2020.09.23 WU, Lei、 XIAO, Xian、FANG, Hao
Article 3 of the Detailed Implementation Rules on Non-Public Offering of Shares by Listed Companies (“Detailed Rules on Non-Public Offering of Shares”) provides that the directors, supervisors, senior executives, sponsors and underwriters of a listed company that issue shares non-publicly; the professionals and their employers that issue special documents for such issuance of shares; as well as the controlling shareholders, de facto controllers and other insiders of such listed company; shall all comply with relevant laws, regulations and rules, act with due diligence and care, and shall not seek improper benefits by taking advantage of any non-public offering by a listed company; nor shall the foregoing personnel disclose any insider information or trade securities, or manipulate securities trading prices by taking advantage of such insider information. The China Securities Regulatory Commission (CSRC) has penalized many insider trading cases involving the non-public offering of shares by listed companies.
Pursuant to the Administrative Measures on Issuance of Securities by Listed Companies, the non-public offering of shares by a listed company refers to the issuance of shares to specific targets, the total number of which shall be not more than 35. According to the issuance targets and the issuance pricing method, the non-public offering by listed companies comes in two forms:
(1) Fixed-price Issuance: Before submitting the non-public offering application to the CSRC, the board of directors of the listed company has determined all issuance targets; the issuance price is calculated by using the announcement date of the resolution of the board of directors or the general meeting of shareholders as the pricing benchmark date; the listed company has already disclosed to the market important information regarding the non-public offering, such as issuance targets, issuance price and quantity of issued shares before announcing the relevant plan for non-public offering of shares.
(2) Bidding-based Issuance: The issuance targets, issuance price and number of issued shares remain uncertain when the listed company submits the non-public offering application to the CSRC; there is no detailed information regarding the issuance targets, issuance price and number of issued shares in the relevant plan for non-public offering of shares announced by the listed company or the approval documents issued by the regulator; the issuance targets, issuance price and quantity of issued shares are finally determined by inviting qualified investors to send requests for quotation (RFQ) after the company obtains regulatory approval; after completion of the RFQ, the listed company shall prepare an issuance report so as to publicly disclose to the market detailed information on the issuance target, issuance price and quantity of shares with respect to the non-public offering.
Although the previous insider trading cases penalized by the CSRC mainly involve non-public offering by listed companies in the form of fixed-price issuance, it does not follow that insider trading will not occur in a bidding-based issuance.
Articles 52 and 80 of the Securities Law of the People’s Republic of China (“Securities Law”) clearly define insider information on shares of listed companies. Specifically, Article 80, Paragraph 2, Item (9) stipulates that a company’s plan for capital increase and important change in the shareholding structure of a company are both major events that may have a relatively significant impact on the trading price of the company’s shares, which the company shall promptly disclose publicly to the market. In the enforcement practices of the CSRC, as we have observed, the foregoing provision is usually referred to when determining whether certain information regarding the non-public offering of a listed company shall be deemed as insider information.
In view of the features of non-public offering, the issuance targets, issuance price and number of issued shares are the key elements of a plan for non-public offering. The lack of any of the foregoing elements will render the plan for non-public offering incomplete and impossible to implement. Therefore, for information regarding the non-public offering by a listed company to be considered fully insider information, it shall contain elements such as information on the issuance targets, issuance price and number of issued shares.
Among the administrative penalties imposed by the CSRC, penalized insider trading cases normally involve a fixed-price non-public offering, and relevant trading activities occurred before the listed company announced its plan for non-public offering to the market. In other words, for insider trading cases involving a fixed-price non-public offering, the regulatory authorities mainly focus on whether the relevant party is aware that the listed company will conduct a non-public offering, without considering whether the party knows the detailed information on the issuance targets, issuance price and/or number of issued shares. And further, regardless of the above penalty cases, the CSRC still has the discretion to determine the important information of non-public offering such as issuance targets, issuance price and number of issued shares to be insider information.
The CSRC has reiterated in many penalized cases that, under the Securities Law, the CSRC has the discretion to determine whether certain information shall be deemed as insider information, and insider information shall have two basic characteristics, namely, that it is material and non-public1. In light of the features of a non-public offering, there is not much controversy that the issuance targets, issuance price and number of issued shares all possess materiality. Accordingly, in some cases, due to the need to crack down insider trading, the CSRC would incline to determine that information on the issuance targets, issuance price and number of issued shares with respect to non-public offering shall constitute insider information, all of which may be disclosed step by step in a bidding-based non-public offering.
