Securities Issuance in Securities Crime Part 1: Legal Boundaries - How Can Enterprises and Intermediaries Avoid Punishment

In the process of legalization of the capital market, securities issuance is undoubtedly the first gate of risk prevention and control - as the starting point for enterprises to enter the capital market, the compliance of the issuance link not only determines whether enterprises can successfully enter the capital market, but also concerns the protection of investors' rights and interests, the stability of the financial market and the effective operation of the socialist market economic system. Throughout the history of securities criminal legislation in China, from the Criminal Law in 1997 for the first time to set up securities crimes, to the Criminal Law Amendment (XI) in 2021 to raise the sentence limit of fraudulent issuance, and then to the "State Nine" in 2024 to establish the "execution of the people's multi-faceted accountability" mechanism, legislators have always regarded the issuance link as the core battlefield of securities crime governance.

Under the background of the in-depth promotion of the registration system reform, the authenticity of information disclosure at the issuance stage has become a regulatory red line: the financial data fraud in the prospectus, the concealment of major related transactions, and the fiction of the core business have evolved from the hard-hit areas of administrative penalties in the past to the high incidence of criminal liability. Once the enterprise and its controlling shareholder and actual controller break the legal boundary, they will not only face the criminal charges of "fraudulent issuance of securities", but also lead to the joint and several liability of the intermediary agency "providing false supporting documents".

As the opening work of this series, this paper focuses on the criminal risk of the whole chain of securities issuance, based on the convergence rules of the new Securities Law and the Amendment to the Criminal Law (XI), in-depth analysis of the constituent elements and judicial determination logic of the three core charges of fraudulent issuance, false certification and unauthorized issuance, combined with typical cases, reveals the regulatory logic of "strong disclosure and strict accountability" in the era of registration system. The following article will continue from the criminal risk in the listing stage, the construction of enterprise compliance system and other aspects, to provide systematic solutions for market entities to build a solid criminal firewall in the issuance link.

Criminal risk in securities issuance

1. Crime of fraudulent issuance of securities:

1) Legal provisions

According to the provisions of Article 160 of the Criminal Law (as amended by the Amendment (XI) of the Criminal Law), a person who conceals important facts or fabricates major false contents in the issuance documents such as the prospectus to issue securities, with a huge amount, serious consequences or other serious circumstances, shall constitute this crime.

The main body of the crime is the securities issuer (unit) and the controlling shareholder, the actual controller, deliberately concealing or fabricating material information to defraud the issuance approval, and it must meet the false document production and securities issuance behavior at the same time, and meet the filing standards.

2) Analysis of legal constitution

(1) The scope of regulation of the crime of fraudulently issuing "securities"

Since the amendment (XI) of the Criminal Law, the scope of regulation of this crime has been expanded, and the orderly docking with the Securities Law has been realized. "Securities" includes: shares; Corporate and enterprise bonds; Depositary receipt; Other bonds lawfully recognized by The State Council. Among the types of securities issued above, the specific documents involved and the main forms of fraud are:

a) Prospectus (the core document of a company's initial public offering (IPO), which needs to disclose information such as financial status, legal status, business risks, fundraising purposes, etc.) The main forms of fraud are fictitious income in the prospectus, concealing major debts, and fictitious core technology and market prospects. Article 19 of the Securities Act clearly requires that the prospectus must be true, accurate and complete. This is also the embodiment of the convergence between the Criminal Law Amendment (XI) and the Securities Law.

b) Prospectus for bond offering (disclosure of key information such as solvency, guarantee measures and use of funds when issuing bonds). The main forms of fraud are inflated solvency indicators (such as cash flow), concealing defects of collateral, and fabricating fundraising projects.

c) Financial audit report (reflecting the company's assets, liabilities, profits and other core financial data, The main forms of fraud are fraud at the revenue end (including but not limited to fictitious transaction cycle, interperiod adjustment confirmation, customer identity fraud), fraud at the cost and expense end (including but not limited to the transfer of related party benefits, abnormal inventory processing), fraud at the asset and liability end (including but not limited to forged bank statements and confirmation letters, fictitious accounts receivable recovery). The well-known Kangmei Pharmaceutical case was to falsely increase monetary funds by 30 billion yuan by forging bank deposit certificates, which was identified as fraudulent issuance.

d) Lawyers' work reports, legal opinions (professional opinions of law firms on the legal compliance of issuers, Such as equity clarity, related transactions and industry competition, asset ownership, litigation risk, etc.) The main forms of fraud are concealing major legal flaws (including but not limited to the concealment of pending litigation/arbitration, administrative penalties), falsification of equity structure (including but not limited to the concealment of the entrustment agreement, the eligibility of fictitious shareholders), and asset ownership fraud (including but not limited to the ownership of movable or immovable property) False identification), connected transactions and falsification of industry competition (including but not limited to hiding related parties, making circumvention of industry competition), etc.

e) Asset appraisal report (appraisal results of the issuer's asset value (such as land, patents), affecting the scale of fundraising) The main forms of fraud are inflated asset valuation (such as fictitious patent value) and concealing asset defects (such as mortgage status).

