between accounts actually controlled by the same party; and (4) manipulating securities market by any other means.
While trading proprietary securities, FSCs might be found to be manipulating the securities market if they unduly affect securities prices or trading volumes by any of the behaviors provided in Article 77 of the PRC Securities Law. Given the CSRC’s latest enforcement practice, FSCs might also be found to be manipulating the securities market when advising on managing listed companies’ market values if they collude with the listed companies’ controlling shareholders or actual owners in manipulating securities prices by unduly manipulating the timing and the substance of disclosure of information.
If found to have manipulated the securities market, an FSC or its personnel could face various administrative penalties, such as warnings, disposal of securities, confiscation of illegal proceeds, or a fine of one to five times of the value of any illegal proceeds. Where the circumstances are serious, individuals might be permanently banned from operating in the Chinese securities market, or even pursued for criminal liabilities potentially along with the FSC itself.
3. Violations of the duty of due diligence
Articles 11, 31 and 173 of the PRC Securities Law specify requirements for securities companies’ when underwriting and sponsoring the issuance of securities, and when providing financial advice on securities trading or investments. These provisions require securities companies to fulfill their duty of due diligence, to comply with operating rules and industry standards, to carry out a thorough examinations of disclosed information and to ensure the authenticity, accuracy and completeness of such disclosure.
FSCs might be found to have violated the duty of due diligence if they fail to comply with operating rules or industry standards in their practice, and this further results in a false record, misleading statement or major omission in information disclosure.
If found to have violated the duty of due diligence, a number of administrative penalties could be imposed on FSCs and their personnel, such as corrective orders, warnings, confiscation of illegal proceeds, fines, suspension, or withdrawal of licenses or permits. Where the circumstances are serious, individuals might also be permanently banned from operating in the Chinese securities market. FSCs and their personnel could also face civil securities-fraud lawsuits brought by the listed companies’ shareholders based on claims for compensation of the shareholders’ losses flowing from the violation, the total amount of which could reach hundreds of millions of RMB.
4. Other violations
Various laws and regulations further provide detailed requirements for securities companies’ daily operations, such as the Regulations for the Oversight of Securities Companies (证券公司监督管理条例). Such requirements cover almost every part of securities companies’ daily operation in China. FSCs might also face administrative penalties in cases where they fail to comply with such requirements in their daily practice, such as securities brokerage, margin financing and securities lending, or consignment sale of securities investment funds. Securities companies could face severe penalties even where they believe their violations are minor and cannot be completely avoided due to the size of their practices. For example, violations are committed when securities companies fail to designate special personnel to explain business rules and the content of contracts to clients in an appropriate manner; fail to reveal investment risks in writing; fail to deposit and manage their clients' funds, capitals and securities in compliance with applicable regulations; fail to recommend products or service which are suitable for their clients' circumstances; or fail to open securities accounts in compliance with applicable regulations.
2 KEY POINTS TO ENSURE PRACTICE IN FULL COMPLIANCE IN CHINA
1. Comprehensive understanding of compliance requirements and deep reading of local enforcement
There are many laws, regulations and rules setting out compliance requirements when setting up and operating securities companies in China, and these cover a broad range of securities companies’ practices. The CSRC is also systematically developing its enforcement rationale and establishing its enforcement standards against securities violations. Higher standards are implemented and a tougher enforcement line is taken in China. For example, the CSRC has developed almost 10 methods of finding the exact time of the generation of inside information, according to the particular facts of its cases. Given the stealthy nature of insider trading, the CSRC further relies on various facts and employs the presumption method when determining whether a wrongdoer has taken advantage of the inside information, such as whether the wrongdoer has made contacts with individuals with such inside information within a certain period, whether the wrongdoer’s securities trading is obviously abnormal, and whether the wrongdoer has any other justifications for apparently abnormal securities trading.
To ensure they operate in full compliance, FSCs should ensure they have a comprehensive and accurate understanding of all applicable laws, regulations and rules in China as well as a deep reading of CSRC’s enforcement practice. Given the systems in place and the complexity of CSRC’s enforcement standards, FSCs should rely on outside counsel’s expertise in the field in order to ensure their accurate understanding and effective implementation of such requirements.
2. Establishment of securities compliance system and focus on internal investigation mechanism
With a comprehensive and accurate understanding of securities compliance requirements in China, FSCs should attach great importance to such requirements and further strengthen their securities compliance system, in order to implement the requirements into their daily operations. Besides enacting internal rules, an FSC’s securities compliance system should incorporate a whistleblowing and internal investigation mechanism at its core. Such a mechanism will facilitate the implementation of securities compliance requirements and the establishment of a pervasive compliance culture by obtaining evidence of potential violations timely, allowing internal investigations to be started effectively, and seriously disciplining any violations which are uncovered.
3. Preparation for crises and assistance from professionals
FSCs should make sure they have established a strong mechanism to assist them to respond to crises such as securities violations or administrative or criminal investigations. With assistance from outside securities compliance lawyers, this mechanism will help to ensure the FSC’s legal cooperation with administrative or criminal investigations, safeguard the FSC’s legitimate rights by pleading their cases, putting forward a robust defence or applying for hearings, and further improve the securities compliance system by detecting, locating and mitigating any defects.