Issues in liability disputes for misrepresentation in securities

By Jiang Sheng, Merits & Tree Law Offices
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Cases of civil compensation arising from misrepresentation in the securities market refer to cases brought before the court by investors in the securities market because they suffer from losses due to misrepresentations made by the party obliged to disclose information, in violation of laws.

Disputes over the liability for misrepresentation in the securities market (which refers to the stock market for the purpose of this article) arise from infringement on property rights and interests. Therefore, applicable provisions of the tort law should be applied in determination of liabilities. With consideration to the particularity of the liability for misrepresentation, the Supreme People’s Court issued Some Provisions on Trying Cases of Civil Compensation Arising from Misrepresentation in the Securities Market to settle such disputes, and the provisions are still in force today.

姜胜-Jiang-Sheng
Jiang Sheng
Merits & Tree Law Offices
Partner

According to the provisions, an investor has the right to claim compensation against the listed company only when the investor buys the securities between the date of misrepresentation and the date of disclosure, and continues to hold such securities after the date of disclosure. In determining the liability for damages arising from misrepresentation in the securities market, factors including imposition of punishment for misrepresentation or not, date of misrepresentation, base date, date of punishment, date of disclosure, investment loss calculation method, and systematic risks, should be considered. Major issues of such disputes are focused on ascertaining the date of disclosure, loss on investment difference, and systematic risks.

The date of disclosure. This refers to the date when the misrepresentation is made public on national media for the first time. Therefore, the date of disclosure, in theory, can be the date when the misrepresentation is reported in the media, the date when the listed company makes a correction, the date when the stock trading is suspended, the date when the regulator places the case on docket for investigation and decides on punishment, or the date when punishment of the listed company is announced.

According to judicial precedents, the court determines the date of disclosure by reference to the following major factors: (1) whether the misrepresentation is made public for the first time; (2) whether the contents disclosed are consistent with the misrepresentation subject to punishment; (3) whether the disclosure is sufficient to warn average reasonable investors in the market; (4) whether the party making the disclosure is authoritative; and (5) the extent to which the stock price falls as a result of the disclosure.

For a listed company, the less the investors claim as compensation, the shorter the time limit of claim is, and the less the compensation amount is, the more beneficial it will be. The listed company may prefer the date closest to the date when the misrepresentation is made, and after which the stock price falls, to be the date of disclosure.

The loss on investment difference. Investors are generally most concerned with the amount of compensation. According to the provisions, the losses an investor may claim include loss on investment difference, commission, stamp tax and interest. Among them, the commission, stamp tax and interest are easy to calculate, while the loss on investment difference is not.

In short, the loss on investment difference equals (the average buying price minus the average selling price) × the number of stocks sold prior to and on the base date; or the loss on investment difference equals (the average buying price minus the base price) × the number of stocks sold or held after the base date. Different calculation methods of the average buying price or average selling price will significantly influence the calculation results and the compensation amount.

The calculation methods of the average buying price include the arithmetic method, simple weighted average method, first-in first-out method, last-in first-out method, and moving weighted average method.

In comparison, it is reasonable to apply the moving weighted average method to calculate the average buying price. The average selling price can be calculated by three methods: (1) if the stock is sold after the date of disclosure but before the base date, the average selling price will be calculated by the same method as the average buying price, and the loss on investment difference will be calculated by the actual average price of the stock sold; (2) if the stock is sold after the base date, the average selling price will be the average closing price from the date of disclosure to the base date; and (3) if the stock is traded several times after the date of disclosure and before the base date, the first-in first-out method will apply. The number of stocks sold earliest will be accumulated and correspond to the number of stocks held by the investor up to the date of disclosure. On this basis, the average selling price will be calculated.

For the listed company, the lower the average buying price of the investor, the better. If the stock price tends to fall before the date of disclosure, the first-in first-out method will be applicable for calculation of the average buying price and be more favourable to the listed company. In the meantime, for the investor, the higher the average selling price, the better. The listed company should first consider the calculation method that produces the higher average selling price.

Systematic risks. Systematic risks of the securities market are one of the grounds for exemption of a listed company. It is provided in article 19 of the provisions that, where the defendant produces evidence to prove that all or part of the losses of the plaintiff result from the systematic risks of the securities market or other factors, the court should rule that there is no cause-effect relation between the misrepresentation and the damages. The provisions, however, fail to clearly define the systematic risk factors, or describe the calculation criteria or methods.

In practice, the court will determine the systematic risks by reference to major factors including the overall rising and falling trends of the stock market index, trends of indexes of industry boards, stock prices of other like enterprises, and existence of a circuit breaker or not. In the precedents where the court rules in support of deduction of risk factors, the proportion of deduction varies from 0-55%.

A listed company should try its best to prove the existence of systematic risk factors, based on which the court will rule deduction of a part of the investor’s loss.

Jiang Sheng is a partner at Merits & Tree Law Offices

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