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19 June, 2018
This client briefing aims to give a brief introduction of the article entitled “Determination on Unit Liability in Insider Trading Involving a Fund” (the “Article”) written by Mandy Wu and Yu Zhen (“Authors”) from our firm. Based on case analysis, the Article provides an in-depth study as to how to determine the unit liability for insider trading involving a fund.
I. Representative Case Analysis
In precedent insider trading cases decided by the China Securities Regulatory Commission (“CSRC”), seldom has the CSRC determined that a fund management firm (“Fund Manager”) holds the unit liability. The Sui Fu Investment Case and the Jin Zhong He Case are among the few instances in which the CSRC ruled against the Fund Managers on the charge of insider trading. In both cases, it is notable that the relevant persons held liable for the insider trading were not only the shareholders in the Fund Manager, but that they also held management responsibilities within the Fund Manager. They were in direct possession of insider information and also had the power of decision making for the relevant asset management product.
II. Legal Analysis
In an administrative law enforcement action, it is vital to carefully identify whether the illegal act of the party concerned reflects the unit’s will as a whole, or is solely an individual’s will independent of the unit’s. This fact distinguishes unit liability from individual liability. The CSRC, in its Guidelines on
Determining the Insider Trading Activities in Securities Market (Trial), provides two elements which together constitute grounds for unit liability: (i) the relevant insider trading act is carried out on behalf of the unit, and (ii) the illegal earnings so generated belong to the unit.
With respect to the constitutive elements of the unit liability for an insider trading act, we, by reference to the Criminal Law and the general rules and principles of punishment of relevant criminal cases, may conclude that the criteria distinguishing the unit liability from the individual liability in an insider trading case shall include:
(i)whether the unit is validly and lawfully incorporated;
(ii)whether the insider trading act is conducted on the unit’s behalf;
(iii)whether the insider trading act is conducted under the unit’s will as a whole;
(iv)whether the illegal earnings belong to the unit;
(v)whether it has reasonably excluded any scenario where the member inside the unit conducts an illegal act without obtaining approval, consent or recognition from the decision-making body thereof, or the illegal act conducted by him/her is irrelevant to his/her duties.
III. Factors to be Taken Account in Determining the Unit Liability and Relevant Issues
Firstly, the Article analyzes the specific features of a Fund Manager by drawing comparisons with other institutions and by distinguishing between mutual Fund Managers and private Fund Managers. It suggests that law enforcers should take those specific features into consideration when determining a Fund Manager’s liability. Such considerations include that the illegal earnings obtained by a Fund Manager are indirect earnings, and the amount earned thereof is lower than that obtained by the fund account itself. In addition, there are some key differences in the management and operational practices of mutual Fund Managers and private Fund Managers. For example, it is fairly common to see a shareholder of a private Fund Manager holding a senior management role in that private Fund Manager, and having responsibility for investment decisions. Secondly, the Authors point out that there are no mandatory laws or regulations for the internal governance and organizational structures for a private Fund Manager, and that a private Fund Manager therefore typically has greater flexibility in how they make investment decisions. Thirdly, the Article indicates that the regulatory requirements of public Fund Managers are more wide-ranging and detailed.
Additionally, it is recommended that law enforcers should not work on an improper presumption that a Fund Manager has conducted insider trading, but rather should consider the specific circumstances of each case. For example, law enforcers should ascertain whether a Fund Manager, prior to the respective employee accessing insider information, has already independently conducted research as to the concerned stocks, and whether the outcome of the Fund Manager’s research is itself sufficient to logically justify the subsequent trading of such stocks. In addition, despite the fact that there are employees of a Fund Manager with awareness of insider information, law enforcers will need to determine whether such holders of insider information have the power to make investment decisions for the relevant fund, or by internal information transfer, directly or indirectly, have disclosed such insider information to a decision-making person of the Fund Manager.
The Article also analyzes the determination criteria for certain specified circumstances. For example, in making a determination on what constitutes the “unit’s whole will”, the Authors believe that it mainly relies upon whether the insider information has entered into the Fund Manager’s investment decision making process, and the roles of the employees and their capacity to use insider information to affect decision making. Furthermore, if the Fund Manager itself does not intentionally organize, approve, mandate or otherwise conspire with the insider trading act of its employees, analysis shall be based upon whether the Fund Manager has diligently performed its duties with regards to the establishment of internal compliance policies and the prevention of insider trading.
Only in the case that a Fund Manager has failed to perform its compliance management duties, or has committed gross negligence in such performance, thereby leading to the failure of the prevention and control system or where there is an improper incentive mechanism, which induces an insider trading act, shall unit liability be imposed upon the Fund Manager for insider trading. Otherwise, the proper diligence of the Fund Manager shall be considered as a factor to mitigate or even discharge its unit liability.
Conclusions
In insider trading cases involving a fund, when determining the unit liability of the Fund Manager, prudent determination shall be made by careful consideration of the features of the fund industry, the Fund Manager’s operations and compliance management and other specific details of the relevant case.
In general, we suggest to adopt the principle of “fault liability”, that is, only when there is sufficient evidence proving that the Fund Manager itself has deliberate intention or gross negligence, shall it be held liable, and a cautious approach should be taken in any case where a Fund Manager could be presumed to be conducting insider trading.
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
