It should be noted that in the current regulatory environment in mainland China, the connotation of “intermediary institutions” as the regulated entities is no longer limited to the traditional ones such as accounting firms, law firms, evaluation agencies, and credit rating agencies. Now, underwriters, underwriting sponsors, trustees, investment advisors and asset managers have all been subject to more stringent supervision and regulation, many of which are so-called “licensed” financial institutions.
Against the backdrop of the economic slowdown and further upon the introduction of the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (关于规范金融机构资产管理业务的指导意见) in 2018 (a consolidation of several regulations previously issued by PBOC, CBRC, CSRC, CIRC and State Administration of Foreign Exchange), which aim to set out a unified strengthened regulatory framework for asset management industry, it is foreseeable that further tightening the supervision and imposing stricter liability on “intermediary institutions” would remain important regulatory measures in the banking and financing sector.
… the Beijing First Intermediate People’s Court held that when discharging its duty of due diligence, a law firm shall conduct a comprehensive analysis in the light of all the relevant materials including “but not limited to” the audit report, and based on its prudent review, issue its “independent” legal opinion, for which it shall be responsible
Echoing the call for a tougher regulatory regime, intermediary institutions’ responsibility of diligence and independence has been within the orbit of judicial attention. In the recent benchmark case of Dongyi Lawyers & Partners v. China Securities Regulatory Commission (CSRC), where a law firm sought to repeal the imposition of penalties by the CSRC for its alleged breach of the duty of due diligence in advising Xintai Electric’s IPO, the Beijing First Intermediate People’s Court held that when discharging its duty of due diligence, a law firm shall conduct a comprehensive analysis in the light of all the relevant materials including “but not limited to” the audit report, and based on its prudent review, issue its “independent” legal opinion, for which it shall be responsible. Such remarks are suggestive of a judicial tendency to expand the scope and raise the standard of responsibilities and obligations that “intermediary institutions” must take in capital market and banking and financing businesses.
There is an increasing importance of the role of intermediaries in the market that comes with greater compliance risks, more direct and stringent liabilities, along with more potential claims and disputes that may arise in future. In this regard, it would be prudent for accounting firms and financial institutions to seek professional legal advice on the duty of due diligence. Take the case of the accounting firm as an example. The firm was engaged by a prominent state-owned enterprise in a large-scale cross-border M&A transaction. Unfortunately, about one year after the completion of the transaction, the acquired company went into bankruptcy. The state-owned enterprise then sued the accounting firm and another international law firm from the U.S. for compensation with an astronomical figure, alleging that they had breached the duty of due diligence in their provision of professional services and failed to discover the material defects in the assets of the target company, and thus should be liable for full compensation.
… intermediary institutions should not be afraid to take legal actions to defend their legitimate interests and rights
For those who are interested in entering the Chinese market, learning how to survive from an increasingly strengthened Chinese regulatory regime is a must. On the one hand, professional service providers and other intermediary institutions should ensure strict compliance with relevant laws, regulatory rules and contractual terms, and fulfill their duty of prudence and due diligence as far as possible. Otherwise, they may face severe risk of administrative, civil and even criminal liabilities. On the other hand, it is practicable and necessary for intermediary institutions to protect themselves from compliance and litigation risks by raising the level of legal awareness and implementing relevant internal rules and policies. For instance, proper process control measures in business management would reduce the risk of malpractice by individual employees, and an effective recording and tracking system could help preserve evidence in case of any potential disputes. More importantly, intermediary institutions should not be afraid to take legal actions to defend their legitimate interests and rights. Intermediary institutions should observe a higher standard of professionalism, prudence and diligence throughout the provision of services, as well as in the process of self-defense against any claims or disputes alleged, so as to fulfill their responsibilities to the public at large and also to themselves.
With increasingly more opening-up measures being implemented, the regulatory regime of mainland China is also being reformed and continuously tightened to keep in line with the international standards. In this regard, the SEC’s enforcement action against A is very helpful to show how far mainland Chinese regulators are willing to go, in terms of enforcement, in the foreseeable future.
This article first appeared in the February 18, 2020 online edition of China Law & Practice © 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or firstname.lastname@example.org