On December 30, 2022, the Beijing Financial Court issued a first instance judgment on the court's No. 1 case, "Blue Stone Assets and a Bank and Other Securities Misrepresentation Liability Dispute Case." This case, as the first nationwide dispute case on the liability for misrepresentation in the interbank bond market, has a landmark significance. In the judgment, whether the Securities Law of the People's Republic of China (hereinafter referred to as the "Securities Law") is applicable to the interbank bond market and its judicial interpretation "When a misrepresentation is not subject to administrative penalties or effective criminal judgments by regulatory authorities, how the court determines it, and the consideration and review of the elements of tort liability in a misrepresentation case are groundbreaking. They further compact the responsibilities of bond underwriters and bond service institutions, emphasizing that institutional investors have a higher duty of care,", It has great reference value for the judicial practice of the future interbank bond market and even the entire bond misrepresentation case.

Based on our experience in the case of misrepresentation in the interbank bond market, this article makes a brief review of this case as follows.

1、 Case Overview

August 4, 2016

Dalian Machine Tool Group Co., Ltd. (hereinafter referred to as "Dalian Machine Tool Company") has publicly issued the "16 major machine tool SCP002" ultra short term financing (hereinafter referred to as "the bonds involved in the case") with a scale of 500 million yuan. The credit enhancement measures section of the bond prospectus states that the bonds involved provide a pledge of accounts receivable of over 500 million yuan, and the accounting period and amount can cover the principal and interest of the bonds involved in the case.

The 16 major machine tool SCP002 issued by Dalian Machine Tool Company is a debt financing instrument issued and traded in the interbank bond market. The main underwriter is a bank, the audit agency is an accounting firm, the credit rating agency is a credit rating company, and the legal adviser is a law firm.

August 9, 2016

Dalian Machine Tool Company will refund a fee of 1% to Bluestone Asset Management Co., Ltd. (hereinafter referred to as "Bluestone Asset"). Bluestone Asset instructed its asset management product as an investment adviser to buy the bonds involved in the case. After the financial crisis of Dalian Machine Tool Company broke out, the bonds involved in the case constituted a cross default on November 29, 2016. On December 12, 2016, the main body rating of Dalian Machine Tool Co., Ltd. was downgraded to C non repayable level.

December 16, 2016 to February 13, 2017

The "Blue Stone Pangu Fund 1", which serves as the manager of Blue Stone Assets, has successively purchased 500 million yuan of bonds from the secondary market, with a price of 50% off.

April 27, 2017

Dalian Machine Tool Company issued a notice admitting that the credit enhancement measures for bond accounts receivable involved in the case were false.

November 10, 2017

Dalian Machine Tool Company entered the bankruptcy reorganization process, and after deducting the amount of repayment available in the bankruptcy reorganization process, Bluestone suffered a loss of more than 500 million yuan in assets.

Bluestone Asset believes that Dalian Machine Tool Co., Ltd. made false statements in three aspects: financial fraud, fictitious pledge guarantees, and concealment of important information in the issuance of "16 Machine Tool SCP002" bonds, which are the fundamental reasons for its investment losses. As the liability that Dalian Machine Tool Co., Ltd. should bear has been determined through bankruptcy and reorganization procedures, it filed a lawsuit against a bank that acted as the lead underwriter in the issuance of "16 Machine Tool SCP002" bonds An accounting firm that serves as an auditing agency, a credit rating company that serves as a credit rating agency, and a law firm that serves as a legal adviser are jointly and severally liable for the remaining losses of 500 million yuan. [1]

March 18, 2021

The Beijing Financial Court (hereinafter referred to as the "Financial Court") accepted this case.

May 25, 2021

A court hearing. Before the formal hearing, the collegial panel of the Financial Court organized several pre-trial meetings on the case to exchange evidence. The two sides submitted a total of 166 pieces of evidence, and conducted sufficient proof and cross-examination of their respective claims.

Finally, the Financial Court, based on the degree of fault of each participant in the case regarding the losses, and the causal relationship between the misrepresentation behavior and the losses, decided, at its discretion, that the lead underwriter, a bank, should bear joint and several liability within the scope of 10% of the liability of Dalian Machine Tool Company; An accounting firm acting as an auditing agency shall bear joint and several liability within the scope of 4% of the compensation liability of Dalian Machine Tool Company; A law firm acting as a legal adviser assumes joint and several liability within the scope of 6% of the liability of Dalian Machine Tool Company.

2、 Brief Review of Cases

1. Response to disputes: It is clear that the interbank bond market belongs to a national securities trading venue, and cases of misrepresentation occurring in the interbank bond market should be governed by the Securities Law and its judicial interpretation.