(2) The understanding of concealing material facts and fabricating material false content - expanded understanding

In 2022, the newly revised Provisions on the Standards for Filing and prosecuting Criminal Cases under the jurisdiction of Public Security Organs (II) provides more abundant prosecution standards for the crime of fraudulent issuance of securities, but the provisions themselves do not change the virtual state of the major standards for the crime of false statements in judicial practice.

From the literal perspective of judicial interpretation, concealing material facts and fabricating material false content only have two situations where the amount involved is greater than or equal to 50% of the net assets, revenues and profits of the current period, or 30% of the total assets, revenues and profits of the current period, and concealing or fabricating major lawsuits and related transactions. However, it is particularly important to note that in fact, due to the addition of the standard of the fourth paragraph of the direct loss of investors greater than or equal to 1 million yuan, it will actually cause the standard for the identification of this crime to be greatly reduced. As for the standard of "other circumstances with serious consequences or other serious circumstances" outlined in paragraph (10), the relevant provisions of "major events" in Articles 80 [1] and 81 [2] of the Securities Law can be used as reference, although the relevant provisions of the Securities Law are provisions for listed companies, and the company to be listed in the issuance stage is not the subject of this crime. However, due to the existence of the 1 million investor loss clause, the relevant subjects are likely to face criminal responsibility while facing administrative penalties. Therefore, as far as this crime is concerned, the violation of administrative law provisions is very likely to touch the criminal red line at the same time, which also requires all parties to pay attention to the relevant administrative regulations in addition to the provisions of the criminal law and related judicial interpretation to avoid criminal risks.

(3) Rules for the identification of charges against personnel of intermediary agencies

Rules for the identification of joint crime -- principle of consistency between subjective and objective

The main body of this crime is the securities issuer (unit), the controlling shareholder and the actual controller, but in special circumstances, the intermediary may also constitute the accomplice of this crime. The intermediary refers to the third-party institution that provides professional services for the issuer in the process of securities issuance, mainly including: Sponsor agencies (securities companies), accounting firms, law firms, asset assessment agencies, and credit rating agencies. The intermediary agency plays an important role in the process of securities issuance. If the issuer has problems in the process of issuance, it is necessary to examine whether the documents issued by the intermediary agency are false or concealed.

The 55th batch of guiding cases of the Supreme People's Procuratorate, Zhongjia Leather Co., LTD., Zhou Mou, etc. fraudulently issuing bonds, and Ma Mou issuing certification documents (Procuratorial Case No. 219) put forward clear rules for determining the charges of intermediary organization personnel, that is, following the principle of consistency between subjective and objective, if the intermediary organization personnel subjectively know that the issuer has committed fraudulent issuance, Objectively still in accordance with the requirements to cooperate with the issuance of serious false certification documents, in the scope of the crime of fraudulent issuance of securities to establish a joint crime. If there is no collusion between the two parties, a crime shall be established according to the constituent elements of their respective acts.

(4) Responsibility

At present, China's capital market has built a three-pronged "criminal civil bank" three-dimensional fraudulent issuance liability investigation system, once the company is involved, in addition to the unit facing huge compensation, the relevant personnel also face administrative punishment, civil compensation and criminal responsibility.

In recent years, in addition to the company's termination of listing and delisting, the actual controller, the actual controller acting in concert, and the director supervisor were first taken administrative penalties and assumed civil compensation, after the actual controller and the actual controller acting in concert were arrested for criminal offenses. Its sponsors, accounting firms and law firms have also set up a compensation fund of 1 billion yuan to carry out compensation work.

The practice of unit crime is double punishment system. The controlling shareholder of the company that intends to issue securities may still be the company, and the subject who needs to bear the responsibility is still the unit and individual. In criminal cases, penetrative liability is usually adopted, and in civil liability, individual immunity may be achieved through layers of equity structure nesting, which is almost impossible in criminal cases. Once the criminal case is filed, The main responsible person involved in the fraudulent issuance and other directly responsible persons will face criminal responsibility.

