Special Compensation
Case of the Special Fund for Investor Interest Compensation with respect to the Misrepresentation of Wanfu Biotechnology
On September 14, 2012, CSRC started official investigation against Wanfu Biotechnology that was the first listed company in GEM (growth enterprise market) issuing stock fraudulently. On May 10, 2013, Ping An Securities Co., Ltd. (“Ping An Securities”), as the sponsor institution and lead underwriter for Wanfu Biotechnology’s initial public offering and listing, contributed RMB 300 million to set up the “Special Fund for Investor Interest Compensation with respect to the Misrepresentation of Wanfu Biotechnology ” ( “special compensation fund”), for the purpose of compensating eligible investors in advance for their investment loss incurred from such incident. China Securities Investor Protection Fund Company, Ltd. ( “Investor Protection Fund Company”) accepted the commission of Ping An Securities to serve as the manager of the special compensation fund and to take charge of the fund’s routine management and operation. Within 60 calendar days, 95.01% of the eligible investors received compensation.
I. Profile of the Case
(I) Background
The predecessor of Wanfu Biotechnology was Xianglu Wanfu Co., Ltd. in Taoyuan County of Hunan Province, set up in 2003. In March 2006, the company was renamed as Hunan Xianglu Wanfu Agricultural Development Co., Ltd. In October 2009, the whole company was re-established as Wanfu Biotechnology (Hunan) Agricultural Development Limited Liability Company, mainly dealing in research & development, production and marketing of series products of intensively processed rice. On July 19, 2011, it successfully obtained the approval of CSRC’s Issuance Examination Committee, and on September 27 of the same year, it was listed in GEM of Shenzhen Stock Exchange ( “SZSE”), with the stock code of 300268. Its sponsor institution was Ping An Securities. Its Chairman, Gong Yongfu, and his wife, Yang Ronghua, were the largest shareholders and the company’s actual controlling owners.
On March 2, 2013, the self-inspection announcement published by Wanfu Biotechnology reported that according to its self-inspection, approx. RMB 740 million of revenue, approx. RMB 180 million of operating profit and approx. RMB 160 million of net profit were falsely added accumulatively between 2008 and 2011, of which RMB 280 million of operating revenue, RMB 65,413,600 of operating profit and RMB 59,126,900 of net profit attributable to shareholders of listed company were falsely added in 2011.
(II) Affirmation of illegality fact
CSRC’s administrative penalty decision affirmed that Wanfu Biotechnology conducted the following illegal acts:
There existed misrepresentations in the financial data between 2008 and 2010 disclosed by Wanfu Biotechnology in the Prospectus for Initial Public Offering and Listing on GEM (“Prospectus”), and the company did not qualify the conditions for public issuance of stock. In order to meet such conditions and become listed, Wanfu Biotechnology, through decision of its Chairman and concurrently General Manager and implementation arranged by its chief financial officer, Qin Xuejun, falsely added sales revenue by RMB 122.62 million, RMB 149.66 million and RMB 190.74 million and operating profit by RMB 28.51 million, RMB 38.57 million and RMB 45.90 million between 2008 and 2010, respectively. Revenue and operating profit were falsely increased by approx. 47% and 88%, respectively. After deducting the above falsely added operating profit, the net profit of Wanfu Biotechnology between 2008 and 2010 after deducting non-recurring profit and loss was RMB -3.33 million, RMB -710,000 and RMB 3.83 million, respectively.
There existed misrepresentations in 2011 Annual Report published by Wanfu Biotechnology on April 16, 2012, which reported operating revenue of the company to be RMB 553.24 million in 2011. The inspection discovered that Wanfu Biotechnology falsely added sales revenue by RMB 286.81 million in 2011.
Wanfu Biotechnology failed to fulfill its timely report and announcement obligations with respect to the production suspension of the company in the first half of 2012. In the beginning of 2012, the operation of sugar refinery, rice mill and oil mill under Wanfu Biotechnology was suspended. With respect to the facts that production of its main products including sugar products and rice was suspended, Wanfu Biotechnology failed to fulfill its timely report and announcement obligations in accordance with the laws and regulations.
There existed misrepresentations and material omission in the 2012 Semi-Annual Report published by Wanfu Biotechnology on August 23, 2012. In addition to falsely adding sales revenue by RMB 165.49 million, it failed to disclose in this Report the above-mentioned suspension of some production lines of the company in the first half of 2012, which consists of material omission.
(III) Administrative penalty decision
On September 24, 2013, CSRC issued the Administrative Penalty Decisions [2013] No. 47, No. 48, No. 49 and No. 50 with respect to the misrepresentation of Wanfu Biotechnology . According to the provisions of the Securities Law and other relevant laws and regulations, Wanfu Biotechnology was subject to correct its illegal acts, warning and a fine of RMB 300,000; Gong Yongfu was subject to warning and a fine of RMB 300,000. Meanwhile, 19 senior executives, including Yan Pinggui, were subject to warning and a fine of RMB 50,000 to 250,000. In addition, Gong Yongfu and Qin Xuejun were barred from access to securities market for life.. As the fraudulent issuance and misrepresentation by Gong Yongfu and Qin Xuejun were suspected of crimes, they were handed over to public security authorities for criminal investigations.