In view of the fact that neither the Securities Law nor the Several Provisions on the Trial of Civil Compensation Cases for Misrepresentation Infringements in the Securities Market (hereinafter referred to as the "Judicial Interpretation of Misrepresentation") clearly states whether the bonds issued by issuers in the interbank bond market fall within its scope of application, and that there have been no previous cases involving misrepresentation in the interbank bond market in judicial practice, Therefore, there have been disputes over whether the Securities Law and its judicial interpretation are applicable to cases of misrepresentation in the interbank bond market.

One view is that cases of misrepresentation occurring in the interbank bond market should be subject to the Securities Law and its judicial interpretation for the following reasons: First, the interbank bond market belongs to other securities markets or national securities trading venues approved by the State Council. Secondly, in December 2018, with the consent of the State Council, the People's Bank of China, the China Securities Regulatory Commission, and the National Development and Reform Commission jointly issued the Opinions on Further Strengthening Law Enforcement in the Bond Market (Yin Fa [2018] No. 296), establishing a unified bond market enforcement mechanism. Third, on July 15, 2020, The Notice of the Supreme People's Court on Printing and Distributing the Minutes of the Symposium on the Trial of Bond Dispute Cases by National Courts (hereinafter referred to as the "Bond Minutes") (Law [2020] No. 185) clearly states that "in the trial of such cases, the people's courts shall apply the same legal standards to corporate bonds, corporate bonds, and non-financial corporate debt financing instruments with the common attribute of debt repayment and interest payment in accordance with the basic principles stipulated by laws and administrative regulations.". Fourth, regional equity markets can refer to the application of the new Judicial Interpretation of Misrepresentation. The interbank bond market is larger and has more centralized trading methods than regional equity markets, so it should be more applicable or at least refer to the application of the Judicial Interpretation of Misrepresentation [3].

Another view is that the Securities Law and its judicial interpretation cannot be applied to cases of misrepresentation in the interbank bond market, mainly because it is believed that the interbank bond market should be managed in accordance with the relevant provisions of the People's Bank of China Law of the People's Republic of China (hereinafter referred to as the People's Bank of China Law) In response to a reporter's question on the development of the real economy in the bond market held by the relevant responsible person of the China Securities Regulatory Commission, when answering the question "What changes have occurred in the relevant institutional arrangements of the interbank bond market since the issuance of the Securities Law?", "The issuance, trading, registration, custody, and settlement of financial bonds and non-financial enterprise debt financing instruments in the interbank bond market are managed by the People's Bank of China and its designated institutions in accordance with the current relevant regulations formulated by the Law of the People's Bank of China." [4] has become an important argument for this view.

The Financial Court responded to this dispute in the judgment of the first nationwide case of misrepresentation in interbank bonds. The Financial Court clearly determined that the interbank bond market belongs to a national securities trading venue, and that cases of misrepresentation occurring in the interbank bond market should be governed by the Securities Law and its judicial interpretation, The reason of the Financial Court is: "The interbank bond market is the largest bond issuance and trading market in China. The intermediary agencies that apply for issuing and trading bonds in the interbank market and provide corresponding services come from all parts of the country. The mechanisms for issuing, listing, trading, and settlement of bonds in the interbank market have unified national standards. Based on this, the interbank bond market should belong to the Securities Law of the People's Republic of China." Prescribed national securities trading venues; "The issuance and trading of interbank bonds belong to the issuance and trading of other securities recognized by the State Council according to law, and the provisions of the Securities Law of the People's Republic of China and its judicial interpretation shall apply according to law."

The Financial Court also confirmed the burden of proof of each party in this case in accordance with the principle of allocation of the burden of proof in the Judicial Interpretation of Misrepresentation, and applied the provisions on whether to add a co defendant and how to transfer jurisdiction after the addition to determine the jurisdiction of this case.

2. Pioneering: In the case of false statements in the bond market that have not been subject to administrative penalties by regulatory authorities or recognized by effective criminal adjudication documents, false statements are recognized through the allocation of the burden of proof and judicial audit procedures in combination with the evidence submitted by both the original and the defendant.

Although cases such as bond misrepresentation have been specified in the Minutes of the National Court's Symposium on Hearing Bond Dispute Cases in July 2020, the court shall no longer refuse to file a case without obtaining or providing administrative penalties and effective criminal judgments from regulatory authorities when filing and accepting the case; In judicial practice, the court has also made some explorations in cases where securities have been falsely stated without an administrative penalty decision made by the CSRC or an effective criminal judgment. For example, in the "Wuyang Bond Case" and "Zhong'anke Case", some intermediary institutions that have not been subject to administrative penalty or criminal judgment have also been determined by the court to have made false statements in the process of securities issuance or trading, and therefore have been sentenced to assume compensation liability. However, this case is the first case in which the court directly recognized a misrepresentation in the interbank bond market without administrative penalties or effective criminal judgment documents from regulatory agencies.

