Securities Listing Series (Part 1) Case Warning - The Legal Liability Logic for Financial Fraud by Listed Companies

In recent years, the process of legal reform in the capital market has accelerated, and the regulatory signal of zero tolerance for financial fraud has been continuously strengthened. The investigations of landmark cases such as Kangmei Pharmaceutical and Zanzhai Island have clearly delineated the extensive legal net for administrative, criminal and civil accountability. This article will, through the review of typical judicial cases, focus on analyzing the core logic, evidence transformation path and key challenges in current accountability practices for financial fraud from administrative determination to criminal prosecution, aiming to provide guidance for all market participants in understanding and responding to the legal risks of financial fraud.

I. Typical Cases and Analysis of Behavior Patterns

1. Kangmei Pharmaceutical Case

(1) Overview of the Case

The financial fraud case of Kangmei Pharmaceutical Co., Ltd. (stock code: 600518, hereinafter referred to as "Kangmei Pharmaceutical") is one of the largest and most serious systematic financial fraud cases in the A-share market. From 2016 to the first half of 2018, Kangmei Pharmaceutical used various means to falsely increase huge operating income, monetary funds, and fixed assets, resulting in significant false records in its disclosed annual reports. This case was exposed in April 2019 due to the disappearance of nearly 30 billion yuan in monetary funds on the books, shocking the market and ultimately triggering a series of accountability including administrative, criminal, and civil. (2) Core Fraud Methods and Behavior Patterns

The typical characteristics of Kangmei Pharmaceutical's fraud behavior:

1) False increase in operating income and profits: Mainly through forging and altering value-added tax invoices and business vouchers, fabricating normal medicinal trade business, without a real transaction background, confirming operating income and transferring costs, thereby falsely increasing operating profits.

2) False increase in monetary funds: Behind the abnormal phenomenon of high deposits and loans is the forgery and alteration of large-denomination bank certificates of deposit or bank statements, false recording of monetary fund balances. This made the monetary funds item in its financial statements seriously inaccurate, covering up the actual financial situation.

3) False increase in fixed assets and other items: Some funds were circulated within the company, through false bookkeeping and voucher forgery, falsely increasing construction in progress, fixed assets, etc., making the asset scale artificially inflated.

Its behavior pattern can be summarized as: With the core of the controlling shareholder and the chairman, organizing the company's financial personnel, through forging business vouchers, bank documents and other original vouchers, conducting the entire process of fraud, ultimately compiling false financial statements and disclosing them to the outside. This is a typical premeditated and organized accounting fraud.

(3) Violated Legal Provisions

The behavior of this case violated multiple core laws and regulations of the capital market, forming a complete chain from administrative violation to criminal offense:

From the administrative regulation level, its behavior directly violated Article 63 of the original "People's Republic of China Securities Law" (revised in 2014) regarding that the information disclosed by issuers and listed companies must be true, accurate, and complete, and must not have false records, misleading statements, or significant omissions. Therefore, the China Securities Regulatory Commission imposed the maximum administrative penalty on it.

From the criminal law level, its long-term and systematic fraud behavior, with extremely serious circumstances, seriously damaged the interests of shareholders and others, seriously disrupted the securities market order, and exceeded the scope of administrative violation, constituting a criminal offense. The company and relevant responsible persons were ultimately held criminally responsible, the core charge being the "Unlawful Disclosure or Failure to Disclose Important Information" stipulated in the "People's Republic of China Criminal Law". This crime requires "legally obligated companies and enterprises to provide false or conceal important facts in financial accounting reports, or fail to disclose legally required other important information, seriously damaging the interests of shareholders or others, or having other serious circumstances".

The investigation and handling of the Kangmei Pharmaceutical case clearly revealed a complete fraud chain from falsely increasing revenue, forging financial instruments to false disclosure, and ultimately due to "seriously damaging the interests of shareholders" and "extremely serious circumstances", from administrative violation "escalated" to criminal offense, sounding the loudest alarm bell for all information disclosure obligors of the capital market. Zhangzidao Group Co., Ltd. (stock code: 002069, hereinafter referred to as "Zhangzidao") is a listed company mainly engaged in marine product farming. The core of its financial fraud case is not the forgery of traditional documents, but rather, by taking advantage of the industry characteristics of the marine farming sector where inventory verification is difficult and subject to natural disasters, it adjusts aspects such as seeding, harvesting, and write-offs to inaccurately record the bottom seeding, growth, death, and harvesting of its main product (Haliotis diversicolor), thereby systematically reducing costs and adjusting profits. This case is well-known for its frequent announcements of "the scallops have run away" or "the scallops starved to death" under bizarre reasons, resulting in a significant change in performance. It was only after the regulatory authorities used technologies such as Beidou satellite positioning to penetrate and verify, and ultimately confirm the illegal act that it could be verified.

