In April this year, the China Securities Regulatory Commission ("CSRC") released the 20 representative cases of securities violations in the year of 2021 (available only in Chinese language). This is the sixth consecutive year in which CSRC has selected and published its representative enforcement actions. These cases provide a glimpse of the market dynamics, regulatory developments, types of misconduct, and potentially the priorities of CSRC's enforcement actions.
The representative cases over the past six years have always included disclosure violations, intermediary misconduct, insider trading and market manipulation. The largest composition, however, shifted from market manipulations in the earlier years to disclosure violations more recently. In 2020 and 2021, over half of the cases were disclosure violations, especially corporate financial reporting frauds and related misbehaviors. The overall trend is on the rise – CSRC reported that it handled 163 cases of misrepresentation in 2021, including 75 cases of accounting and reporting fraud, representing a year-on-year increase of 8%.
Studying some of the financial fraud cases in 2021, I have the following observations:
- First, several cases revealed systematically organized fraud schemes using "conventional" methods such as fabrication of transactions with fictitious counterparties, forgery of documentation such as contracts, invoices, even bank statements. Collusion with third parties, especially undisclosed related entities, was common. In certain cases, companies masked their fictitious transactions with an extra layer under the guise of "new business" or "new model".
- Second, in fewer instances, companies manipulated their financials exploiting accounting issues which involve management discretion. These "softer" means included, among others, adopting aggressive and unrealistic accounting estimations, recognizing revenue prematurely, deliberately understating impairment and provisions. Compared with the "conventional" methods above, these were much harder to detect.
- Third, merger and acquisition transactions bring intrinsic high risk. Two of the 20 cases this year related to M&A – the lack of effective corporate governance in the subsidiary or partnering operations victimized the parent group.
- Finally, the CSRC continued its dual-investigations-in-one-case strategy. While acting vigorously against the issuers on financial frauds, CSRC has also been holding intermediaries accountable as "gatekeepers". There was a clear increase in enforcement actions against deficient exercise of due diligence of bankers, auditors, lawyers and asset appraisal professionals. Among the 20 representative cases released this year, four involved intermediaries, up from two in the previous year. In 2021, the number of cases on intermediary misconduct investigated by the CSRC more than doubled from 2020.