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Focus: Greater China – Financial Regulation – June 2008

Tighter regulation of stock, securities and futures markets in the PRC

In brief: The Supreme People's Procuratorate and the Ministry of Public Security have jointly announced new rules to regulate the stock, securities and futures markets and to combat securities fraud in the People's Republic of China. Partner Simon McConnell (view CV) and Senior Associate Mun Yeow look what the new regulations mean. 

How does it affect you?

  • After the implementation of the new rules, investors will be empowered to take legal action against wrongdoers for a broader spectrum of financial crimes, including the making of false financial statements by listed companies, damage to listed companies, insider trading, disclosure of insider information, manipulation of trading prices of securities and futures, and manipulating trust assets in bad faith.
  • More detailed explanatory notes to the criminal law regarding economic crimes are addressed in the rules, which reflect the PRC Government's strong motivation to tackle the problems of market irregularities and to monitor irregular market transactions.
  • The rules represent a nationwide policy that further defines the law to minimise ambiguity and give clearer guidelines to law enforcement organisations, lawyers and market players. Officers in companies and fund managers should familiarise themselves with the new ethical standards.

Duty of properly disclosing relevant candid information

Under Article 161 of the Criminal Law of the PRC, persons directly in charge of a company that gives shareholders and the general public false financial and accounting reports, or reports that conceal important facts, will be criminally liable.

In particular, an officer of a company would commit an offence if he fraudulently withholds important facts in the financial reports that have later shown to have caused shareholders, creditors or others direct economic loss amounting to an aggregate sum of 500,000 yuan.

Legal action can also be taken against a company that inflates or diminishes corporate profits or assets by more than 30 per cent. It should be noted that when the sum involved in any litigation, arbitration, surety or affiliated exchange that amounts to 50 per cent of the total net assets of the company for the past 12 consecutive months, it should be disclosed accordingly.

These rules should increase transparency in the stock, securities and futures markets in the PRC. Its promulgation is expected to be welcomed by investors who would like to have certainty and completeness of information prior to making investment decisions.

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Insider trading

Under Article 180 of the Criminal Law, any company insider who possesses pre-published information about any stock or futures exchange transactions that has a vital bearing on the stock price, or anyone who illegally obtains such information, buys or sells the respective stock or divulges such pre-published information shall be held liable.

The insider can be prosecuted if he or she uses that insider information directly or indirectly to sell or buy securities and futures contract that amounts to an aggregate of 500,000 yuan and 300,000 yuan respectively. Moreover, it will also be unlawful if insider information is used to prevent loss or for making profit of up to 150,000 yuan or above.

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Manipulating stock or futures prices

Attention should be given to Article 182 of the Criminal Law, which provides that a person who rigs stock or futures prices to obtain illegitimate profits or transfer risks, will be held liable to a fine of not less than one time and not more than five times the illegal gains. Where the circumstances are serious, he or she will also be sentenced to a fixed-term imprisonment in addition to a fine.

It is unlawful for a person, either working alone or by conspiracy, to rig stock or futures prices through concluding transactions more than 30 per cent of the total volume of trade in 20 consecutive trading days.

Likewise, stock or futures exchange transactions amounting to more than 20 per cent of the total volume of transactions in twenty consecutive trading days are illegal if they are carried out at a time, price or in a manner previously agreed between colluding parties.

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Damage on benefits of listed companies

Under Article 169 of the Criminal Law, board directors, supervisors and senior officers who provide or accept capital, goods, services and other assets under unfair conditions or alternately, provide surety to someone who has no obvious ability of repayment, thereby resulting in direct economic loss of 1,500,000 yuan to the listed company, are criminally liable.

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Effect of the promulgation of the rules

In January 2008, the China Securities Regulatory Commission (CSRC) expressed an intention to rectify the serious issue of securities fraud by joining forces with the People's Supreme Court and the Ministry of Public Security. In relation to the 366 cases of alleged securities fraud that the PRC police investigated last year, 48 people have been detained for further questioning.

The CSRC believes that the implementation of the rules, together with close collaboration between law enforcement and the judiciary, would greatly enhance the PRC government's ability to combat financial crimes in the stock, securities and the futures markets.

In view of a fast-growing economy, financial crimes in the PRC have become more sophisticated. The supplemental rules are targeted to cover a wider range of securities fraud than that existing under the earlier rules introduced in 2001.
 
It is anticipated that more illegal insider trading activities and legal actions will be made public in the coming months.

It would appear that the CSRC and the rule drafters had worked closely together in the drafting process to ensure that the new rules would be effective in punishing market manipulators, and at the same time, give a clear guide to the markets on what is to be considered illegal conduct under the new regime.

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Criticism of the rules

Notwithstanding that new rules have been introduced to tackle difficult situations concerning market irregularities, the CSRC has been criticised because of the apparent lack of protection concerning retail investors.

Despite only two fund managers having been fined 500,000 yuan each for insider trading, it is argued that the penalty should be increased if the new rules are to provide an effective deterrence to potential offenders.

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Conclusion

Market players and investors in the PRC markets should familiarise themselves with the new rules and the prevailing attitude of the regulators towards insider trading and market manipulation activities. What was previously regarded as acceptable market behaviour may no longer be permissible under the new rules. Given the well-known aspiration of the PRC markets and regulators to achieve international best practice, it is expected that further rules will be introduced to increase transparency and corporate governance with a view to protecting the investors.

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