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“If the share prospectus, measures for offer of corporate bonds, financial or accounting report, listing report document, annual report, interim report or ad hoc report announced by an issuer or securities underwriting company contain or contains any falsehood, misleading statement or major omission, thus causing losses to investors in the course of securities trading, the issuer or the company shall be liable for the losses and responsible director(s), supervisor(s) and/or the manager of the issue or the company shall be jointly and severally liable for such losses.”
Who should be liable? In this article, directors, supervisor and manager must ensure that information disclosed it true, correct and complete, without any false statement, serious misleading statement or material omission. Directors have joint and separate liability for information disclosure. However, the difficulty with the current provisions is that they fail to define causes of action with specificity. For example, article 63 states that falsehood, misleading statement or major omission by an issuer or the company shall be liable for the losses. Just what is meant by this term is unclear. Therefore, the possibility that a shareholder will be able to bring a successful private action under the current vague provisions is questionable.
Under the Interim Rule, if the documents are found to contain above elements, the offering company should not offer invitation or offers. If the offers have been issued, the selling activities must be stopped and remedial measures shall be taken.
But in the Hongguang case regarding the shareholder sued for compensation, which will be discussed below, the Court declined to hear the suit on the ground of no direct connection between the losses and the false disclosure because there is no specified civil liability enacted in the Securities Law. So, the above provisions are the civil liability at all?
Hongguang Industrial Co. case
Chengdu Hongguang Industrial Shareholding Company specialized in the production of electron vacuum devices, which was the main supplier to Changhong company, one of the largest producers of television sets in China and the darling of the Shanghai Securities Exchange. Hongguang made its public offering in June 1997 and the company had reported substantial profits for the previous three years. In its prospectus, Hongguang announced that it expected an after-tax profit of 0.37 yaun per share. However, in its 1997 annual report, the company reported a loss of 0.86 yuan per share. The main reason behind this astonishing change of fortune was a problem with a production line. An investigative report uncovered that the production problems began prior to Hongguang’s public offering, a fact not disclosed by the company in the prospectus. The CSRC also took note of the huge losses reported by the company and began an investigation of its own.
The results of the CSRC’s investigation were made public on November 20 and depicted one of the most flagrant cases of fraud to hit the Chinese market in its young history.[xxx]
The CSRC fined Hongguang, its underwriter and accounting firm, and securities companies. Directors and other high-level officers were either banned from ever holding high-level positions in publicly traded companies or received warnings. The CSRC also informed Hongguang, the other companies, and responsible individuals that they were under suspicion for criminal activity and that an investigation was ongoing.
As indicated above, laws were broken in both the Hongguang and Minyuan cases. The cases described above are two of the most egregious examples of fraudulent disclosures to hit the Chinese stock markets. They provide insight into some of the problems with company compliance with disclosure regulations and some of the risks posed to investors.
In addition, another problem with enforcement in the larger context of the Chinese stock markets was exposed as well. These two cases have brought to light some of the problems facing the CSRC as an enforcement body. Investors need the CSRC to enforce existing laws effectively, but the CSRC may not be able to police disclosures for their accuracy. It is no doubt to say the CSRC enforcement may not be desirable because duped shareholders do not have significant legal recourse against the companies once they have been penalized, the truth is known, and prices of the shares tumble. Therefore, requirements for corporate transparency might not be effective in light of a lack of lawmaking transparency.
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