2. The crime of providing false supporting documents/the crime of providing major false supporting documents

1) Legal provisions

According to Article 229 of the Criminal Law, an intermediary agency intentionally provides false certification documents in the issuance of securities, if the circumstances are serious, it constitutes this crime. The main body of the crime is accounting firms, law firms and other intermediaries and responsible personnel, deliberately issued documents inconsistent with the facts, and the contents of the documents are false and have a substantial impact on the issuance of audit. The statutory penalty is up to 5 years' imprisonment + fine in serious cases, and 5-10 years' imprisonment + fine in especially serious cases.

2) Analysis of legal constitution

This crime targets the personnel of intermediary institutions who provide professional services such as accounting, auditing, law and evaluation. This crime puts forward higher requirements for the professionalism and service attitude of intermediary service personnel. It needs to be reminded that, for the intermediary organization personnel who issue false certification documents such as audit reports, they should distinguish whether they are subjectively aware of the issuer's financial fraud and deliberately issue false certification documents, or seriously irresponsible, should be found and not found, causing serious consequences, to determine whether they constitute the crime of providing false certification documents and the crime of issuing major false certification documents.

3. Crime of issuing stocks, corporate bonds or corporate bonds without authorization

1) Legal provisions

According to the provisions of Article 179 of the Criminal Law, without the approval of the relevant competent authorities of the State, the issuance of stocks or corporate or enterprise bonds without authorization, the amount is huge, the consequences are serious or there are other serious circumstances, shall constitute this crime.

The statutory penalty is a natural person's imprisonment of less than 5 years or criminal detention, and also or only a fine of 1%-5% of illegally raised funds. The unit shall be fined, and the person directly responsible shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention.

Without the approval of the relevant competent departments of the State, the issuance of stocks or corporate or enterprise bonds without authorization, suspected of one of the following circumstances, shall be filed for prosecution:

(1) The amount of illegally raised funds is more than one million yuan; (2) The cumulative amount of direct economic losses caused by the investor is more than 500,000 yuan; (3) all or mainly the funds raised are used for illegal and criminal activities; (4) other serious consequences or other serious circumstances; (5) More than 200 people are issued.

2) Crime analysis

This crime is a unit crime, the public issuance requirements of more than 200 people, generally belongs to the category of misdemeanors, the maximum sentence is less than 5 years. However, special attention should be paid to the fact that the purpose of the perpetrator's implementation of this crime is basically to finance, which is essentially different from the illegal operation of futures and securities business in the crime of illegal operation, but in the process of financing, there is competition with the crime of illegally absorbing public deposits, fund-raising fraud and other felonies. The difference between this crime and that crime will be clearly defined in the subsequent defense series.

3) Case (Shanghai No.1 Intermediate People's Court (2019) No. 40, Hu01 Xingchu)

In June 2015, Zhang Zhengliang, the then legal representative of Aohai Company, led the launch of the equity financing plan and illegally transferred the company's equity to the public through third-party institutions. Within one year since July 2015, the company has raised a total of 148 million yuan from 131 non-specific investors through telemarketing and interpersonal communication with the publicity point of "New Third Board listing is imminent" and "high yield is expected" without the approval of the securities regulatory authorities.

The court found out that Aohai Company issued shares in disguise in the form of equity transfer through fictitious listing expectations and concealing true operating conditions, and the raised scale far exceeded the legal standard. According to Article 179 of the Criminal Law, his behavior was found to constitute the crime of issuing stocks without authorization. In the end, Aohai was sentenced to a fine of 4.5 million yuan, and the directly responsible person Zhang Zhengliang was sentenced to four years in prison.

Enterprise compliance system construction

1. Key points of internal control integration

1) Dual-track information disclosure system

Establish a "business department self-examination + compliance department review" mechanism to ensure that key information such as financial data and related transactions is true and accurate, and also ensure that the approval authority of related transactions and income recognition is separated.

2) Behavioral constraints of controlling shareholders

We have strictly formulated relevant internal control systems, coordinated the Audit Committee of the Board of Directors to establish a special audit mechanism, restricted the controlling shareholder's right to deploy funds through the company's articles of association, and required major transactions to be reviewed by both independent directors and the audit committee.

3) Introduce ai technology

AI financial anomaly monitoring system is introduced to benchmark the fluctuation threshold of business indicators of listed companies in the same industry. When the core indicators such as gross profit margin and accounts receivable turnover deviate from the industry average correlation ratio, the early warning is triggered.

2. Key points of diligence and responsibility of intermediaries

1) Upgrade of due diligence standard

For major customers and suppliers of the issuer, the adoption of "penetrating verification" (such as on-the-spot visits, cross-verification of bank statements) to ensure the authenticity of business. For customers whose revenue accounts for more than 15% of a single customer, implement the "three views and three core" procedure: see the physical object, see the logistics, see the capital flow; Verification of industrial and commercial registration, verification of tax payment certificates, verification of bank statements.

