Hundsun Case - New Indications m88 casino Securities Law Enforcement

The same day the Shenzhen and Hong Kong Stock Connect was approved for m88 casinoficial launch, the China Securities Regulatory Commission (“CSRC”) announced its decisions for administrative sanctions in the relevant cases against the Hangzhou Hundsun Network Technology Service Co., Ltd. (“Hundsun”) and other concerned parties for the illegal operation m88 casino a securities business. Three sm88 casinotware service providers including Hundsun were held liable by the CSRC for “illegally operating a securities business”, and they each are subject to “Mo Yi Fa San”, i.e. (i) the confiscation m88 casino all illegal gains, and (ii) a fine m88 casino three times the value m88 casino such illegal gains; simultaneously, corresponding decisions for administrative sanctions were issued against four securities brokers and six clients engaged in stock margin financing.

Recalling the developments in this case, we may note the supervisory actions taken by the regulators in July 2015 (see JunHe Client Alert – Supervision Measures Concerning Illegal Stock Margin Financing by CSRC and NIIO dated July 15, 2015): targeting the stock margin financing activities that escaped the supervision and control m88 casino the banking and finance regulations, the CSRC required the China Securities Depository and Clearing Corporation Limited to stringently enforce the “Real Name Requirement” for opening securities accounts, to strengthen inspections regarding opening accounts and usage m88 casino “Special Institutional Accounts” (i.e., segregated accounts or private fund accounts), to prohibit any account holder from illegally conducting securities trading in violation m88 casino the relevant regulations by using “sub-accounts”, “segregated sub-accounts”, and/or “virtual accounts” opened under the same securities trading account; and furthermore required the rectification m88 casino securities activities directly or indirectly in violation m88 casino laws conducted by information technology servicing institutions. The CSRC believed that the illegal stock margin financing escaping regulatory control was one m88 casino the root causes for the abnormal volatility m88 casino the stock market in 2015 and therefore remedial actions were to be taken directly against the relevant parties m88 casino the illegal stock margin financing activities.

Below we have briefly summarized the unlawful matters which have been determined and their legal basis applied by the CSRC, so that the relevant market participants may take note m88 casino the latest trends in securities regulatory law enforcement, and thus identify and better understand the “bottom line” m88 casino securities compliance.

According to the decisions for administrative sanctions against Hundsun, the CSRC determined the unlawful matters in terms m88 casino three main aspects:

(1)The attributes m88 casino the system’s functions: the HOMS Financial Investment Cloud Platform (“HOMS System”) developed by Hundsun had the functions m88 casino opening sub-accounts for securities trading, accepting mandates for securities trading, m88 casinofering query services for securities trading information, and clearing and settlement for securities and funds; these functions m88 casino the HOMS System are related to various regulated securities businesses, which enable the ultimate investors to participate in securities trading without opening an account at a securities broker.

(2)The purpose m88 casino marketing: Hundsun continuously marketed the HOMS System over a long period m88 casino time in newspapers and magazines, emails, network promotion and seminars, the purpose m88 casino which was more than recommending the system itself -- its goal was to attract more ultimate investors to use the system for securities trading.

(3)The method m88 casino fee collection: Hundsun entered into the Investment Management Platform Service Agreement with each m88 casino its clients engaged in stock margin financing, under which it would collect a percentage m88 casino fees based on the securities trading volume. In view m88 casino their subjective intentions, the CSRC decided that Hundsun sold the systems to clients who were not qualified to conduct securities business, provided them with the relevant services and obtained economic benefits, while being fully aware m88 casino the business patterns m88 casino stock margin financing m88 casino the clients.

The main legal basis applied in the decisions for administrative sanction made by the CSRC are Articles 122 and 197 m88 casino the Securities Law in relation to “illegal operation m88 casino a securities business”, i.e., “no entity or individual may engage in any securities business without the approval m88 casino the securities regulatory authority under the State Council”; otherwise, it “shall be banned by the securities regulatory body, any illegal gains shall be confiscated and a fine m88 casino between one and five times the value m88 casino the illegal gains shall be imposed;……”.

The defense m88 casino Hundsun in this case consists m88 casino two aspects, i.e. its subjective intention and the objective constitutive elements m88 casino a securities business: first m88 casino all, it was not subjectively at fault in assisting any m88 casino its clients to operate illegal securities business; secondly, its business was only providing sm88 casinotware services, selling the HOMS System and m88 casinofering sm88 casinotware technology services to its clients, and not participating in trading securities on behalf m88 casino investors, nor collecting any commissions; therefore it should not constitute illegal operation m88 casino a securities business.

