Disputes continue over the notorious securities misrepresentation saga at Changyuan Group. Among them, Changyuan v Shandong Zhibo Information Technology (2023) recently resulted in a first-instance court ruling that the company pays RMB345 million (USD47.3 million) in compensation.
Chair of Partners’ Meeting
Starrise Law Firm
The case originates from 2020, when the China Securities Regulatory Commission found that the company’s 2016–2017 annual reports contained false information. Subsequently, Changyuan was administratively penalised by the Shenzhen Securities Regulatory Bureau and faced multiple securities misrepresentation claims.
In this latest Shandong Zhibo Information Technology case, the company contends that its reasons and purpose for purchasing its stock differ substantially from those of ordinary small and medium investors, so it should not be regarded as a typical financial investor.
Dissatisfied with the first-instance decision, the company now plans to appeal, igniting a broader debate about the differences in compensation rights between major shareholders and small investors.
Core dispute
The central issue is whether major shareholders and small to medium investors have equal rights to claim compensation, and whether the court should differentiate their trading purposes and responsibilities.
During the period in which Changyuan Group engaged in financial fraud, the original major shareholder, Woer Heat-Shrinkable Material, acquired Changyuan Group shares through a block trade.
On 26 February 2024, Woer Heat-Shrinkable Material initiated a civil lawsuit against the company on the grounds of securities misrepresentation, with the total disputed amount reaching about RMB56 million.
Subsequently, Shandong Zhibo Information Technology (formerly Shandong Kexing Bioproducts), having acquired the shares held by Woer Heat-Shrinkable Material through agreement, continued to increase its stake and became a major shareholder.
It then claimed that the false statements by Changyuan Group resulted in investment losses of RMB1.14 billion and sought compensation of RMB345 million, the claim recently supported at first instance by Shenzhen Intermediate People’s Court.
Judicial inclination
According to article 85 of the Securities Law, if an information disclosure obligor causes investor losses due to false statements, it shall be liable for compensation unless it can prove an absence of fault.
But although both the Securities Law and the provisions emphasise the causal relationship between the transaction and the loss, they do not clearly differentiate the responsibilities of major shareholders from those of small and medium investors.
In Changyuan Group’s case, the company argues that the source of its major shareholder’s shares (acquired through an agreement transfer and block trade) and its investment purpose (strategic holding) were distinct from those of small and medium investors in the secondary market – and hence the major shareholder, having nominated directors and potentially influencing corporate governance, should bear a higher duty of care.
However, the court at first instance did not adopt this view, ruling in favour of the plaintiff, Shandong Zhibo Information Technology, in its compensation claim.
This suggests that, under the current legal framework, the court tends to focus on the authenticity of information disclosure and treat investors uniformly when assigning liability, although this approach has raised concerns over insufficient consideration of the special status of major shareholders.
Liability determination factors
Differences in information acquisition. Major shareholders, especially those who nominate directors, typically enjoy superior access to information and due diligence capabilities. Whether such parties should bear greater responsibility in securities misrepresentation cases on a “presumed knowledge” basis – thereby alleviating the listing company’s liability – remains unsettled in the law.
Trading purposes and market impact. Major shareholders acquire shares through agreement transfers or block trades, generally for strategic investment or control battles (as seen in the historical control dispute between Woer Heat-Shrinkable Material and Changyuan Group). It is debatable whether loss calculations should incorporate non-market factors such as control premiums, whereas small and medium investors mainly rely on public information, causing their losses to be more directly linked to the false statements.
Judicial practice comparisons. In China’s first demonstration judgment in a securities dispute, the Founder Technology securities misrepresentation case, the court did not differentiate based on investors’ shareholding ratios or transaction methods. Instead, it established a systematic risk deduction ratio through the model judgment mechanism to avoid excessive compensation.
In the Changyuan Group case, the Shenzhen Intermediate People’s Court similarly applied a model judgment without adjusting for the special status of major shareholders. This “one-size-fits-all” approach may invite controversy.
To precisely determine the responsibilities of different types of investors and adjust compensation ratios, the “contributory negligence” principle should be introduced.
For example, major shareholders could see their compensation ratio reduced based on their due diligence capabilities or level of knowledge. This requires the judiciary to clearly define the boundaries of the investor duty of care, establishing tiered standards differentiating ordinary investors, professional investors and major shareholders.
In this scenario, ordinary investors should be assessed according to the reasonable person standard by examining whether they reviewed the prospectus, periodic reports and other statutory documents. Professional investors must demonstrate adherence to industry customary due diligence procedures, and major shareholders must prove that even with comprehensive information obtained through shareholder rights they could not detect any fraud.
Impact of judgments
The first-instance court based its decision on the Securities Law and judicial interpretations, focusing on the authenticity of information disclosure and making no distinction between investor identities, in line with current legislative trends aimed at protecting all investors.
However, it did not fully consider the special status of major shareholders, potentially overlooking their significant influence on the company and leading to an imbalance in liability allocation.
If the second-instance court subsequently upholds the original judgment, it will reinforce the “one share with one vote” principle, thereby encouraging more major shareholders to initiate claims. But it may also increase litigation risks for listed companies, especially those that have previously attracted strategic investors.
Implications
Listed companies should strengthen internal controls and information disclosure compliance – especially in verifying the financial authenticity of acquisition targets – to avoid group litigation arising from significant omissions or false statements.
When introducing strategic investors, agreements should clearly specify risk-sharing provisions to prevent future disputes.
Prior to agreement transfers or block trades, investors should conduct thorough due diligence and preserve evidence to address potential false statement risks. Additionally, if participating in corporate governance (for example, by nominating directors), decision-making records should be maintained to avoid being classified as an “informed party”.
In order to assert reasonable rights, it is also important to retain transaction records and carefully monitor the time window between the occurrence of false statements and their disclosure.
Cheng Xiaolu is the chair of the Partners’ Meeting at Starrise Law Firm
Beijing Starrise Law Firm
Room 1701, 17/F, China Resources Building
8 Jianguomen North Street, Dongcheng District
Beijing, China
Tel: +86 10 6401 1566
E-mail: chengxiaolu@xinglailaw.com
