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Opinions on the Trial of Cases Concerning Investor Suitability —— SPC Solicits Comments on its Draft Summary

2019.08.29 XIE, Qing (Natasha)GU, Yi

On August 6, 2019, the Supreme People’s Court (SPC) released the Summary of the National Courts’ Work Concerning Civil and Commercial Trials (Draft for Comments) (the “Summary”), which expressly addresses the relevant issues in relation to the investor suitability. Once approved for implementation, the Summary will have a profound impact on the trials of cases concerning investor suitability nationwide. Overall, the Summary provides specific and actionable opinions regarding the relevant issues of investor suitability obligations, as well as sets a higher standard for issuers, distributors and service providers (collectively the “selling institutions”) of financial products or services. We have summarized below the most important points: 

I. Specifying the Nature of Obligations

First of all, it is worth noting that prior to the issuance of the Summary, it was unclear how to characterize the liability incurred by not fulfilling the investor suitability obligations. In practice, some courts characterize such liability as a fault liability in the contract conclusion while others treat it as tort liability. The Summary makes it clear that obligations concerning investor suitability are pre-contractual obligations, and the liability imposed on selling institutions in breach of such obligations is a fault liability in the contract conclusion. In future judicial practice, this change is expected to give a unified guidance to the courts’ characterization of liability incurred by breach of investor suitability obligations. Furthermore, the Summary specifies the scope of compensation for the fault liability in the contract conclusion – namely, that the actual loss shall be calculated as the amount paid by a financial consumer for the financial products or services minus the amount that has already been returned to the financial consumer.

In addition, the Summary provides more actionable rules governing investors’ claims for loss of monetary interests under various scenarios, which will be handled on a case-by-case basis, thusly: (i) if the contract for a financial product provides an expected return rate, then the expected return rate shall be used to calculate the loss; (ii) if the contract for a financial product provides a floating range for the expected return rate and the financial consumer claims to use the upper limit of the range for the calculation of the loss, then the court shall so calculate; (iii) if the contract for a financial product is silent on the expected return rate but the financial consumer can provide evidence to prove that the relevant advertising materials states an expected return rate, then the advertising materials for the financial product shall be regarded as an integral part of the contract; (iv) if neither the contract nor the advertising materials provide an expected return rate, then the loss shall be calculated by referencing the benchmark deposit rate of similar products as released by the People’s Bank of China over the same period.

II. Determining the Liable Party and the Ways of Assuming Liability

Secondly, the Summary provides further clarity on determining the liable party and the ways of assuming liability. In terms of the liable party, financial consumers’ rights are further protected to the extent that if a selling institution causes a loss to a financial consumer due to its breach of investor suitability obligations, the financial consumer shall be entitled to be compensated by the issuer or the distributor, severally or jointly. In addition, as for ways of assuming liability, the Summary provides that if the issuer and the distributor require the court to determine their respective proportion of liability, at the time when the issuer and the distributor are held jointly liable for the loss incurred to the financial consumer by the court, the court may allow the party actually assuming the whole liability to recover from the other party the part of compensation that should have been paid by that party. From this we can see that the selling institutions assume joint and several liability, meaning that the selling institutions are jointly liable for the financial consumer but among the selling institutions the liability of each is limited to its respective proportion.

III. Burden of Proof

The Summary addresses the distribution of burden of proof, as well as imposes a higher burden of proof on the selling institutions. A financial consumer is simply required to prove that a loss has been incurred due to the financial product or service, whereas a selling institution bears the burden of proof in showing that it has fulfilled the relevant investor suitability obligations, namely, that it has sold suitable products (or services) to suitable financial consumers. However, the Summary does not specify what constitutes “suitable products” or “suitable financial consumers” but rather exemplifies that a selling institution would be regarded as being fulfilling its investor suitability obligations by verifying the financial consumers’ risk tolerance, risk perception, risk preference, etc., and by disclosing the major risk factors of the financial products (or services) to the financial consumers. 

IV. Specifying the Criteria for Disclosure Obligation 

Disclosure obligation is at the core of the investor suitability obligations imposed on selling institutions, which is also the key to financial consumers’ true understanding of the risks and returns of the financial products or services. The Summary explicitly states that selling institutions shall determine the scope and content of disclosure according to the risks of the financial products and the financial consumers’ specific circumstances, taking into consideration both the objective criteria that an average person could understand and the subjective criteria that a financial consumer could understand. A selling institution’s claim that it has fulfilled its disclosure obligation merely by requiring a financial consumer to write by hand acknowledgements such as “I have acknowledged the risk of loss of principal” will not be supported by the court. It is our view that stricter criteria have been adopted for the selling institutions’ disclosure obligation from the legislative perspective. 

Our Observation

It is our observation that the Summary has enhanced the protection for financial consumers. Pursuant to the provisions and requirements under the Summary, the selling institutions shall take the following measures and preserve relevant proof before issuing or selling any financial products or services: (i) verifying the financial consumers’ risk tolerance, risk perception and risk preference; (ii) disclosing to the financial consumers factors that may impact the return on the financial products or services or major risks of the financial products or services; (iii) establishing the risk evaluation and management schemes for the financial products (or services). If a selling institution fails to produce any proof of taking such measures before issuing or selling the financial products or services, then it may face adverse consequences thereof.

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