Securities litigation risks and liabilities for continuous supervisors

In recent years, many stock investors have brought lawsuits against continuous supervisors for securities misrepresentation. This article draws on the authors’ own professional experiences with relevant regulations and judicial practice to analyse the administrative and civil liabilities that may arise for securities companies during their continuous supervision.

Definition and scope

According to the relevant laws, regulations and rules, continuous supervisors refer to securities companies, including sponsors or financial advisers bearing the responsibility of continuous supervision for initial public offerings, listings and securities issuance, M&A and restructuring of listed companies, as well as lead brokers for dealings on the National Equities Exchange and Quotations (NEEQ).

During continuous supervision, securities companies are in charge of supervising the relevant entities as they fulfill their obligations relating to standardised operation, information disclosure and compliance with commitments, and review information disclosure documents. These duties remain largely consistent between different types of activities.

Administrative liabilities

Under relevant laws and regulations, securities companies may be subject to administrative penalties or regulatory measures imposed by the China Securities Regulatory Commission (CSRC), or regulatory measures or disciplinary actions imposed by the stock exchange, for failure to exercise diligence in continuous supervision.

Based on regulatory cases, securities companies that fail to exercise diligence in continuous supervision experience real risks of administrative penalties by the CSRC if there is any misrepresentation.

For example, in an administrative penalty decision issued by the Chongqing branch of the CSRC in 2021, the agency found Haitong Securities failed to obtain the current corporate credit report of Aurora Optoelectronics and keep it in the continuing supervisory working papers, and did not conduct the required review and inspection of the report.

Consequently, it failed to discover Aurora’s irregular provision of external guarantee, or the omission in its disclosure of information. Haitong’s failure to uphold its continuous supervisory duties led to misrepresentation in its 2017 report of annual on-site inspections.

Based on the authors’ research, the risk of administrative penalty faced by securities companies for failing to exercise diligence in continuous supervision is relatively low, but the odds for regulatory measures or disciplinary actions are greater. At least 20 brokers have been issued warning letters from the regulators for such non-compliance.

Civil liabilities

Liability of a securities company for compensation should be conditional upon the issue of an inaccurate report. In other words, if the securities company did not issue any opinion on the listed company’s violations during continuous supervision, it should not be liable for compensation.

According to article 163 of the Securities Law, only when the securities service provider issues an inaccurate report and is lax in its due diligence shall it be liable for compensation for the investors’ losses.

In a misrepresentation case involving Soling, the Shenzhen Intermediate People’s Court held that none of the illegalities identified in the penalty decision were major asset restructuring matters, with China Merchants Securities (CMS) as the independent financial adviser, whose report in this capacity also did not contain an opinion issued on Soling’s annual reports from 2016 to 2018. Therefore, CMS was not liable for misrepresentation.

Securities companies bear no obligation of substantive review for listed company’s periodic and interim reports during continuous supervision, and have no duty to ensure the truthfulness, accuracy or completeness of the disclosed information.

Based on historical judicial practice, even if there was misrepresentation in the listed company’s periodic or interim reports, the securities company would not be held liable for compensation as it had no substantive review obligations for those reports.

For instance, in the above-mentioned Soling case, the Shenzhen court held that the securities company was under the obligation to supervise the listed company in its information disclosure, but not to verify the contents, nor ensure they were true, accurate and complete.

In a separate case involving creative craft and ceramic manufacturer The Great Wall, the Guangzhou Intermediate People’s Court held that the security company was under obligation to verify the periodic disclosures. Therefore, investors’ claims for the security company to bear liability for misrepresentation due to failure to verify and validate periodic reports in its continuous supervisory lacked legal basis.

Continuous supervisory report does not contain any information on stock investment value, and there is little cause and effect between it and the activity of stock investment.

In the misrepresentation case involving Er-Kang Pharmaceutical, the Hunan High People’s Court held that the continuous supervisory report issued by Western Securities contained no information on the value of stock investment, and there was no reason for investors to base their investment decisions on it.

There was also no evidence that any regulator deemed Western Securities to have breached its obligations, or that it was subject to any form of penalty as a result of the relevant disclosure. Accordingly, Western Securities was under no liability to compensate for investors’ losses.

Authors’ analysis

Judicial practice has provided fairly clear delineation of duties and corresponding civil liabilities of securities companies during both listing and continuous supervision. They are not responsible for verifying the contents of listed companies’ periodic and interim reports, nor ensure their truthfulness, accuracy and completeness.

Instead, their duties revolve around the standardised operation, information disclosure and fulfilment of commitments of the listed entity and reviewing its disclosed information. In particular, such review is formal and procedural, not substantive. On that note, the authors believe continuous supervisors should not be civilly liable to investors for securities misrepresentation.

Li Amin is a partner at Commerce & Finance Law Offices. He can be contacted at +86 150 0066 6860 or by e-mail at liamin@tongshang.com.
Cai Xiaoyu is a associate at Commerce & Finance Law Offices. He can be contacted at +86 187 1772 0569 or by e-mail at caixiaoyu@tongshang.com.