Looking back at 2023, the securities industry has undergone great changes. Whether it is the establishment of the State Administration for Financial Supervision and Administration, or the multiple normative documents and exchange business rules issued by the China Securities Regulatory Commission, all convey the country's attitude towards strong supervision of the securities market. After 30 years of development, our securities market has indeed entered a deep reform zone, and many problems have accumulated for a long time. Among them, fraudulent issuance has always been a "cancer" in the securities market. There are mature "packaging" institutions in the market that specialize in providing comprehensive decoration and packaging for potential listed companies, enabling them to issue stocks or bonds to obtain undue benefits. Financial fraud incidents such as Luckin Coffee and Purple Crystal Storage continue to emerge, causing a huge impact on the securities market and investors, endangering the order and financial security of China's securities market. The China Securities Regulatory Commission has repeatedly stated that it will promote the implementation of administrative, civil, and criminal penalties for fraudulent issuance to form a strong deterrent. To this end, we have launched a series of articles on fraudulent distribution, sharing practical cases related to fraudulent distribution with everyone and exploring relevant legal issues. This article is the first in a series of articles, please continue to follow.

As early as early as 2020, Wang Jianjun, Secretary of the Party Committee of the Shenzhen Stock Exchange and National People's Congress representative, proposed at the Two Sessions to accelerate the revision of the Criminal Law and include fraudulent issuance in the "financial fraud crime", with a maximum sentence of life imprisonment. At the end of 2020, the Eleventh Amendment to the Criminal Law was introduced, which amended the criminal qualifications and fines for the crime of fraudulent issuance of securities. The upper limit of the sentence for this crime was increased from 5 years to 15 years, and the activities of controlling shareholders, actual controllers organizing and directing fraudulent issuance were included in the scope of criminal law crackdown, significantly increasing the severity of the punishment. Criminal law, as the ultimate weapon of judicial compulsion, punishes fraudulent securities issuance in the securities market, increasing the risk of criminal liability for issuers and requiring attention from issuers and intermediaries.

Basic case details

In the first half of 2013, Fujian Zhongmoutong Machinery Manufacturing Co., Ltd. planned to issue private equity bonds to alleviate the company's financial pressure due to insufficient working capital. The actual controllers of the company, Lu Hanmou, Lu Wenmou, and Lu Huamou, falsely increased operating income by more than 513 million yuan, total profit by more than 131 million yuan, capital reserve by more than 655.5 million yuan, fictitious credit of 5 million yuan from China Merchants Bank, concealed foreign debt of 20.25 million yuan, and issued an audit report with significant inaccuracies by a certain accounting firm. The underwriter, a certain securities company, based on this audit report, issued the 2014 Private Equity Bond Offering Prospectus for Small and Medium Enterprises issued by Zhongmoutong Company. From May to July 2014, Zhongmoutong Company issued two-year private placement bonds "14 Zhongmou 01" and "14 Zhongmou 02". Subsequently, the head office of China Merchants Bank, the head office of Postal Savings Bank of China, and Che subscribed to the private placement bonds of Zhongmoutong for 50 million yuan, 20 million yuan, and 30 million yuan respectively, totaling 100 million yuan.

Afterwards, this money was used to repay bank loans and private debts, as well as to pay deposit, audit fees, and underwriting fees. After the private placement bond matures, Zhongmoutong Company is unable to pay the bond principal and interest. In September 2016, Zhongmoutong Company became insolvent and entered bankruptcy reorganization proceedings.

Court rulings

After the court's trial, it was found that the application documents for private equity bonds submitted by Zhongmoutong Company contained significant financial data false records, which deceived the Shanghai Stock Exchange into obtaining approval for issuance and used the raised 100 million yuan to repay bank loans and private debts. Failure to pay overdue principal and interest later, with serious consequences, constitutes the crime of fraudulent bond issuance.

Lu Han and three other executives were directly responsible for fraudulent bond issuance, and their actions constituted the crime of fraudulent bond issuance. Lu Han is the actual controller of the company, who initiated, planned, and led the implementation of fraudulent bond issuance, playing a major role and core position in corporate crime; Lu Wenmou and Lu Huamou respectively serve as the legal representatives and financial directors of the company. They were instructed by Lu Hanmou to directly and actively participate in the above-mentioned actions. Although they played a secondary role and held a lower position compared to Lu Hanmou, they were not yet able to distinguish between the main accomplices. Lu Huamou directly participated in the production of false off balance sheet income and false shareholder resolutions, and his role was more important than Lu Wenmou. The three individuals voluntarily surrendered and truthfully confessed the main facts. According to the law, it was determined that all three of them had committed self surrender, so it was also determined that Zhongmoutong Company had committed self surrender.

