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On 1 June 2024, Jinzhou Port issued an announcement reporting that it had received a notice of administrative penalty and a market ban from the China Securities Regulatory Commission and included the full content of the notice. The announcement revealed that the state-owned listed company had engaged in continuous financial fraud from 2018 to 2021. This incident not only shocked the public but also underscored the critical importance of the diligence and loyal duties of directors, supervisors and officers (DSOs) of listed companies.

Case details

To inflate income and profits, and meet bank loan requirements, from 2018 to 2021 Jinzhou Port purchased bulk commodities such as electrolytic copper, asphalt, aluminium ingots, cotton and rubber from five companies: Dalian Hejing Trade; Shanghai Yinhong International Trade; Ningbo Langyi Energy; Ningbo Bairong Energy; and Chongqing Yuecheng Chuanju Trade.

Concurrently, Jinzhou Port signed sales contracts with Shanghai Shengzhe International Trade and Zhoushan Fengju Yishang Energy. However, the trade activities with these seven companies lacked commercial substance.

The fictitious business activities inevitably led to financial fraud. From 2018 to 2021, Jinzhou Port¡¯s trade with these companies resulted in inflated operating income, operating costs and total profits, causing false records in the annual reports for four consecutive years.

Specifically, in 2018, operating income was inflated by RMB2.12 billion (USD291.5 million), accounting for 35.81% of that year¡¯s operating income, and total profits were inflated by RMB20.7 million, accounting for 5.67% of that year¡¯s total profits. In 2019, operating income was inflated by RMB3.95 billion, accounting for 56.13% of that year¡¯s operating income, and total profits were inflated by RMB39 million, accounting for 17.78% of that year¡¯s total profits.

In 2020, operating income was inflated by RMB2.48 billion, accounting for 36.47% of that year¡¯s operating income, and total profits were inflated by RMB44.1 million, accounting for 18.3% of that year¡¯s total profits. In 2021, operating income was inflated by RMB75.1 million, accounting for 2.56% of that year¡¯s operating income, and total profits were inflated by RMB75.1 million, accounting for 47.85% of that year¡¯s total profits.

Neglect of due diligence

The notice detailed the specific failures of Jinzhou Port¡¯s executives to fulfil their diligence duty, along with the penalties for the main responsible parties. The chair and vice chair were found to have neglected management duties and failed to perform their responsibilities, signing written confirmation opinions on reports from 2018 to 2021.

As a result, they received warnings, were fined RMB4 million each, and were banned from the market for 10 years. Other executives, including directors, the chief financial officer and vice presidents, received varying degrees of punishment, including warnings and fines ranging from RMB1 million to RMB2 million.

Liabilities for violations

Common violations of information disclosure obligations include falsifying financial data and making seriously misleading statements. The diligence and loyalty duties of DSOs in listed companies mean they must not only disclose information objectively, impartially and truthfully, but also proactively identify, supervise and protect the interests of the issuer and minority shareholders.

Failing to meet these obligations can lead to administrative, civil and even criminal liabilities. The core of the new Measures for the Administration of Information Disclosure by Listed Companies is to enforce legal accountability, squarely addressing illegal and improper conduct. According to it and the new Securities Law, the legal liabilities of DSOs of listed companies mainly include the following.

Administrative penalty. Generally, violations of information disclosure obligations are punished under article 197 of the new Securities Law. If the obligated party fails to report or disclose information, they will be ordered to make corrections, given a warning, and fined between RMB500,000 and RMB5 million. Responsible executives and other directly liable personnel will also be warned and fined between RMB200,000 and RMB2 million.

If the disclosed information contains false records, misleading statements or significant omissions, the party will be ordered to make corrections and given a warning, with fines ranging from RMB1 million to RMB10 million. Responsible executives and other directly liable personnel will be warned and fined between RMB500,000 and RMB5 million.

Civil liability. Failure to disclose or improper disclosure of information that causes losses to investors must result in compensation. The new Securities Law includes several situations requiring civil compensation liability, which are not elaborated on here.

Criminal liability. Article 70 of the new law states that violations of this measure suspected of being criminal offences will be transferred to judicial authorities for criminal prosecution. According to the Criminal Law, the primary charge is violations of disclosure or non-disclosure of important information.

China¡¯s capital market has long neglected the protection of small and medium investors¡¯ rights in its institutional design, resulting in a significant imbalance where issuers have more power than investors.

The frequent occurrence of financial fraud among listed companies, including state-owned enterprises, highlights issues such as information asymmetry in the market, an inadequate investment return mechanism, and poor channels for small and medium investors to protect their rights. Addressing these issues requires the courage for self-reform, strict management and implementation of information disclosure obligations, and resolute accountability enforcement.

This approach will help create a market where issuers and investors have symmetrical information. As the capital market relies on information for pricing, ensuring that small and medium investors fully enjoy their right to know and have fair access to all publicly available information is the fundamental premise in protecting their legitimate rights and interests.