2) Risk isolation of signature rights

It is forbidden for intermediaries to "sign" or "name". Prospectus, audit reports, lawyers' work reports, legal opinions and other important documents shall be verified by the project leader and team partners, and the draft shall be retained for future reference.

3) Regular simulation

By setting up an exercise mechanism, the annual simulation of the CSRC on-site inspection scenario, the organization of intermediaries to test key subjects, and the reserve of response plans three months in advance.

3. Regulatory convergence and crisis response

1) Administrative criminal risk linkage

If an investigation is filed, immediately launch an internal self-examination and immediately entrust a professional team of lawyers to enter, collect evidence under the guidance of lawyers to prove that the duty of diligence has been fulfilled, to avoid being identified as "knowing" or "intentional".

2) Investor compensation plan

Set up a special fund, according to the situation according to 5% of the raised funds as a reserve fund for dealing with possible class action lawsuits, reduce social impact.

The criminal risk prevention and control of securities issuance should be based on the strategy of "actively blocking before the event" and "timely remedy after the event" : enterprises should build a penetrating internal control system, intermediaries should strictly abide by the professional bottom line, and controlling shareholders and actual controllers should abandon the speculative mentality of the capital market. In the future, AI monitoring technology will be rapidly popularized, and the capital market will move towards the era of transparency of "disclosure is responsible". With the strengthening of the linkage mechanism between criminal punishment and execution, only by embedding compliance into the whole business process and strictly controlling the criminal risks of securities by enterprises and intermediaries can it avoid becoming a typical case under "strong supervision" in the capital market.

Footnote:

[1] Occurrence of major events that may have a greater impact on the trading prices of listed companies or companies whose stocks are traded in other national securities trading venues approved by The State Council. The alleged material events include:

(1) Major changes in the company's business policy and business scope;

(2) Major investment activities of the company, where the purchase or sale of major assets of the company exceeds 30 percent of the total assets of the company within one year, or the mortgage, pledge, sale or scrapping of major business assets of the company exceeds 30 percent of the assets at one time;

(3) The company enters into important contracts, provides significant guarantees or engages in affiliated transactions, which may have an important impact on the company's assets, liabilities, rights and interests and operating results;

(4) The company incurs major debts and fails to pay off major debts when they are due;

(5) The company suffers major losses or major losses;

(6) Major changes in the external conditions of the company's production and operation;

(7) The directors, more than one third of the supervisors or managers of the company are changed, and the chairman or manager is unable to perform his duties;

(8) There is a major change in the holding of shares or control of the company by shareholders or actual controllers who hold more than 5 percent of the company's shares, or a major change in the engaging of the same or similar business with the company by the actual controllers of the company and other enterprises under their control;

(9) the company's plan to distribute dividends and increase capital, important changes in the company's equity structure, the company's decision to reduce capital, merge, split, dissolve or file for bankruptcy, or enter bankruptcy proceedings or be ordered to close down according to law;

(10) Major litigation, arbitration involving the company, resolutions of the shareholders' meeting or the board of directors are revoked or declared invalid according to law;

(11) The company is placed on file for investigation for suspected crimes, and the controlling shareholder, actual controller, director, supervisor and senior management of the company are taken compulsory measures according to law for suspected crimes;

(12) Other matters stipulated by the securities regulatory body under The State Council.

[2] There is a major event that may have a significant impact on the trading price of a publicly traded company's bonds. Major events include:

(1) Major changes in the company's ownership structure or production and operation conditions;

(2) The company's bond credit rating changes;

(3) mortgaging, pledging, selling, transferring or scrapping the company's major assets;

(4) The company fails to pay off maturing debts;

(5) The company's new loans or external guarantees exceed 20 percent of its net assets at the end of the previous year;

(6) the company's abandonment of creditor's rights or property exceeds 10% of its net assets at the end of the previous year;

(7) Major losses of the company exceeding 10% of its net assets at the end of the previous year;

(8) the company distributes dividends, makes decisions on capital reduction, merger, division, dissolution or application for bankruptcy, or enters bankruptcy proceedings or is ordered to close down according to law;

(9) Major litigation and arbitration involving the company;

(10) The company is placed on file for investigation for suspected crimes, and the controlling shareholder, actual controller, director, supervisor and senior management of the company are taken compulsory measures according to law for suspected crimes;

(11) Other matters stipulated by the securities regulatory body under The State Council.