Investor suitability in proxy sales of wealth management products

By Ren Guobing and Wu Nan, Jingtian & Gongcheng
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With the development of wealth management companies in recent years, proxy sales have become one of the top options available to wealth management companies. A unique proxy sale system gradually formed between wealth management companies and sales agents, where the diligent performance of either party’s obligation of investor suitability often emerges as a key issue.

However, current judicial practice is marred by numerous shortcomings such as the relegation of relevant rules to a relatively low position in the legal hierarchy, inconsistent interpretations, and uneven application in court, making it difficult to clarify the responsibilities and obligations between wealth management companies, as the product issuers, and sales agents, as promoters.

MANAGING INVESTOR SUITABILITY

Investor suitability in proxy sales of wealth management products Ren Guobing
Ren Guobing
Partner
Jingtian & Gongcheng

The management responsibilities of investor suitability in proxy sales of wealth management products appeared a number of times in the Interim Measures for the Administration of Sales of Wealth Management Products of Wealth Management Companies, issued by the China Banking and Insurance Regulatory Commission (CBIRC) and implemented since June 2021. They include the responsibility of sales agents of wealth management products to fully understand the requirements on investor suitability, complete the matching of investor suitability, and strengthen the management of investor suitability, so as to protect investors’ rights and interests.

Wealth management companies, as issuers of wealth management products, should regularly carry out normative evaluation of sales agents and conscientiously perform their management responsibilities concerning sales agents. Article 4 of the above-mentioned measures provides that, “a wealth management company and a sales agent shall, in accordance with laws, regulations, regulatory provisions and co-operation agreements, reasonably define the rights and obligations of both parties, and jointly assume the management responsibilities for the sale of wealth management products”.

According to regulations, the wealth management company and the sales agent should jointly assume the management responsibilities of investor suitability.

LEGAL LIABILITIES FOR VIOLATIONS

Contracting negligence or tort? There has long been a dispute over whether wealth management product issuers and sales agents should be held liable for contracting negligence or tort if they violate the obligation of suitability. Before the issuance of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, judicial adjudications were mostly based on tort, considering that if there was no improper promotion by the sales agent, the investor would not have bought the wealth management product and incurred losses.

Investor suitability in proxy sales of wealth management products Wu Nan
Wu Nan
Associate
Jingtian & Gongcheng

Therefore, a causal relationship exists between the improper promotion by the sales agent and the economic losses of the investor, and the sales agent should compensate the investor for the losses to the extent of its liabilities.

The draft for comment of the above-mentioned minutes expressly provided that verifying suitability is one of the pre-contract obligations of sales agents set out in article 60(2) of the Contract Law, and if the sales agent breached such obligation, it shall assume liabilities according to article 42(3) of the Contract Law.

Although the final version of the minutes deleted the expression relating to pre-contract obligation, the rules of contracting negligence still applied. In current judicial practice, certain courts have taken the above view in making judgments, but few require issuers of wealth management products to fully assume joint and several liability for compensation with sellers according to the provisions of article 74 of the minutes.

Different rules applied in the same case. In the contract dispute of China Merchants Bank Beijing Yuquan Road Sub-branch v Xiao Haitang (2019), the courts of first and second instance respectively applied the rules of tort and contracting negligence liabilities, resulting in completely different judgments.

The court of first instance held that the China Merchants Bank sub-branch violated the suitability obligation, was at fault for Xiao’s losses, and should compensate Xiao according to article 120 of the General Provisions of the Civil Law and articles 2 and 15(6) of the Tort Liability Law.

However, the court of second instance held that the application of the rules of tort was not appropriate and the court of first instance’s judgment should be overturned. The court of second instance decided that violation of the suitability obligation should be subject to relevant rules of contracting negligence, and the China Merchants Bank sub-branch did not violate this obligation. The first-instance judgment was reversed and all claims of Xiao were rejected.

Investors of wealth management products are themselves financial consumers. If a sales agent fails to fulfil its suitability obligation in the contracting stage, leading to the financial consumer buying unsuitable products based on their trust in the professional institution, and suffering losses, the sales agent obviously has violated the requirement of good faith stipulated in article 500 of the Civil Code, and therefore is liable for compensation. However, the basis of this liability is contracting negligence as defined in the above-mentioned provisions.

In practice, the provisions of articles 591 and 592 of the Civil Code are both applicable in most cases decided, based on the liability for contracting negligence, with sales agents and investors bearing losses according to their respective wrongdoing.

Article 11 of the measures provides that the headquarters of a sales agent and the wealth management company should sign a sales agency and co-operation agreement in written form, which should include, at minimum, “the legal liability to be assumed by each party in accordance with the law for any violation of investor suitability management obligation during the sale of wealth management products”.

In sum, the wealth management company and sales agent should clearly define their respective rights and obligations, and in particular specify each party’s responsibilities for performing the suitability obligation during the sale of wealth management products. However, the authors note that the minutes are ranked relatively low in the legal hierarchy. Whether courts will demand wealth management companies and sales agents to assume 100% joint and several liability based on the minutes is a matter awaiting further judicial practice.

Ren Guobing is a partner and Wu Nan is an associate at Jingtian & Gongcheng

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