(2) Core Fraud Methods and Behavior Patterns

The fraud behavior pattern of Zhangzidao can be summarized as using natural risks as a reason, using inventory adjustment as a means, and aiming to manipulate the performance for profit adjustment or to avoid losses:

1) False Recordation and Major Omissions: In some years, inaccurate records were made for the seeding area, survival rate, and inventory quantity of scallops. Through methods such as overestimating or underestimating costs and writing off assets, the profits of each reporting period were artificially adjusted. For example, in poor performance years, the scale of scallop deaths (impairment) was exaggerated, and large-scale centralized write-offs were carried out to release profit space for future years.

2) Cross-period Transfer and Cost Adjustment: The core method is to adjust the operating costs that should be transferred in different reporting periods through false autumn tests and year-end inventories, resulting in serious inaccuracies in the financial reports.

3) Nature of the Behavior Pattern: This behavior pattern, which packages subjective and artificial adjustments as accounting estimates affected by natural disasters, reflects the fraudsters' attempt to take advantage of information asymmetry and the difficulty of verification, operating illegally within the legal commercial shell, and also exploiting the difficulties in auditing and supervision of biological assets.

(3) Violated Legal Provisions

This case's behavior also constitutes illegal information disclosure, and due to its severity, it crossed the criminal red line:

From the administrative regulations level, its behavior violated Article 78, Paragraph 2 of the "People's Republic of China Securities Law" (revised in 2019), which stipulates that information disclosure obligors must disclose information truthfully, accurately, and completely, and must not have false records, misleading statements, or significant omissions. The China Securities Regulatory Commission determined that its 2016 and 2017 annual reports and multiple interim announcements contained false records.

From the criminal law level, the relevant responsible persons (such as the chairman, president, and financial director, etc.) were held criminally responsible for planning and organizing the aforementioned false recordation behavior, resulting in significant false information disclosure that seriously misled market investors. They were ultimately transferred to the judicial authorities and prosecuted for the crime of "unlawful disclosure or failure to disclose important information" as stipulated in the "People's Republic of China Criminal Law" Article 161. The uniqueness of this case lies in that its fraud methods are concealed and closely combined with industry characteristics, but it was ultimately classified as an intentional false statement. The criminal logic lies in the severity of the subjective intent and the consequences of the behavior, rather than whether the fraud methods are traditional.

3. Luckin Coffee Case (Reference for Chinese-listed Companies)

(1) Case Overview

The financial fraud case of Luckin Coffee (Luckin Coffee Inc. NASDAQ: LK, hereinafter referred to as "Luckin") is one of the most significant systemic fraud cases among Chinese-listed companies in the United States in recent years. From April 2019 to January 2020, Luckin fabricated commodity card transactions, inflated related-party income, and exaggerated advertising expenses, etc., resulting in a cumulative increase in sales of several hundred million US dollars. This case was exposed by the short-selling institution Muddy Waters in January 2020, and Luckin disclosed the fraud in April of the same year, causing a stock price crash, delisting, and a series of cross-border legal investigations.

(2) Core Fraud Methods and Behavior Patterns The fraudulent behavior pattern of Luckin Coffee is a typical and systematic manipulation of business data targeting the Internet new retail business model:

1) Fabricating transaction records: The company used its internal system to forge a large number of false sales records of goods exchange codes (coffee vouchers), and arranged related parties to purchase these vouchers, thereby creating fictitious sales revenue. This is a systematic and organized full-chain fraud starting from the source of transaction orders. 2) Overstating revenue and cost matching: To make the overstated income appear reasonable in the financial statements, it simultaneously overestimated related advertising expenses, store operation costs, etc., so that key indicators such as gross profit margin do not show abnormal fluctuations, making it more deceptive.

3) Core of the behavior pattern: This is the extreme manifestation of the money-spending-for-growth model in the Internet era. The core of the fraud lies in exploiting the complexity of verifying online transaction data, through technical means and the network of related parties, systematically forging core business indicators (such as sales volume, user numbers, daily sales per store), in order to maintain the high-growth narrative and capital market valuation. (3) Violated legal provisions

This case involves legal jurisdiction in both China and the United States and is a typical example of cross-border securities enforcement collaboration:

1) US legal level: As a company listed on the Nasdaq, Luckin's actions directly violated Section 10(b) of the US Securities Act of 1934 and the corresponding 10b-5 rules (anti-fraud provisions), submitting regular reports containing significant false statements to the US Securities and Exchange Commission (SEC). Eventually, the company reached a huge settlement (180 million US dollars) with the SEC, and its relevant responsible persons also faced criminal charges from the US Department of Justice.