Fraudulent issuance is one of the most serious illegal activities in the securities market, which seriously erodes the operational foundation of the securities market. Taking into account the above circumstances and the specific roles and positions of each defendant, the court ruled that a certain company committed the crime of fraudulent issuance of bonds and was fined 3 million yuan; The defendants Lu Hanmou, Lu Huamou, and Lu Wenmou committed the crime of fraudulently issuing bonds and were sentenced to three years and six months, two years and six months, and two years of imprisonment (with a two-year probation) respectively; Zhongmoutong Company refunded China Merchants Bank 50 million yuan, China Postal Savings Bank 20 million yuan, and Chemou 30 million yuan.

commentary

What is the crime of fraudulent issuance of securities?

The crime of fraudulent issuance of securities is stipulated in the third section of the third chapter of the Criminal Law, which is the crime of disrupting the management order of companies and enterprises. It targets significant concealment and falsification during the process of issuing stocks and bonds. The subject of the crime of fraudulent issuance of securities can be either a unit or an individual. In this case, a certain company among the bond issuers, as well as the actual controllers and executives of the issuer, are also listed as joint defendants. Subjectively, it can only be intentional, and negligence does not constitute this crime. That is to say, the perpetrator is required to actively act despite knowing that the prospectus, subscription form, fundraising method, etc. are not a true, accurate, and complete reflection of the issuer or the current issuance situation. Objectively speaking, the perpetrator must have engaged in concealing or fabricating false content in the prospectus, subscription form, fundraising methods, and other documents, and this behavior must reach a certain level of severity, that is, "a huge amount, serious consequences, or other serious circumstances.".

Fraudulent issuance behavior harms not only the management order of the securities market by the state, but also the property rights of a large number of investors (i.e. shareholders, creditors, and the public). In previous judicial practice, the judicial department focused more on protecting property rights, but it is evident that fraudulent issuance harms the integrity system and healthy development of the securities market the most. Therefore, regulatory authorities have been emphasizing "zero tolerance" in recent years. We believe that the attitude of regulatory authorities will be transmitted to the judicial department, and increasing punishment for fraudulent issuance will be the future trend.

2. Is it possible for other individuals involved in the issuance of stocks or bonds to become the subject of this crime?

An interesting question is whether other individuals involved in the issuance of stocks or bonds, apart from the issuer, may become the subject of this crime? In this case, there is another detail. The relevant person in charge of a securities company, Bian, who was the underwriter of this project, accepted a bribe from Lu and deeply participated in the fraud of Zhongmoutong Company. He even used a needle to recommend other intermediary agencies for Zhongmoutong Company. Is it possible for Bian to constitute an accomplice in this case? I hold a positive opinion on this. If the behavior carried out by the staff of securities firms and intermediary institutions meets the constitutive requirements of this crime, it can constitute accomplice.

In judicial practice, there are very few cases of this charge, and according to the publicly available judicial documents, there are only about 10 precedents applicable to this charge. In one of the cases [see the first instance of the crime of fraudulent issuance of stocks and bonds by Suqian Zhifu Leather Industry Co., Ltd., (2018) Hu 01 Xing Chu 58 Criminal Judgment.], the project accountant, knowing that the issuer's financial situation did not meet the requirements for issuing bonds, required the issuer to provide false financial data and introduced individuals who forged financial vouchers to the issuer in order to achieve the issuance goal, was recognized as a joint crime of fraudulent issuance of securities. In this case, although existing evidence shows that the project leader of the securities firm, Bian, was not only aware of financial fraud in issuing bonds, but also involved in the transfer of interests between the two parties, due to the complexity of the case, the prosecution ultimately only treated Bian as a non state employee for bribery in a separate case, while the auditor and accountant in charge of auditing were treated as guilty of issuing a certificate of significant misrepresentation.

Is the crime of fraudulent issuance of securities a misdemeanor?

The essence of the crime of fraudulent issuance of securities is to raise funds in the securities market through fraudulent means using false information (especially financial information). In our criminal law system, crimes related to fraudulent issuance of securities include illegal absorption of public deposits, fundraising fraud, contract fraud, insider trading, etc. The author compared the punishment situation of the crime of fraudulent issuance of securities with typical related charges, as shown in the table below.

We can clearly see from the table above that before the promulgation of the Eleventh Amendment to the Criminal Law, the punishment for the crime of fraudulent issuance of securities was the lightest in all major aspects of punishment, including the starting point, sentencing range, and maximum penalty. The crime of fraudulent issuance of securities, as a "cancer" in the securities market, has two characteristics: first, the perpetrator has obvious malice, that is, intentional falsification, concealment, and the existence of fraudulent intent; Secondly, the social harm of this crime is very significant, which will have a negative impact on the securities market and bring huge losses to investors. These two characteristics are highly similar to the crime of fundraising fraud. The crime of fundraising fraud refers to raising funds through fraudulent means with the purpose of illegal possession. The criminal acts of both crimes are financing activities, both involving deceptive and fraudulent behavior, which not only damages the property ownership of investors, but also infringes on the national financial management system and order. But before the Eleventh Amendment to the Criminal Law, there was a huge difference in punishment between the two. The highest penalty for fundraising fraud was life imprisonment, which could have been sentenced to death; The maximum sentence for the crime of fraudulent issuance of securities is only 5 years, and in practice, the defendants accused of this crime are basically sentenced to imprisonment of less than three years, with relatively light sentencing.