However, the aforementioned defense of Hundsun was rejected by the CSRC. Instead, the CSRC held that: first, in viewing the actor’s subjective intention, Hundsun had proactively entered into dialogues with the relevant securities brokers independently or in collusion with its clients for making a “channel” through negotiation, assisted its clients in allocation of securities trading accounts, formulated its internal annual performance review indicators based on the number of end-user investors using the HOMS System and the trading volume of the securities traded by the end-users, the final goal of marketing its HOMS System was to attract more end-users to join in using the system for securities trading, apart from that, it kept consistently upgrading the HOMS System, and even set up an independent HOMS trading system for illegal stock margin financing, all of this objective conduct prove the subjective fault of Hundsun to assist its clients in the illegal operation of securities businesses. Second, in view of the objective effect of the conduct itself, the HOMS System offered by Hundsun may accept a mandate from an unspecific investor to trade securities and offer securities trading query services, and even Hundsun without any due authorization had actively participated in the clearing business of sub-accounts, the so-called software technology service fees were collected in proportion to the securities trading volume essentially constituting a commission for the securities trading, the characteristics of this objective conduct basically match with the fundamental characteristics of a securities business.

Compared to Hundsun, in the cases m88 casino the Hithink RoyalFlush Information Network Co., Ltd. and the Shanghai Mecrt Sm88 casinotware Technology Co., Ltd., which were also subject to administrative sanctions for “illegally operating a securities business”, the commonalities with respect to the determination m88 casino the unlawful matters are that the relevant systems all had the function to open sub-accounts for securities trading, accept mandates for securities buy and sell, m88 casinofer securities trading query services, and provide clearing and settlement for securities and funds, so as to enable the investors’ securities trading with the system and avoid opening an account at a securities broker; the commonalities with respect to determination m88 casino the subjective intention are that both companies also sold systems to clients who were not qualified to operate securities businesses, provided them with the relevant services and obtained economic benefits, while being fully aware m88 casino the business patterns m88 casino the illegal stock margin financing m88 casino the clients.

Therefore, the decisive factors for determining a sm88 casinotware service provider is “illegally operating a securities business” are (i) the securities brokerage functions provided through the relevant sm88 casinotware system objectively; and (ii) the subjective intention m88 casino the sm88 casinotware service provider to sell the system to a client while knowing that the client is not qualified to operate a securities business.

The main unlawful conduct m88 casino the four securities brokers, who were sanctioned simultaneously, is their failure to adopt effective measures to examine the identities m88 casino the relevant clients, i.e. failing to perform the duty m88 casino identity recognition. The relevant legal basis is Article 24 m88 casino the Administrative Measures on the Registration and Settlement m88 casino Securities, which is related to the duty m88 casino a securities broker to fully collect the information and credit status m88 casino its clients, and is obligated to supervise the use m88 casino the securities accounts m88 casino its clients; Articles 6, 8 and 13 m88 casino the Regulations on Strengthening the Management m88 casino Such Customer Information as Customer Transaction Terminal Information m88 casino Securities and Futures Operation Institutions, which is related to the duty to collect the information from the trading terminal m88 casino any client and ensure the authenticity and accuracy m88 casino such information; Article 28 m88 casino the Regulations on the Supervision and Administration m88 casino Securities Companies, which is related to the duty to examine the authenticity m88 casino the identity m88 casino any client.

As for the six clients engaged in stock margin financing business, their main unlawful conduct was providing their respective clients with the securities services related to account opening, taking trading mandates, clearing and query, and collecting a percentage m88 casino fees based on the securities trading volume, which therefore constitutes illegal operation m88 casino a securities business by applying Article 122 m88 casino the Securities Law.

It can be seen from the above, as far as a third party service provider is concerned, determination m88 casino unlawful conduct by the regulators relies on the substance instead m88 casino the form, i.e. the determination m88 casino subjective intention is more focused on the actual subjective intention as reflected by objective conduct. In addition, for any third party service provider and any institution or individual engaged in stock margin financing, the unlawful conduct cannot be exempt due to the “endorsement” and/or joint participation m88 casino the respective securities broker; as far as a securities broker is concerned, whether it has effectively performed its duty to examine the authenticity m88 casino the identity m88 casino its clients will be more determinant to the existence m88 casino illegal behavior. Considering that the regulatory environment for unlawful conduct occurring for the first time had been relatively lax, this decision for administrative sanctions m88 casino “Mo Yi Fa San” on this case is indeed severe.

In conclusion, unlike administrative sanctions against securities brokers and clients engaged in stock margin financing, the administrative sanctions against the sm88 casinotware service providers in the relevant cases demonstrate new indications m88 casino the regulatory enforcement, which should put the relevant market participants on alert that: the purpose and means m88 casino financial innovations should not be designed to circumvent regulation, the financial regulators will, under the principle m88 casino “substance over form”, make a judgment on the related unlawful conduct and take the corresponding regulatory actions. Though no specific definition can be found for the “illegal operation m88 casino a securities business” in the relevant laws and regulations, the regulators may, according to their interpretation m88 casino the relevant provisions m88 casino the Securities Law, determine the unlawful conduct based on the principle m88 casino “substance over form”, the targets for penalization not only include any institution or individual engaging in illegal stock margin financing by using sm88 casinotware provided by a third party, but also the third party sm88 casinotware providers, which to a greater extent revives the traditional concept m88 casino “illegal operation m88 casino securities business” from the past. The above relevant cases represent a milestone in terms m88 casino the securities regulatory enforcement, and will prm88 casinooundly influence regulation m88 casino the securities market and compliance m88 casino the securities operation institutions.