Evidentiary standards in securities fraud administrative penalties

With increasing regulatory scrutiny in the securities market, the legal risks for issuers and intermediaries involved in securities offerings have significantly risen. Drawing from the first administrative penalty case for fraudulent securities offerings on the Star Market, this article examines the evidentiary standards used in such penalties.

Basis for evidentiary standards

Regulatory perspectives on standards of proof in current fraudulent securities offering cases. In recent administrative penalty decisions for securities fraud, the China Securities Regulatory Commission (CSRC) has articulated its standards of proof in the following ways:

1. Clear standard of proof. This includes comprehensive or prudent judgment based on principles favouring the party involved, application of the preponderance of evidence principle, and achieving a clear and convincing standard of evidence;
2. Vague standard of proof. Evidence from application materials, prospectuses, public offering documents, meeting resolutions, financial records, business contracts, bank account details, relevant inquiry transcripts and explanatory statements deemed sufficient to establish facts; multidimensional evaluation of evidence; and
3. No stated standard of proof.

Clarification on the preponderance of evidence standard. In the enforcement of current securities fraud administrative penalty cases, regulatory authorities have not strictly distinguished between the preponderance of evidence standard and the clear and convincing evidence standard.

The CSRC only clarifies its consistent enforcement standards when respondents raise objections regarding the standards of proof. However, this clarification is not uniformly stated. If respondents do not mention the standards of proof in their objections, the CSRC typically uses vague formulations such as “the evidence on file is sufficient to prove”, “the evidence on file is legal and effective”, or “comprehensive evaluation of multidimensional evidence”.

These statements do not clearly establish that the standards of proof have been met and appear more as assertions without thorough analytical reasoning.

Application of the preponderance of evidence standard. In administrative penalty cases, the enforcement authorities and the parties involved are not on equal legal footing, and there are significant disparities in their ability to gather evidence. Even if the parties obtain testimonies or records that directly contradict the partial evidence collected by the enforcement authorities, the probative value of such evidence is generally not considered superior to that obtained by enforcement authorities.

Currently, the application of the preponderance of evidence standard has evolved to require the parties to provide evidence that overturns the findings of the investigation authorities. If the parties fail to achieve this, the penalty committee will adopt the evidence obtained by the investigation authorities under the preponderance of evidence standard, thereby confirming the existence of the violation.

Challenges in implementation

Current practices in securities administrative enforcement, particularly in cases involving fraudulent issuance and significant violations of information disclosure, still require improvement in the determination of illegal activities.

1. Parties often struggle to review case files and gather evidence in a short timeframe. Based on the authors’ practical experience, the investigation period by securities regulatory authorities for fraudulent issuance typically lasts about six months.

   Parties are only allowed access to the files after receiving a preliminary notification. However, due to the voluminous nature of the materials, the right to review these documents is not adequately protected. Consequently, the parties’ effectiveness in collecting counter-evidence and cross-examining is significantly compromised.

2. Insufficient hearing procedures impede effective defence. Drawing from the authors’ practical experience, particularly in hearings related to fraudulent issuance cases, there are notable constraints on the time allocated for presenting arguments and cross-examining evidence.

   Faced with extensive case files and numerous personal testimonies, parties often find themselves limited to submitting written objections without the opportunity for face-to-face cross-examination. As a result, the hearing process risks becoming merely procedural, lacking the substance necessary for a robust defence.

3. The threshold for imposing administrative penalties in cases involving criminal offences is relatively low. Administrative penalties for securities fraud issuance often correspond to two criminal charges: fraudulent issuance; and the illegal disclosure or non-disclosure of crucial information.

Adjusting evidentiary standards

The purpose of administrative penalties in securities fraud cases varies depending on whether the illegal activity has concluded. When penalties solely address past infractions, aiming to “set legal consequences for illegal actions to incentivise individuals to refrain from such behaviour preemptively”, the evidentiary standards must be rigorous, employing a standard that excludes reasonable doubt.

However, if the purpose of the administrative penalties includes preventing future risks, adherence to the principle of risk prevention may warrant a more lenient evidentiary standard such as a clear and convincing evidence standard, or even preponderance of evidence standard.

Securities fraud issuance carries accompanying liabilities. These include consequences such as market bans, restrictions on refinancing and limitations on holding positions. However, the authors believe that these constraints or accompanying consequences are insufficient to raise the evidentiary standard in the administration of securities fraud to the level of excluding reasonable doubt.

Instead, it should be recognised that there is no insurmountable gap between the standards for securities fraud issuance and the criminal thresholds for securities fraud; rather, there exists an often overlooked connection between the two.

Given the significant harm that securities fraud issuance poses to the development of the securities market and its substantial negative impact, it is subject to stringent criminal sanctions.

In determining administrative penalties for securities fraud issuance, care must be taken as it closely approaches the criminal threshold for securities fraud. Therefore, it may be more appropriate to elevate the evidentiary standard for these administrative penalties to one that excludes reasonable doubt.

Guan Zhaoyang is an associate and Jeffery Quan is a senior partner at ETR Law Firm