Seller’s liability in financial asset management disputes

Many enterprises, especially in real estate, have encountered debt crises in recent years from a tsunami of the pandemic, macroeconomic control and business cycles. Consequently, asset management products directly or indirectly invested in such enterprises have been mired in the payment mud, provoking a large number of disputes.

As banks and other sales agencies have become common channels for investors to subscribe to financial products, investors usually sue issuers along with sales agencies, resulting in a significant increase in the number of lawsuits filed against sales agencies. Having advised many cases involving institutional agent sales in recent years, the author discusses core controversial issues and resolution of such cases, taking banks’ sales of trust products as an example.

Defendants, basis of claims

There are two main types of lawsuit avenues involving investors in institutional agent sales cases. One is to sue the agent bank alone for compensation liability, and the other to sue both the trust company and the agent bank for joint and several liabilities.

In the first type, investors usually claim that the agent banks partially fail to fulfil suitability obligations, with a clear basis for the claim. In the second, investor claims against the trust companies are usually over their breach of fiduciary duties, such as violation of a law or contractual agreement in managing the trust property and non-complied information disclosure obligation, while agent banks are usually sued for their unsatisfied suitability obligation.

According to the law, the assumption of joint and several liabilities must be stipulated by law or agreed upon by the parties, and the issuers and sellers of financial products can assume joint and several liabilities only on failure to fulfil suitability obligation, not other legal obligations. Since managing products is not the legal obligation of agent banks, it is beyond their legal duties to bear such liabilities.

Therefore, for this type of lawsuit, investors should first clarify the claim of joint and several liabilities, whether based on breach of suitability obligations, or breach of fiduciary duties. In the latter case, the claim may lack legal basis, making it difficult to win support.

Suitability obligation

A breach of the suitability obligation is a prerequisite for the bank’s assumption of compensation liability and is the essential focus of controversy in such cases. The obligation includes duties to know the customer, know the product, sell the appropriate product to the appropriate consumer, and to inform and explain.

(1) Know the customer. Knowing the customer, including verifying their qualified investor status and assessing their risk tolerance, is the starting point of sales by agent banks, and important part of protecting investor rights and interests.

In past judicial practice, courts usually adopted a formal examination in this regard. However, in recent years, there is a tendency to adopt a substantive examination, namely examining not only whether agent banks have completed the work of knowing the customer, but also if they appropriately determined investors’ qualified investor status and approved risk tolerance.

(2) Know the product. Investors usually claim that agent banks don’t know the products well, based on the investment losses or regulatory opinion of the China Banking and Insurance Regulatory Commission (CBIRC) on illegal operation of the product, to further claim breach of the suitability obligation. However, courts are usually more cautious, pointing out that failure of agent banks to fulfil their suitability obligation cannot necessarily be inferred from investment losses.

Regarding regulatory opinion of the CBIRC or other regulatory authorities on the illegal operations of products, unless the agent banks knew, or should have known, about the illegal operations before the sales of products, they should not be liable for illegal operations of the products after conclusion of the contracts.

As to determining whether the agent banks have fully fulfilled their duty to know the product, the examination based on due diligence conducted by banks before starting agent sales is a general way. In this regard, regulations such as the Notice of the China Banking Regulatory Commission on Regulating the Agent Sales Business of Commercial Banks and the Interim Measures for the Administration of Sales of Wealth Management Products of Wealth Management Companies clearly require that the agent bank shall conduct independent due diligence and risk rating of the products they sell, in terms of their legality and compliance.

If a product has defects in its legality and compliance, the agent bank may be determined to have failed in the performance of its duty to know the product.

(3) Inform and explain. The scenario of traditional agent sales cases is that investors subscribe for products offline at bank service outlets. The regulatory rules require agent banks to carry out dual recording when promoting products offline, which can help to determine whether its duty to inform and explain was fulfilled.

In recent years, with the rising popularity of selling wealth management products through digital channels, more and more investors subscribe to such products through mobile and online banking.

Currently, many disputes occur when investors subscribe online to products recommended by their wealth managers through WeChat or other social media. In this case, how does one judge whether agent banks have fulfilled their duty to inform and explain? Is it based on the wealth managers’ information and explanation, or the subscription procedure?

There is no clear regulatory rule on this issue. In current cases involving sales of wealth management products through digital channels, the mainstream judicial view is that agent banks have fulfilled their duty to inform and explain as they make each confirmation step following the subscription procedure before investors pay for the product.

There is little discussion on the specific role of wealth managers. Whether the agent banks have fulfilled their duty to inform and explain should not be judged based on the information and explanation of wealth managers at the time of online sales. However, induced sales or misrepresentation in the product’s promotion by wealth managers are regarded as deficiencies by agent banks in fulfilling their duty to inform and explain.

Summary

In the event of a payment crisis of asset management products, disputes involving sales agencies often break out in a concentrated manner, and sales agencies are inevitably passive in temporary response. It is recommended that sales agencies pay close attention to the operation of products, regularly review their fulfilment of suitability obligations, and pre-plan proper resolutions for such disputes.

Gao Ping is a partner at AnJie & Broad Law Firm. She can be contacted at +86 10 8567 5906 or by e-mail at gaoping@anjielaw.com