Prior to this, when there were previous administrative penalties that identified the issuer as having made false statements, such as the "Wuyang Bond Case" and the "Zhong'anke Case", the CSRC made an administrative penalty decision that identified false statements in the securities issuance or trading process in a relevant administrative penalty decision. The plaintiff can directly use this as evidence, and the court usually accepts it, so it is less difficult for the plaintiff to collect evidence on its own. From the experience of a case of misrepresentation in the interbank bond market previously represented by our team, it is extremely difficult for a plaintiff to prove the existence of false statements by the issuer and bond service institutions, especially when the issuer does not admit the existence of false statements without prior administrative penalties or effective criminal judgment documents as a prerequisite, "Because the key evidence that can prove false statements is mostly held by issuers and bond service institutions, while issuers and bond service institutions usually do not actively provide relevant evidence to bond investors (i.e., plaintiffs) or courts, the plaintiffs need to collect relevant evidence through various means, which is very difficult to obtain evidence. Therefore, the plaintiffs have a very heavy burden of proof. This can be seen from the 166 evidence submitted by both parties in this case.".
The financial court in this case, in accordance with the allocation principle of the burden of proof in the "Judicial Interpretation of False Statements", confirmed through the plaintiff's proof and judicial audit procedures in the lawsuit that Dalian Machine Tool Co., Ltd. had engaged in false statements during the issuance of bonds, including concealing the true financial situation and fabricating the pledge of accounts receivable.

Given that there may be a second instance of this case, and the court of first instance has not yet published the judgment of first instance, there is currently no complete judgment to carefully study the evidence submitted by the plaintiff and the court's determination process. As far as we can understand, on April 27, 2017, Dalian Machine Tool Company announced that the credit enhancement measures for the bond accounts receivable involved in the case were false or key evidence for the plaintiff to prove their claims. In addition, judicial audit procedures should also play a crucial role in identifying the true financial situation of Dalian Machine Tool Company.

3. Tracing back to the source: Grasp the essence that misrepresentation belongs to infringement, determine whether the defendant has misrepresentation, the causal relationship between the misrepresentation and the plaintiff's losses, and determine the responsibility of each party based on the proportion of fault of the original and defendant.

First of all, from the perspective of the summary of the focus of the dispute in this case, in addition to the issue of legal application and the existence of false statements, "whether each service organization is at fault and has fulfilled their respective obligations", "whether there is a causal relationship between the losses suffered and the false statements involved in the case", and "what kind of liability each service organization should bear for losses" all belong to the trial of the constitutive requirements of tort liability.

Secondly, in the trial of this case, different situations such as intent and negligence were distinguished, and whether each service agency had performed its duty of diligence and responsibility was identified, and their respective legal responsibilities were determined. The impact of multiple factors on the infringement results was fully analyzed, and the degree of liability and the degree of error were combined. Finally, each party's responsibility was judged based on the fault of each party in this case. For example, different proportions of joint and several liability are determined for each service agency, and a credit rating company that does not violate its information disclosure obligations has not been judged responsible; Based on the plaintiff's identity as a professional institutional investor in Bluestone Assets, as well as the fact that he received a refund from Dalian Machine Tool Group, was responsible for marketing work, and that the financing bonds involved in the case had been continuously issued with a risk reminder that they could not be redeemed by the issuer, underwriter, and rating agency, Bluestone Assets still insisted on purchasing, and it was determined to mitigate the liability of other infringers. Neither the "one size fits all" determination of the full joint and several liability of each party due to the fault of the bond underwriter or bond service institution, nor the rejection of all litigation claims by institutional investors due to their failure to exercise due diligence.

Although the legal basis cited in the judgment cannot be seen from the information disclosed by the financial court at present, based on the above analysis, the judgment of the financial court in this case should apply the relevant provisions of the tort section of the Civil Code of the People's Republic of China to determine the responsibilities of each party, as well as the size and proportion of responsibilities.

4. Seller's due diligence: The responsibilities, obligations, and service activity norms of various service institutions in the interbank bond market originate from the laws, regulations, administrative rules, and professional norms of industry self-regulatory organizations that they should comply with when providing intermediary services for debt financing instruments.

In determining the responsibilities of various service institutions, the Financial Court stated that, in accordance with the provisions of laws, regulations, administrative rules, and industry self-discipline organization practice standards, the financial court should comply with the provisions of various service institutions in providing intermediary services for debt financing instruments in the interbank bond market, comprehensively consider the scope of work and professional fields of bond service institutions such as accounting firms, law firms, and credit rating agencies, while distinguishing between intentional Based on different circumstances such as negligence, it is necessary to identify whether each service institution has fulfilled its obligations of diligence and responsibility, and determine their respective legal responsibilities.

