Sales suitability obligation for financial products

By Wang Weibin and Qiu Dongmei, AllBright Law Offices
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In August this year, the dispute over the contract for entrusted wealth management between Wang Xiang and China Construction Bank’s Enji branch attracted wide attention and aroused hot discussion in financial markets.

In June 2015, Wang Xiang subscribed units in an index fund at a price of more than RMB960,000 (US$137,000) recommended by an employee of China Construction Bank’s Enji branch. In March 2018, Wang Xiang redeemed the units in the fund at a loss of approximately RMB580,000.

financial
Wang Weibin
Senior partner
AllBright Law Offices

In the first instance, the People’s Court of Haidian district, Beijing, held that: “During selling units in the fund involved in the lawsuit, China Construction Bank, Enji Branch, shall perform the compliance obligation of a securities investment fund sales institution, as well as that of a commercial bank for personal wealth management business”, but China Construction Bank’s Enji branch committed gross negligence in the sales process, and thus the court determined that the bank’s Enji branch should compensate Wang Xiang for the entire loss of his principal and interest.

China Construction Bank lodged an appeal, but Beijing No. 1 Intermediate People’s Court upheld the original verdict. After that, China Construction Bank applied for retrial, but the application was dismissed by Beijing High People’s Court. Although China is not a country where case law is applicable, the conclusions and influence of the case cannot be overlooked.

In early August this year, the Supreme People’s Court (SPC) asked for opinions from the public on the Minutes of Working Conference of Courts in China for Civil and Commercial Trials, in which the contents about “trial of dispute cases regarding protection of rights and interests of financial consumers” were called the most rigorous sales provisions in the history of the industry.

financial
Qiu Dongmei
Legal counsel
AllBright Law Offices

With regard to sales suitability obligations, the minutes specify that: “If a sales organization causes losses to a financial consumer due to its failure in performing its suitability obligation, the actual losses shall be equal to the total amount paid by the financial consumer for the financial product and service, less the remaining amount recovered,” and also: “If a sales organization fails in performing its suitability obligation … the issuer and the seller of the financial product may be required to be jointly and severally liable for compensation.”

Regardless of other content, merely based on “full compensation” and “joint and several liabilities”, the sales organization and the manager will be bound together to become defendants and bear the risk of compensating investors for the entire loss of their principal in a large number of disputes.

As Wang Xiang is a judge in financial trials, China Construction Bank’s Enji branch pointed out that he had professional knowledge of financial investment and rich experience. However, the court held that: “Wang Xiang, as a judge in financial trials, may have rich legal knowledge and high awareness of legal risks, but this does not mean that he has more knowledge of securities investment than common people.”

In spite of disagreement with this judgment, the author has to acknowledge the existence of bias protection of investors in juridical practice. In July this year, at the working conference of courts in China for civil and commercial trials, Liu Guixiang, a grand justice at the Judicial Committee of the SPC, said that equal protection and bias protection should be combined, and bias protection of minority shareholders, financial consumers and other special groups is a necessary supplement to the principle of equal protection.

Thus, from guiding principles to judicial practice, bias protection of financial consumers is unavoidable, which poses higher legal risks to financial institutions in disputes over wealth management.

Risk prevention suggestions

Adhering to compliance. In terms of the principle of application of laws, the minutes specify that regulatory provisions in departmental rules and normative documents developed by relevant departments with regard to promotion and sales of high-risk financial products, if not conflicting with laws and regulations, may be applicable. In the case of Wang Xiang, the court also directly cited industry rules regarding commercial banks to hold that China Construction Bank committed gross negligence in promotion of the product.

At present, accepting and applying departmental rules and normative documents of the financial industry on a judicial basis is gradually becoming a consensus. Therefore, financial institutions should pay attention to compliance requirements, or otherwise they will be warned and punished by regulatory authorities, and face a greater risk of losing disputes.

Understanding your customers and refraining from providing unsuitable products. Sales suitability means selling and providing suitable products or services to suitable investors. When selling a product, financial institutions should first understand their customers, including their personal information, financial condition, investment objective and risk appetite. In current practices, financial institutions conduct a risk evaluation for an investor before selling wealth management products, but assessing the risk tolerance of an investor is normally based on the total score of an investor obtained when completing a full set of risk evaluation questionnaires.

However, in the case of Wang Xiang, based on the answer to a question in the evaluation, the court held that China Construction Bank’s Enji branch recommended a high-risk product that was unsuitable for Wang Xiang. Therefore, the authors suggest that financial institutions should reasonably set risk evaluation conclusions and the weights of individual questions to prevent the risk of providing unsuitable products.

Recording the whole sales process and enhancing file management. The Measures for the Suitability Management of Securities and Futures Investors specify that operators shall, in accordance with relevant provisions, properly keep information on their performance of the suitability obligation. Matching schemes, disclosure and warning information, recordings, videos, etc., shall be kept for not less than 20 years.

The minutes specify that, “The people’s court shall not uphold the claim of a sales organization that it has performed the obligation of disclosure only on the ground that the financial consumer wrote that ‘I am clearly aware of the risk of losing the principal’, and other information”. Therefore, the current commonly used method of exempting from liability based on written confirmation by an investor may be invalid. As to the fact of whether the sales organization has fully understood its customers, and whether it has performed the disclosure and warning obligations, financial institutions should record the whole process of their performance, so that they can provide information on the sales process and reduce the risk of failing to produce evidence in case of a dispute.

Wang Weibin is a senior partner and Qiu Dongmei is a legal counsel at AllBright Law Offices

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