2) Legal and regulatory collaboration in China: Although the main listing location is overseas, the China Securities Regulatory Commission, based on the "long-arm jurisdiction" principle granted by the newly revised "Securities Law of the People's Republic of China" (Article 2), investigated the illegal acts of Luckin's domestic operating entity, demonstrating the strength of cross-border regulatory cooperation. The actions of its domestic affiliated parties and direct responsible personnel could also disrupt the order of China's securities market and infringe upon investors' interests, and they would face domestic administrative penalties and market bans. If such actions occurred entirely within a domestic-listed company, they would also constitute the crime of "unlawful disclosure or failure to disclose important information" as stipulated in Article 161 of the "Criminal Law of the People's Republic of China" or more serious fraud-related crimes.

II. Core Logic of Criminal Liability Determination for Financial Fraud

1. Core Crime Classification: Fraudulent Issuance and Inappropriate Disclosure

Fraudulent Issuance of Securities: The core lies in the existence of significant financial falsehoods in the issuance documents. The logical starting point is that the fraudulent behavior occurs during the financing process, directly harming the issuance system.

Inappropriate Disclosure and Failure to Disclose Important Information: The core is the existence of significant falsehoods or omissions in regular reports or interim reports. The logical starting point is the violation of the continuous information disclosure obligation, damaging the investors' right to know and market order.

2. Key Factors for the Connection between Administrative Violations and Criminal Offenses: Severity and Particularly Severe

Threshold for Transition from Administrative Violations to Criminal Offenses: From the "false statement" in administrative penalties to the "inappropriate disclosure" in criminal offenses, the key lies in whether it reaches "seriously harming the interests of shareholders or others, or having other serious circumstances" (such as involving "important facts" or "huge interests", etc.).

Comprehensive Judgment of Amount, Circumstances, and Subjective Malice: The absolute amount of inflated profits/asset, relative proportion, whether it is repeatedly carried out, whether it resists investigation, whether it causes significant losses to investors, etc., jointly constitute the criteria for "serious circumstances".

3. Dual Punishment Logic for Corporate Crimes and Individual Responsibilities

"Corporate Will": Manifested as being decided by the decision-making body or responsible person of the company to seek benefits for the company.

Definition of "Directly Responsible Managers and Other Directly Responsible Personnel": Including the actual controller, chairman, general manager, as well as the financial director and secretary who specifically carried out financial fraud and prepared false reports. The liability determination follows the principle of "matching fault and responsibility".

III. Main Challenges in the Pursuit of Accountability

1. Evidence Conversion and Proof Standards

Criminal Admissibility of Administrative Evidence: The financial data, interrogation records obtained during administrative investigations, etc., in the criminal procedure need to undergo legality review and conversion. The appraisal opinion is the key to determining the amount of fraud.

2. Criminal Pursuit Has Lagging Characteristics

Financial fraud behavior is highly concealed and has a long cycle. Criminal filing often occurs after the fraud is exposed, the stock price drops, and significant losses occur, resulting in a lag. At the same time, not all cases that meet the filing standards can be smoothly transferred and prosecuted.

3. Connection between Civil Compensation, Administrative Penalties, and Criminal Fine

In practice, there are legal application details issues such as the implementation of the principle of giving priority to civil compensation, how to reconcile the fines of administrative penalties and criminal fines to avoid double punishment, which need to be further clarified.

IV. Conclusion and Outlook

The criminal liability logic of financial fraud is essentially the strong intervention and correction by the state's criminal power after the failure of the market's gatekeeper mechanism. Currently, with the significant increase in criminal penalties for securities crimes in the "Amendment to the Criminal Law of the People's Republic of China (Eleventh Amendment)", and the continuous optimization of the connection mechanism between administrative and criminal penalties, the deterrent effect of criminal punishment is increasingly prominent.

In the future, the pursuit of criminal liability for financial fraud will tend to: (1) Precision: Targeting the "prime offenders" more accurately, and holding accountable more strictly for the intermediaries that cooperate in fraud; (2) Efficiency: Improving the efficiency of case transfer and investigation through information sharing and joint case handling; (3) Synergy: Criminal pursuit will be more closely coordinated with civil compensation, administrative supervision measures, and integrity record keeping.

For listed companies and their employees, the only legal path is to adhere to the bottom line of truthful, accurate, complete, and timely information disclosure. Any attempt to obtain illegal benefits through financial fraud will ultimately fail in the face of the strict criminal liability legal net.