After the promulgation of the Eleventh Amendment to the Criminal Law, the crime of fraudulently issuing securities became two criminal offenses, with a maximum sentence of 15 years, which is higher than the maximum sentence of 10 years for insider trading, and has become a serious crime. The amendment to the Criminal Law has expanded the scope of application of this offense, including depositary receipts and other securities recognized by the State Council in accordance with the law. It has also revised the fine for individuals from 1% -5% of illegally raised funds to "impose a fine", abolished the upper limit of 5%, and increased the fine for units from 1% -5% of illegally raised funds to 20% -1 times. As shown in the above figure, the amendment to the Criminal Law balances the sentencing relationship between the crime of fraudulent issuance of securities and various related charges, in line with the principle of adapting criminal liability and punishment in the Criminal Law, making the criminal law system more reasonable and also responding to practical needs in legislation. It can be imagined that in future judicial practice, the defendant of this charge will not pick it up high and then gently put it down as in previous precedents.

The last clause of this case judgment is somewhat special. In the judgment, a certain company should refund and compensate subjects such as China Merchants Bank 50 million yuan, 20 million yuan, and 30 million yuan respectively. This is a manifestation of the cross disciplinary nature of the crime of fraudulent issuance between civil and criminal law. In future articles, we will analyze this specifically.

Related law search (scroll down to view)

1. Securities Law

Article 85: If the information disclosure obligor fails to disclose information in accordance with regulations, or if there are false records, misleading statements, or significant omissions in the securities issuance documents, periodic reports, temporary reports, and other information disclosure materials announced, resulting in damage or loss to investors in securities trading, the information disclosure obligor shall bear compensation liability; The controlling shareholders, actual controllers, directors, supervisors, senior executives, and other directly responsible personnel of the issuer, as well as the sponsors, underwriting securities companies, and their directly responsible personnel, shall bear joint and several liability with the issuer, except for those who can prove that they are not at fault.

2. The Criminal Law of the People's Republic of China

Article 160 [Crime of Fraudulent Issuance of Securities] Whoever conceals important facts or fabricates major false content in issuance documents such as prospectuses, subscription letters, company and enterprise bond offering methods, issues stocks, company and enterprise bonds, depositary receipts, or other securities recognized by the State Council in accordance with the law, and the amount involved is huge, the consequences are serious, or there are other serious circumstances, shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention, and shall also or only be fined; If the amount involved is particularly huge, the consequences are particularly serious, or there are other particularly serious circumstances, the offender shall be sentenced to fixed-term imprisonment of not less than five years and shall also be fined.

If the controlling shareholder or actual controller organizes or instructs to carry out the acts mentioned in the preceding paragraph, they shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention, and shall also, or shall only, be fined not less than 20% but not more than one time the amount of illegally raised funds; If the amount involved is particularly huge, the consequences are particularly serious, or there are other particularly serious circumstances, the offender shall be sentenced to fixed-term imprisonment of not less than five years and shall also be fined not less than 20% but not more than one time the amount of illegally raised funds.

If a unit commits the first two crimes, it shall be fined not less than 20% but not more than twice the amount of illegally raised funds, and the directly responsible person in charge and other directly responsible personnel shall be punished in accordance with the provisions of the first paragraph.

Article 161 [Crimes of Violating Disclosure or Not Disclosing Important Information] If a company or enterprise that is obligated to disclose information in accordance with the law provides false or conceals important facts in financial and accounting reports to shareholders and the public, or fails to disclose other important information that should be disclosed in accordance with the law, seriously harming the interests of shareholders or others, or if there are other serious circumstances, the directly responsible person in charge and other directly responsible persons shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention, and shall also or only be fined; If the circumstances are particularly serious, he shall be sentenced to fixed-term imprisonment of not less than five years but not more than ten years and shall also be fined.

If the controlling shareholder or actual controller of a company or enterprise as stipulated in the preceding paragraph implements or organizes or instructs the implementation of the behavior as stipulated in the preceding paragraph, or conceals relevant matters, resulting in the occurrence of the situation as stipulated in the preceding paragraph, punishment shall be imposed in accordance with the provisions of the preceding paragraph.

