Establishing the materiality of false securities information

Civil trials and administrative regulations have different emphases on determining the materiality of securities misrepresentations. These differences offer investors an opportunity to adopt remedy strategies that are most appropriate to their particular circumstances.

Considering the information disclosure obligations of listed companies, information that may have a significant impact on investors’ decision-making is of material concern. So, if an information disclosure obligor fails to disclose information of materiality, then, by law, it constitutes a false statement of materiality to the securities market.

It is in assessing whether the content of a false statement has a sufficient impact on investors’ decisions that the administrative and judicial perspectives differ in emphasis.

ADMINISTRATIVE PERSPECTIVE

Making a punishment decision about a false statement, pursuant to the public law, is to safeguard the financial management order. Therefore, from an administrative perspective, determining materiality shall focus on how far the disclosure obligor’s behaviour (act or omission) deviates from the standard. Penalties and regulatory decisions are based on the level of violation.

The primary consideration is not whether a behaviour has caused material information asymmetry, or has significantly impacted the market investment decision and the scale of investors’ loss. In fact, it is not feasible for administrative regulators to make a punishment decision relying on the investors’ proof of loss. Administrative regulators may issue a punishment without evidence of the material impact on the market or the loss suffered by investors.

According to articles 181 and 182 of the Securities Law and article 73 of the Administrative Measures for the Registration of Securities Issuance by Listed Companies, the China Securities Regulatory Commission and its dispatched offices may, depending on the severity of a false statement, impose administrative penalties such as fines and warnings, or take regulatory measures such as ordering rectification, holding regulatory talks, issuing warning letters and imposing market bans on the issuer, the sponsor and other accountable persons.

CIVIL JUDICIARY PERSPECTIVE

Retrieving investors’ loss pursuant to private law is to safeguard their reliance interests impaired by the false statement. In the determination of materiality, the judiciary should consider whether a false statement caused a significant impact on investment decisions, and whether the investors’ loss is entitled to be indemnified, more than how far the false statement has deviated from the standard.

According to article 10 of the of the Supreme People’s Court’s Several Provisions on the Trial of Civil Compensation Cases Involving Infringement with False Statement in Securities Market, the determination standard of false statement materiality can be categorised as either “investor-sensitive standard” or “price-sensitive standard”.

The former estimates whether a false statement falls within the range of statutory material events; the latter estimates the fluctuation of stock trading price and volume caused by a false statement.

This determination standard does not involve gauging how a disclosure obligor publishes or conceals the information and whether its violation was severe enough to get an administrative punishment.

That is to say, the judiciary shall not overrule a claim merely because an obligor has not received an administrative punishment; rather, it may adjudge a false statement free from administrative punishment to be of materiality, in reference to Liang Yu v China Security (2020) and Postal Savings Bank of China v Mei Ji Te Deng Du (2020).

DUAL PERSPECTIVE

The author believes that legal interests and social effects pursued by civil trials and administrative regulation are not completely identical; therefore, it is inappropriate to directly align administrative results with the materiality determination of civil trials.

An absence of administrative penalties or criminal charges also no longer exempts any information disclosure obligor from liability.

Nonetheless, it should not be ignored that the administrative department is on the front line of regulating information disclosure in the securities market. It is prompter and more professional in terms of investigation, evidence collection and determination.

The facts of a case and the legal basis for punishment set out in documents such as administrative punishment decisions, and decisions for administrative regulatory and management measures, disciplinary sanctions and self-discipline management measures imposed by the stock exchange, could provide a foundation for the judiciary to apply the “investor-sensitive standard”.

For example, these things might assist in determining whether a false statement falls within the scope of “the material event provided by paragraph 2 of article 80, and paragraph 2 of article 81 of the Securities Law” and/or “the material event or important matter required to be disclosed in the rules and normative documents formulated by regulatory authorities”.

As to false statements made before initiating an issuance or non-public offering (such as non-public issuance of bonds or stocks and special trusts for asset securitisation), with no reference to open market bidding and stock trading volume fluctuations, they are not applicable to “price-sensitive standards” practically. This makes it even more important to gain a decision from an administrative regulator.

CONCLUSION

With the promulgation of the provisions, the judiciary has established a set of standards to determine the materiality of false statements, which are independent of administrative regulation logic.

Investors are provided with opportunities to exploit various litigation strategies and evidence formation to carry out a more adequate elaboration of the materiality of a false statement during trial.

However, in any case, if the wrongfulness of a false statement is not severe enough to incur an administrative punishment or other measures from administrative authorities, the impediment for investors to prove and argue the materiality is plain.

Written by the Capital Market Department at Lianyue Law Firm