Chinese nationals, arrested on suspicion of operating a large-scale cyber fraud operation, are taken to a police vehicle for deportation from Kathmandu to their homeland on January 8, 2020. Regulators in China now want greater penalties for bond and securities fraud committed in mainland China. Photo: Prakash Mathema / AFP

China is moving to beef up its company and criminal laws by increasing penalties for fraud and other crimes linked to securities and bond trading. With Beijing opening up its financial markets more to international investors – and greater scrutiny over the risks of doing that, the move is timely.

Liu Xinhua, a deputy member at the National People’s Congress and deputy director of the NPC’s Finance Committee, has suggested that company law and criminal law be revised as soon as possible to support the new securities law by increasing the punishment for fraud and other offences. He said jail terms of up to 25 years seemed reasonable for securities and bond fraud, Phoenix TV reported late last week.

Liu Xinhua put forward proposals at the “Two sessions” parliamentary meetings in 2018 and 2019 to promote joint amendments of the company law, criminal law and securities law. And this year, in regard to implementation of the new securities law, he once again proposed amending China’s company law and criminal law to supplement the legal framework from a higher perspective.

The legal framework underpinning China’s securities and bond trading markets has loopholes and is regarded as deficient – particularly in regard to provisions to protect minor shareholders against abuses by larger shareholders of companies – when compared to laws in Western nations, as Liu has noted.

The case of the ‘Crude Oil Treasure’, an investment product sold by the Bank of China, is perhaps just one example of the many ways in which minor investors can get stung in China. When the price of oil plunged last month, investors in Crude Oil Treasure not only lost their money, the Bank of China said they owed the lender more cash – $37.63 for every barrel they had bought, according to The New York Times.

“The outrage that followed has exposed the plight of small investors in the world’s second-largest economy. They have few safe places to park their money. They enjoy limited legal protections compared with investors in other countries. And when they protest, they are often silenced by the authorities. Crude Oil Treasure investors said the police had called and visited them to make sure they would not cause a public fuss,” the paper said. 

This is just one example of the pitfalls or complexities that investors in global markets need to consider. But it shows why Liu and regulators in China see a need to bolster the capital market and promote a standardised operation of their markets.

Liu Xinhua believes that, with the securities law now implemented, joint amendments to unite it with the company law and criminal law will help in coordinating and handling common issues. It would also help strengthen corporate governance within companies.

‘Five changes needed’ 

He suggested that amendments should be made in the company law in regard to the internal corporate governance of listed companies: Firstly, establish the controlling shareholder and actual controller’s obligations of integrity, and clarify that the controlling shareholder and actual controller must not damage the interests of other shareholders and the company when exercising their rights.

Secondly, the law should prohibit directors and supervisors from breaching their trust and damaging the interests of the company. If the controlling shareholder or actual controller instructs directors and supervisors to engage in a breach of trust, they shall bear joint and several liabilities according to law.

Thirdly, the law should enrich the capacity for small and medium-sized shareholders to participate remotely in voting at meetings of shareholders of listed companies. 

Fourth, it should stipulate the minimum attendance required at meetings for shareholders of listed companies and avoid individual shareholders from controlling shareholders’ meetings. Fifth, it is necessary to increase relevant regulations for subsidiaries of listed companies which are not allowed to purchase shares of listed companies.

A key objective is to expand the scope of criminal laws and regulations and enhance the implementation of the newly revised securities law.

Liu Xinhua said the new securities law already stipulates that depositary receipts are of the statutory securities type, and that public offerings (IPOs) should meet the conditions for IPOs of new shares and other conditions prescribed by the China Securities Regulatory Commission (CSRC).

In practice, red-chip companies have submitted applications for the public issuance of depository receipts and go public. If a fraudulent issuance of depository receipts occurs in the future, it will be more harmful, so there is an urgent need to revise the criminal law to expand the scope of legal regulation.

At the same time, with the development of science and technology, the manipulation of securities and futures markets has become more covert and the methods are more diversified, such as “robbing hat trading operations”, “confused trading operations” and “spoof trading operations”. At present, more than half of case judgments are punished by citing pocket clauses, which reflects a disconnect between such manipulations in criminal law and practice.

Market manipulation, non-disclosure

“The new securities law has added new market manipulation practices and detailed regulations. In order to adapt to the development and changes of the market and connect with the newly revised securities law, it is recommended that we add new enforcement,” Liu Xinhua emphasized.

The second goal is to increase penalties for fraudulent issuance of stocks and bonds. The number of investors affected by fraudulent issuance crimes is large, and the social impact is bad, he said.

However, compared with the maximum penalty for capital swindling, the penalty for fraudulent issuance crimes is significantly lower, which is inconsistent with the serious consequences of the crime. And, from the perspective of overseas legislative experience, countries and regions set very strict criminal liability for fraudulent issuance. For example, the United States stipulates a maximum sentence of 25 years in prison, and China’s Taiwan region stipulates a maximum sentence of 15 years in prison.

The third goal is to severely punish the crime of illegal disclosure and non-disclosure of important information.

Liu Xinhua believed that in the context of the implementation of the registration system, information provides the basis of the capital market and determines the efficiency and effectiveness of capital flows and resource allocation. He said it was necessary to increase the crackdown on fraudulent information disclosure, so that dishonest fraudsters pay a heavy price.

The new securities law clearly implements a “double penalty system” for companies that disclose fraudulent information.  Other countries and regions also have higher criminal liability for fraudulent information disclosure, he said. For example, people doing this in the United States can be sentenced to 20 years in prison, and in Japan and Hong Kong they can be sentenced to 10 years in prison.

The fourth goal is to expand the scope of regulation for the crime of false certification documents.

Liu Xinhua said that intermediaries required under the new securities law to provide supporting documents include not only sponsors, but also credit rating agencies, financial advisors, and underwriters. These agencies are very important in bond underwriting, major asset restructuring, and listed company acquisitions, he said. The company had a high obligation to ensure that the issuer’s information disclosure is true, accurate and complete. So, they needed to amend the law to expand the scope of regulations regarding the crime of supplying false certification documents.

Big stick needed: Wang Jianjun

Liu is not the only influential official pushing for tougher laws. Wang Jianjun, deputy to the National People’s Congress and chairman of the Shenzhen Stock Exchange, believes that implementation of front-end market-based access to the securities issuance registration system must rely on the back-end – raising a “big stick” for fraudulent issuance and other illegal activities, otherwise it will reduce the effectiveness of reforms.

To this end, Wang Jianjun proposed a bill at the ‘Two sessions’, proposing amendments to the criminal law, to adjust the crime of fraudulent issuance to the category of “financial fraud” and raise the maximum penalty to life in prison, with an increase in the amount of fines, broadening the scope of the crime, and clarifying the “key minority” who have “criminal responsibility”.

This is the third consecutive year that Wang Jianjun has proposed amending the criminal law to severely punish fraudulent issuance.

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