Pursuant to laws, regulations and the enforcement practices of the CSRC, the method for determining whether insider information is publicized is relatively simple. According to Article 85 of the Securities Law, only insider information that has been announced by the listed companies via the website of the stock exchanges or other media that meets the conditions prescribed by the securities regulatory authority of the State Council shall be deemed as having been publicly disclosed to the market, and thereby no longer insider information. If a listed company and other entities aware of insider information notify certain investors of relevant insider information before the listed company announces such information in accordance with law, this information may still be considered non-public and the foregoing entities may be suspected of divulging insider information.
In addition, according to the Detailed Rules on Non-Public Offering of Shares, listed companies shall disclose the plan for non-public offering of shares and the issuance report during the process of non-public offering. In terms of a bidding-based issuance, important information, such as issuance targets, issuance price and number of issued shares, are only disclosed to the market by the listed company in the issuance report after the RFQ is over. Therefore, it is a highly contentious view and may be hard for a law enforcement agency to accept that, for a bidding-based issuance, given that the plan for non-public offering of shares and relevant regulatory approvals announced by the listed company do not contain important information on non-public offering, such as issuance targets, issuance price and number of issued shares, and the important information of non-public offering has been fully disclosed to the market when the listed company announces the plan for non-public offering of shares and regulatory approvals, thus, any subsequent trading of shares of such listed company shall not constitute insider trading.
It is also worth noting that when the Securities Law was amended in 2019, it incorporated a new Article 83 regarding the principle of fair disclosure, which provides that information disclosure obligors shall disclose information to all investors at the same time, and shall not divulge such information to any entity or individual in advance. Article 83 further requires that no entity or individual shall illegally require an information disclosure obligor to provide information that is required to be disclosed according to law but has not yet been disclosed; any entity or individual aware of the foregoing information in advance shall keep such information confidential before the information is disclosed pursuant to law. Therefore, in the process of a bidding-based issuance, before the listed company discloses the issuance targets, issuance price and number of issued shares in the issuance report, if any of the listed company, underwriters, or investors qualified to participate in the RFQ, notifies other investors of such information in advance, it may be suspected of violating the principle of fair disclosure and thus subject to administrative penalties.
According to the Securities Law, there are two types of parties that are prohibited from trading relevant stock after they become aware of insider information: (1) insiders aware of insider information; (2) persons obtaining insider information by illegal means. Between the two, insiders aware of insider information mainly refer to (i) listed companies and their directors, supervisors and senior executives, (ii) shareholders of listed companies and their directors, supervisors and senior executives, (iii) counterparties to transactions regarding the acquisition of listed companies or major asset restructuring of listed companies, and (iv) persons who participate in the formation of insider information or otherwise associated with listed companies. Persons obtaining insider information by illegal means, on the other hand, refer to persons who obtain insider information by means of eavesdropping, theft, fraud, or other illegal methods, or persons who have a close relationship or contact with persons knowing the insider information, that is, insider information has been transmitted from one party to another.
In practice, the CSRC, when determining whether there is any transmission of insider information, may make relevant determination by reference to objective evidence, such as the trading activities of relevant parties and whether there has been any contact between such parties and persons knowing the insider information. Among the insider trading cases penalized by the CSRC, more than half of such cases are determined by presumption2. In addition, when determining the trading period related to insider information, the CSRC views the formation of insider information as a whole, rather than dividing the trading period into several parts.
It can be observed that in the process of bidding-based issuance, important information, such as the issuance targets, issuance price and number of issued shares, is formed in the course of RFQ. When the regulatory authorities investigate whether insider information has been transmitted, they view the formation of insider information as a complete process, including (i) the listed company and the underwriter issue subscription invitations to qualified investors, (ii) investors submit subscription quotations, and (iii) issuance targets, issuance price and number of issued shares are finally determined. For any large volume of securities trading that occurs over such period, if a party has contact with various RFQ participants, especially investors who have received the subscription invitations, and the foregoing investors finally obtain the share placement, the regulator may presume according to law that insider information has been transmitted between the party and the investors participating in the RFQ, thereby determining that the party engages in insider trading.
We will continue to monitor the situation and keep our clients apprised of any important developments.
1. E.g., the insider trading case of EverBright Securities, CSRC Administrative Penalty Decision  No. 59.
2. Statistics based on administrative penalty decisions of the CSRC from 2013 to 2019 as published on the CSRC website (http://www.csrc.gov.cn/pub/zjhpublic/index.htm?channel=3300/3313).