Judicial revisions to insider trading

The Supreme People’s Court and the Supreme People’s Procuratorate have released the amended Interpretation on Several Issues Concerning the Specific Application of Law in Handling Criminal Cases of Insider Trading and Disclosure of Inside Information. The revision, which is the first comprehensive update in 14 years since the interpretation came into force in 2012, signals the extension of the capital market’s zero-tolerance enforcement stance into the realm of criminal law.

Definition

Insider trading is defined as the purchase or sale of relevant securities, engagement in related futures trading, disclosure of information, or recommendation or inducement of others to trade, by persons with knowledge of or unlawful access to inside information, prior to the public release of that information. At its core, it is a form of securities fraud in which those with informational superiority exploit material non-public information for unjust enrichment.

In practice, insider trading manifests in three principal forms:
(1) direct trading by insiders using their own accounts or accounts under their control; (2) tipping, where the insider passes inside information to associates, family members or other interested parties; and (3) recommendation trading, where the insider, without directly disclosing the information, uses suggestive remarks, such as “it is time to buy” or “leave the market now” to prompt others to act.

Liability

Insider trading exposes offenders to a tripartite enforcement regime encompassing administrative sanctions, criminal penalties and civil claims. On the administrative level, offenders must surrender any unlawful gains and pay a fine of one to 10 times the value of those gains and may additionally be prohibited from participating in the securities markets in serious cases.

On the criminal level, offender shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention, and shall also, or shall only, be subject to a fine, while especially serious offences attract a sentence of five to 10 years’ imprisonment and a fine. On the civil level, offenders are liable for losses suffered by investors as a result of their conduct.

The regime for enforcing securities laws in China operates on a model of administrative priority backed by criminal justice collaboration. Securities regulators conduct initial investigations and impose administrative sanctions. Cases suspected of involving criminal conduct must be referred to the police for criminal investigation, in line with the statutory requirement that all qualifying cases be handed over.

Key revisions

The new judicial interpretation revises the law in four principal respects, namely, the definition of insiders, the standards for determination, the prosecution threshold and the available defences.

A broader definition of insider. The interpretation updates its statutory foundation to article 51 of the Securities Law and article 15 of the Futures and Derivatives Law. Certain previously ambiguous categories are now expressly covered, including persons who obtain inside information through their professional roles or commercial relationships acquirers of listed companies, parties to significant asset transactions and their controlling shareholders, de facto controllers, directors, supervisors and senior executives.

Advanced trigger for the restricted trading period. Under the new judicial interpretation, the moment at which a controlling shareholder, actual controller or relevant decision maker conveys a preliminary intention to form inside information to a close associate, or carries out transactions on the basis of such an intention, is deemed to be the starting point of the preliminary move.

The prohibited period was previously measured from the time of a formal proposal or written formulation. The interpretation now moves the trigger much earlier, so that the restricted period begins immediately upon the communication of a preliminary intention to certain persons, or upon trading motivated by that intention.

Recalibrated thresholds for prosecution and sentencing. For general offenders, the threshold based on the value of securities transactions has been lifted from RMB500,000 (USD74,395) to RMB2 million, while the profit-based threshold has been increased from RMB150,000 to RMB500,000. A reduced threshold, set at half the general level, applies to statutory insiders, persons who sell inside information, and those with a criminal record. The interpretation also clarifies that the standard for particularly serious cases is 10 times the ordinary prosecution threshold.

Narrowed grounds for exculpation. The defence of acquisition is now subject to the express condition that trading, which is clearly not in furtherance of the acquisition and has no reasonable basis, will not excuse the defendant, thereby blocking the abuse of acquisition structures for speculative gain.

The defence of a pre-existing trading plan was made stricter by specifying that the plan must have been in place before inside information arose or before the defendant was aware of it, and by requiring that it sets out trading method, volume, price and timing with sufficient clarity and is otherwise in compliance with the law, to preclude the backdating of plans. The disclosure defence has been tightened by inserting the requirement that the information be made public through appropriate channels to the general investing public.

Compliance recommendations

Drawing on practical experience from insider trading criminal cases and focusing on core changes, the authors offer these compliance tips.

Adopt a risk mindset where intent equals sensitive information. Controlling shareholders, actual controllers and key decision makers must drop the old misconception that “preliminary ideas are not insider information”. The moment a major deal enters the incubation phase, whether through formal paperwork or through other means, all trading must stop and strict secrecy must be enforced.

Preserve an airtight paper trail for transaction decisions. Prior to increasing stakes or executing acquisitions, major shareholders should map out comprehensive strategies, outlining the deal’s objectives, funding sources and disclosure timelines while archiving every approval, decision and execution document.

This safeguards their eligibility for statutory exemptions, preventing them from losing protection if their trading pace or shareholding structure noticeably deviates from their stated objectives or initial plans.

Strengthen the co-ordination in linkage between administrative enforcement and criminal justice. Evidence collection and factual findings during administrative penalty proceedings frequently dictate the direction of subsequent criminal prosecution. During administrative investigation, parties should engage legal counsel early to pre-assess criminal exposure and build the bridge between administrative defence and subsequent criminal proceedings.

Administrative findings do not equal criminal guilt. As administrative penalties and criminal prosecutions have different standards of proof, a case transferral from administrative enforcement to criminal proceedings does not necessarily mean an insider trading conviction is set in stone. With skilled legal defence, there may still be room to avoid criminal liability in certain cases.

Zhang Bbaosheng is a partner at Zhong Lun Law Firm. He can be contacted by phone at +86 139 1079 1801, and by email at zhangbaosheng@zhonglun.com

Xiao Qiang is a non-equity partner at Zhong Lun Law Firm. He can contacted by phone at +86 188 1067 0411, and by email at xiaoqiang@zhonglun.com