Stock market manipulation can be broadly divided into trading-based manipulation and information-based manipulation. The former requires significant advantages in funds and securities holdings and is closely supervised by stock exchanges and the China Securities Regulatory Commission (CSRC). This means there is little chance of profiting from it while eschewing legal liability.
The latter, as defined in China’s Securities Law currently in force, includes “manipulation by means of trading to affect the price or volume of securities” (article 55.1), “demagogic trading” (article 55.5) and “scalping” (article 55.6). The focus of this article will be placed on information-based manipulation as the author explores the causality elements in relevant civil compensation cases.
Regarding public law liability, whether the trading price or volume of securities is affected or not does not constitute an element of information-based manipulation. Objective failure constitutes attempted manipulation, while minor circumstances are insufficient to trigger imposition of a penalty. In practice, however, stock exchanges and the CSRC will take notice and initiate an investigation only when the trading price or volume of securities changes abnormally.
The author divides the civil compensation cases caused by market manipulation into three circumstances:
(1) Market manipulation has not been investigated by the CSRC or any other authority and detection or proof by investors can be challenging due to its elusive nature;
(2) Market manipulation has been investigated by the CSRC or other authorities and eventually identified as attempted manipulation or minor manipulation, which did not affect the trading price or volume of securities, thus proven not to be the cause of investors’ loss; and
(3) Market manipulation has been investigated by the CSRC or other authorities and is found to have affected the trading price or volume of securities.
In the third circumstance, which the author will further delve into, the causality elements in the civil compensation case should be presumptively established and the perpetrators of market manipulation may deny it by presenting evidence to the contrary.
A look into causality
In the Wang Jianzhong case, Liu v Cheng Wenshui and Liu Yanze, and other civil compensation cases regarding market manipulation, the court ruled the plaintiff failed to substantiate the transaction causality and loss causality. However, the author proposes an opposite view.
From the perspective of burden of proof, in cases where administrative penalties or criminal judgments are awarded, the CSRC or public prosecution services has provided evidence beyond a reasonable doubt or presented a preponderance of evidence to substantiate the causality between the trading price or trading volume of securities and the act of market manipulation. Therefore, the plaintiff in a civil case has no burden of proof in respect of causality elements.
Furthermore, stock market manipulation is subject to dual judgment of transaction causality and loss causality. The fraud-on-the-market theory and the principle of constructive reliance should be applied to transaction causality.
According to the fraud-on-the-market theory, in an open and efficient stock market, the price of a company’s stock is determined by all material information available about the company. Stock fraud, as a type of publicly available information, will inevitably be incorporated in the relevant stock prices. Since investors rely on the market to trade, any market manipulation or other frauds are bound to impair the interests of investors.
Similarly, the judicial interpretation of false statements adopts the fraud-on-the-market theory and the principle of constructive reliance to establish rules for transaction causality. Both false statements and information-based manipulation are stock frauds and there may be a concurrence when the information-based manipulation is achieved by releasing false information.
Accordingly, the author suggests that from the day of manipulation to the day of disclosing information-based manipulation, there is a causality between investors’ trading in the underlying stock and the act of manipulation. The plaintiff in a civil action is not obligated to produce additional evidence.
As for loss causality, since the price of securities is affected by various factors such as market manipulation by others, stock market risks, stock market overreaction to specific events, and internal and external operating environments of the listed company, there is no causality between loss caused by such factors and the act of stock market manipulation, and such loss does not fall within the scope of compensation from the manipulator.
Factors unrelated to market manipulation are divided between systemic risks and non-systemic risks, and the exclusion of these factors can be approved by the court. For example, the net loss method and the price comparison method can be adopted to calculate the loss amount based on the difference between the investor’s actual trading price and the real price of the stock in the same period. If necessary, a third-party professional agency can be engaged to issue an opinion on the securities investor’s loss verification.
To sum up, for an alleged act of market manipulation that has been investigated by the CSRC or other authorities, if it is eventually found to have affected the trading price or volume of securities, the causality elements in civil compensation cases should be presumptively established. The perpetrator of market manipulation can produce contrary evidence for denial, including a denial of transaction causality and defence for loss causality reduction or exclusion.
It should be noted that the application of the fraud-on-the-market theory and the principle of constructive reliance above are conditional on an “efficient market”. It is generally believed that China’s efficient stock market includes the main boards of the Shanghai and Shenzhen stock exchanges, ChiNext and the Star Market, and the method does not apply to the NEEQ and private placements, which means the burden of proof rests with the plaintiff.
For example, in a 2021 market manipulation case involving Zhuquezhu Yucheng Investment Centre, the Shanghai Financial Court held that “the principle of constructive causality established in securities infringement based on the fraud-on-the-market theory to protect the legitimate rights and interests of non-specific investors does not apply to the plaintiff. As a specific investor, the plaintiff should prove that there is a causality between the stock market manipulation committed by the perpetrator and the losses suffered by the investor”.
Hai Lan is a partner at Grandway Law Offices
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