In terms of specific judgment, the Financial Court held that a bank did not fully fulfill its obligations of due diligence and independent judgment with respect to the corporate financial information issued by Dalian Machine Tool Group Corporation, especially the four high-value pledged accounts receivable, and did not fulfill its obligations of prudent verification and necessary investigation and review with respect to the annual audit report issued by an accounting firm and the legal opinion issued by a law firm, all of which constitute false statements; A certain accounting firm fails to make professional judgment or maintain professional suspicion during the audit process, and there are instances of failure to exercise due diligence during the audit process, which also constitute false statements; A law firm failed to verify the authenticity of accounts receivable in accordance with industry requirements to determine whether the bonds involved in the case have obtained legal and effective credit enhancement, and then issued a legal opinion, which constitutes a false statement. It is believed that a credit rating company does not violate its information disclosure obligations, so it is not required to undertake false statements.

In view of the absence of a complete judgment, it is not possible to determine which laws, regulations, administrative rules, and professional norms of industry self-regulatory organizations the financial court believes the above intermediary services should comply with in this case. In the previous "Five Ocean Bond" case, the focus of the trial court on the determination of the underwriter's liability was whether it complied with the relevant provisions of the Securities Law and relevant industry norms; The focus of attention on the determination of liability of accounting firms lies in whether it complies with the relevant provisions of the "Several Provisions of the Supreme People's Court on the Trial of Civil Infringement Compensation Cases Involving the Auditing Activities of Accounting Firms"; The focus on the responsibility determination of credit rating agencies lies in whether they comply with the Interim Measures for the Administration of Credit Rating Business in the Securities Market and relevant industry norms; The focus on determining the responsibility of law firms lies in whether they comply with the relevant provisions of the Administrative Measures for Law Firms Engaging in Securities Legal Business. The interbank bond market involved in this case may also refer to the relevant provisions on debt financing instruments in the interbank bond market in detail.

The judgment in this case will also urge underwriters and bond service institutions that provide services to sellers in the interbank bond market to strictly abide by the laws, regulations, administrative rules, and professional norms of industry self-discipline organizations in the process of providing bond issuance services, and to be diligent and responsible in the process of providing services, so as to ensure that sellers are responsible. Conversely, they will face a huge legal risk of being claimed by bond investors.

5. Buyer's Responsibility: Professional institutional investors have a higher duty of prudence and care than ordinary investors.

In this case, the Financial Court held that because Bluestone Asset is a professional institutional investor and a rational investor, its investment decisions are affected to some extent by false information disclosure, but its duty of care is different from that of ordinary investors. In the event that the SCP002 of the 16 major machine tools has been continuously issued with a risk reminder that it cannot be redeemed by the issuer, underwriter, and rating agency, Bluestone Asset still insists on purchasing the SCP002 of the 16 major machine tools, which can alleviate the liability of other infringers.

Moreover, based on the facts identified, the Financial Court held that Bluestone Asset arranged for its asset management product, which acted as an investment consultant, to purchase the bonds involved in the case at the beginning of the issuance of the bonds involved in the case, and actually engaged in the marketing of the bonds involved in the case, and received a refund from the issuer. After the bonds involved in the case defaulted, Bluestone Asset explained part of the reason for its purchase as a consideration for fulfilling the management obligations of investment advisors outside the case, rather than purchasing them solely for investment purposes. In this case, the liability of each infringing party should be further alleviated.

On the one hand, this case emphasizes the higher duty of prudent care of professional institutional investors; On the other hand, examine the causal relationship between investment behavior and its losses from multiple perspectives, balancing the responsibilities of the "buying and selling" parties. It provides a model for future review directions and standards for such cases.

The judgment in this case also reminds professional institutional investors to exercise higher prudential care obligations, higher due diligence obligations, and higher judgment and decision-making obligations than ordinary investors in the process of investing in bonds issued in the interbank market. Otherwise, even if the bond issuer, underwriter, and bond service institution make false statements during the bond issuance, the court will not fully support all losses claimed by the professional institutional investor due to the fault of the professional institutional investor itself, and the professional institutional investor shall bear the corresponding losses according to the proportion of their fault.

References and Notes:

[1] The above content is organized according to the Beijing Financial Court's (2021) Jing 74 Min Chu No. 1 Civil Ruling.
[2] Refer to the 7-person collegial panel formed by the Beijing Financial Court to hear the "No. 1 case" in public, https://bjfc.bjcourt.gov.cn/cac/1621989021428.html 。
[3] Xing Huiqiang: Legal Application of Civil Liability Disputes over Misrepresentation in the Inter bank Bond Market, "Research on Multilevel Capital Markets," Issue 2, 2022.
[4] Referring to the questions answered by the relevant heads of the People's Bank of China and the Securities Regulatory Commission on the support of the bond market for the development of the real economy, http://www.gov.cn/xinwen/2020-03/11/content_5490109.htm 。