If the controlling shareholder or actual controller who commits the crime mentioned in the preceding paragraph is a unit, the unit shall be fined, and the person in charge and other directly responsible persons shall be punished in accordance with the provisions of the first paragraph.

Article 176 [Crime of illegally absorbing public deposits] Whoever illegally absorbs public deposits or indirectly absorbs public deposits, disrupts financial order, shall be sentenced to fixed-term imprisonment of not more than three years or criminal detention and shall also, or shall only, be fined; If the amount involved is huge or there are other serious circumstances, the offender shall be sentenced to fixed-term imprisonment of not less than three years but not more than ten years and shall also be fined; If the amount involved is particularly huge or if there are other particularly serious circumstances, the offender shall be sentenced to fixed-term imprisonment of not less than ten years and shall also be fined.
If a unit commits the crime mentioned in the preceding paragraph, it shall be fined, and the person in charge and other directly responsible persons shall be punished in accordance with the provisions of the preceding paragraph.
If there are the first two behaviors, actively returning stolen goods and compensation before initiating public prosecution to reduce the occurrence of damage results, the punishment may be lighter or mitigated.

Article 192 [Crime of Fundraising Fraud] Whoever illegally raises funds with the purpose of illegal possession and uses fraudulent methods, and the amount involved is relatively large, shall be sentenced to fixed-term imprisonment of not less than three years but not more than seven years and shall also be fined; If the amount involved is huge or there are other serious circumstances, the offender shall be sentenced to fixed-term imprisonment of not less than seven years or life imprisonment, and shall also be fined or have his property confiscated.

If a unit commits the crime mentioned in the preceding paragraph, it shall be fined, and the person in charge and other directly responsible persons shall be punished in accordance with the provisions of the preceding paragraph.

Article 180 [Crime of Insider Trading and Leakage of Insider Information] Those who are informed of insider information in securities or futures trading or illegally obtain insider information in securities or futures trading shall, before the issuance of securities, securities or futures trading or other information that has a significant impact on the prices of securities or futures trading is made public, buy or sell the securities, engage in futures trading related to the insider information, or disclose the information, or explicitly or implicitly imply that others are engaged in the above-mentioned trading activities. If the circumstances are serious, they shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention, and shall also, or shall only, be fined not less than one time but not more than five times the illegal gains; If the circumstances are particularly serious, he shall be sentenced to fixed-term imprisonment of not less than five years but not more than ten years and shall also be fined not less than one time but not more than five times the illegal gains.

If a unit commits the crime mentioned in the preceding paragraph, it shall be fined, and the person in charge and other directly responsible persons shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention.

The scope of insider information and insiders shall be determined in accordance with the provisions of laws and administrative regulations.

The crime of using undisclosed information for trading: Employees of financial institutions such as stock exchanges, futures exchanges, securities companies, futures brokerage companies, fund management companies, commercial banks, insurance companies, as well as staff of relevant regulatory departments or industry associations, who use undisclosed information other than insider information obtained through their positions, violate regulations, engage in securities and futures trading activities related to that information, or express or imply that others engage in related trading activities. If the circumstances are serious, they shall be punished in accordance with the provisions of the first paragraph.

Article 67: If a person voluntarily surrenders after committing a crime and truthfully confesses their crime, it is considered as voluntary surrender. For criminals who surrender themselves, the punishment can be lighter or mitigated. Among them, those who commit minor crimes can be exempted from punishment. If a suspect, defendant or criminal serving a sentence who has taken compulsory measures truthfully confesses his other crimes that the judicial organ has not yet mastered, he shall be deemed to have surrendered himself. A suspect who does not have the circumstances of voluntary surrender as prescribed in the preceding two paragraphs but truthfully confesses his crime may be given a lighter punishment; Those who truthfully confess their crimes and avoid particularly serious consequences can receive reduced punishment.

Article 72 [Application Conditions] For criminals sentenced to criminal detention or fixed-term imprisonment of not more than three years, if they meet the following conditions, probation may be declared. For those under the age of 18, pregnant women, and those who have reached the age of 75, probation shall be declared: (1) The circumstances of the crime are relatively minor; （2） Having signs of repentance; （3） There is no risk of committing another crime; （4） The announcement of probation has no significant adverse effects on the community in which one resides. Proclamation of probation can be based on the circumstances of the crime, while prohibiting criminals from engaging in specific activities, entering specific areas and places, and contacting specific people during the probation period. Criminals who have been sentenced to probation must still be executed if they are sentenced to an additional sentence.

Article 73: The probation period for probation of criminal detention shall be not less than the original sentence but not more than one year, but not less than two months. The probation period for probation of fixed-term imprisonment is not less than the original sentence but not less than five years, but not less than one year. The probation period for probation shall be calculated from the date of the judgment.