China’s liability system for misrepresentation by securities intermediaries has entered a new era with significant reform under the Several Provisions of the Supreme People’s Court on the Trial of Civil Tort Compensation Cases for Misrepresentation in the Securities Market, promulgated in January 2022.
Most significantly, article 13 of the misrepresentation provisions stipulates that only in cases of “gross negligence” shall securities intermediaries and other bodies be jointly and severally liable for misrepresentation under the Securities Law. However, the relevant rules do not exempt such bodies from general tort liability in cases of general negligence.
Previously, articles 85 and 163 of the Securities Law stipulated that any responsible person other than the information disclosure obligor shall be jointly and severally liable with the obligor, unless able to prove they are not at fault. The above-mentioned misrepresentation provisions covered all circumstances of tort liability for misrepresentation by relevant bodies – either no-fault exemption or joint and several liability, with no specific provisions on the proportion for corresponding liability to be borne according to extent of fault. This was also the longstanding understanding and application view of relevant provisions in Chinese judicial practice.
In fact, this legislation only considered misrepresentation of stocks for unspecified investors, striving to maximise protection of the interests of small and medium-sized retail investors, without considering bonds, asset-backed securities and other securities.
As a result, along with the economic downturn and reform of the “registration-based system” in recent years, a large number of securities intermediaries have grown alarmed to carry out their business, as they may be held liable for civil damages in hundreds of millions of renminbi due to minor negligence – hampering sustained and healthy development of the capital market.
Article 13 of the misrepresentation provisions now stipulates that the “fault” under articles 85 and 163 of the Securities Law refers to situations where perpetrators intentionally commit fraud or “seriously violate their duty of care by being negligent in the formation or publication of a misrepresentation in an information disclosure document”.
In this regard, in the article of understanding and application for the judicial interpretation, the judge of the Supreme People’s Court further clarifies that article 13 limits fault to intentional and gross negligence based on three main reasons: (1) legal system interpretation; (2) comparative law interpretation; and (3) traditional judicial practice.
Thus, article 13 limits the application of joint and several liability for misrepresentation by securities intermediaries under the Securities Law to “gross negligence” through a scaled-down interpretation.
This is a breakthrough from the existing legal provisions and previous general judicial practice, and of subversive significance. Thus, legal provisions for joint and several liability of securities intermediaries for misrepresentation due to general negligence and the basis for such claim no longer exist under Chinese law.
OTHER FUTURE TORT LIABILITY
Nonetheless, some believe that article 13 of the provisions means that securities intermediaries will no longer be liable for misrepresentation unless they have gross negligence – which is likely an over-interpretation of the provisions. In future, securities intermediaries may still be liable for tort liability under article 1165 of the Civil Code for their own fault. The reasons are as follows.
First, article 13 only interprets the applicable threshold of articles 85 and 163 of the Securities Law, without stipulating whether or how securities intermediaries are liable for compensation in the case of “general negligence”. Such over-interpretation has gone beyond the meaning of the article.
Second, the fault-based liability in article 1165 of the Civil Code is a fundamental principle of tort law, and “fault without liability” is a highly exceptional situation that requires special provisions of law. For example, article 929 of the Civil Code provides that only in “gratuitous” entrustment contracts is the trustee liable solely for intentional or gross negligence. Commercial activities by securities intermediaries are obviously paid; and they are generally trusted as professional institutions with a high duty of care. In the absence of clear legal provisions, it is impossible to draw the conclusion that their general negligence is not subject to legal liability.
Third, the understanding of “no liability for general negligence” also conflicts with relevant judicial interpretations in China. Several Provisions of the Supreme People’s Court on the Trial of Civil Tort Compensation Cases Involving Accounting Firms Engaging in Audit Business is among the judicial interpretations most frequently applied and referred to, second only to the misrepresentation provisions. Article 6 of this interpretation stipulates that accountants who issue false reports due to negligence shall be liable for compensation according to the extent of the negligence. There is no reason why accountants and securities intermediaries should be treated differently on this issue.
PROPORTIONAL JOINT, SEVERAL LIABILITY
In previous judicial practice, to alleviate the inequitable outcome of strict joint and several liability under the Securities Law, some courts have created the concept of “proportional joint and several liability” – namely that securities intermediaries are jointly and severally liable with the information disclosure obligor within a certain proportion (less than 30% in most cases). Such practice lacks legal basis from the Securities Law or other laws, and is inconsistent with the usual legal principle of tort liability, but serves as a compromised solution.
However, with the introduction of article 13 of the misrepresentation provisions that practice, at danger of damaging the rigour of the tort law system, is no longer necessary. Moreover, since the securities intermediary will only be held jointly and severally liable for “gross negligence” in future, it would be logically contradictory if a securities intermediary is determined to have committed gross negligence while only required to bear a lower proportion of joint and several liability.
Therefore, it is reasonable to assume that applicable scenarios of “proportional joint and several liability” will become less common. If applied, the court decision will no longer be mainly based on the fault of securities intermediaries, but according to determination of causation and loss.
RATIONAL NEW SYSTEM
In summary, article 13 of the misrepresentation provisions reforms the “all or nothing” liability determination approach for securities intermediaries under the Securities Law, allowing judges to determine appropriate liability according to extent of fault – which is of great significance to building a more refined and rational liability system for misrepresentation by securities intermediaries.
Eric Liu is a partner at Han Kun Law Office. He can be contacted on +86 10 8524 5519 or by email at firstname.lastname@example.org
Deng Xiaoming is a counsel at Han Kun Law Office. He can be contacted on +86 10 8524 5860 or by email at email@example.com