During Wanfu Biotechnology’s IPO process, three intermediaries including Ping An Securities (as the sponsor institution), Zhonglei Certified Public Accountants (as the auditor), and Hunan Bo’ao Law Firm, and related individuals, were suspected of failing in fulfillment of due diligence and duties which resulted in misrepresentation in related materials they issued, and were therefore officially investigated respectively. According to the facts, nature, specific situation and the level of damage to the society with respect to the illegal acts of related parties, and in accordance with the provisions of the Securities Law, (CSRC) ordered Ping An Securities to correct its illegal acts, gave it a warning, confiscated its business income of RMB 25.55 million, imposed a fine of RMB 51.10 million, and suspended its sponsor license for three months; it gave a warning to Wu Wenhao and He Tao, then sponsor representatives of Ping An Securities for Wanfu Biotechnology project, Xue Rongnian, then General Manager of Ping An Securities, Zeng Niansheng, then Assistant to GM of Ping An Securities, and Cui Ling, then head of Shanghai Operation of Investment Banking Division of Ping An Securities, imposed a fine of RMB 300,000 to each of them, and revoke their securities occupational certifications; and it gave a warning to Tang Dezhi, a member of Wanfu Biotechnology project team from Ping An Securities, imposed a fine of RMB 100,000, and revoked his securities occupational certifications. In addition, it confiscated business income of RMB 980,000 of Zhonglei Certified Public Accountants and imposed a fine of two times of their illegal incomes; and it confiscated business income of RMB 700,000 of Hunan Bo’ao Law Firm and imposed a fine of two times of their illegal incomes. Meanwhile, CSRC penalized the individuals of the two firms involved in the case.
(IV) Establishment of the special compensation fund
On May 10, 2013, Ping An Securities, as the sponsor institution and lead underwriter for Wanfu Biotechnology’s IPO and listing, contributed solely RMB 300 million to set up the special compensation fund, by transferring the contribution amount to the dedicated custodian account for the fund on a lump sum basis before the fund’s establishment date. It commissioned the Investor Protection Fund Company to serve as the manager of the fund, working out online and offline solutions for reconciliation with eligible investors. The special compensation fund operated on a “compensation first and recourse later” basis, with Ping An Securities paying eligible investors with the assets of the fund first and then carrying out recourse through legal channels against major responsible parties and parties with joint liabilities with respect to the misrepresentation of Wanfu Biotechnology. This model where a civil liability subject sets up a fund with respect to misrepresentation, commissions the Investor Protection Fund Company as the manager, and pays investors with actual loss in advance, could provide the investors with a relatively efficient and convenient channel, other than the judicial channel, allowing timely compensation for investors. If investors should not accept the fund’s compensation solutions, they could file lawsuits to competent people’s court in accordance with the law to request compensation from related responsible parties with respect to the misrepresentation of Wanfu Biotechnology.
The Investor Protection Fund Company, as the manager of the special compensation fund, took charge of routine management and operation of the fund, and its legal relation with Ping An Securities was of commissioning and agency. Under this model, the assets of the fund belonged to Ping An Securities, and the Investor Protection Fund Company would be responsible to set up a special working group for fund compensation to take charge of specific implementation of compensation for investors. In addition, the Investor Protection Fund Company would independently appoint a commercial bank as the custodian of the fund, engage experts to form an expert committee to carry out consultation, and engage intermediaries to participate in routine work. The term of the fund was 2 months starting from the date of establishment. The Investor Protection Fund Company might extend the term of the fund according to the actual operation of the fund, but such term shall not exceed December 31, 2013. Upon expiration of the term of the fund, the Investor Protection Fund Company would initiate a liquidation process, with the remaining assets to be returned to Ping An Securities.
As of June 28, 2013, eligible investors who had completed online formalities and effective declaration as well as reached effective reconciliation with Ping An Securities have amounted to 12,756, accounting for 95.01% of the total eligible investors, and the compensation amount paid to eligible investors amounted to RMB 178,565,084, accounting for 99.56% of the total payable compensation amount. By July 3, all compensation amounts had been transferred to the accounts of eligible investors.
II. Features of Wanfu Biotechnology Special Compensation Fund
Wanfu Biotechnology investor interest compensation program was the first case in China’s domestic securities market where a securities intermediary voluntarily contributed fund to compensate investors for their loss in advance. Establishment of the special compensation fund itself was of positive significance in terms of promoting protection of legal interest of investors. The significance was not only about voluntary assumption of compensation responsibility by the responsible parties, but more about an innovative exploration on protection mechanism of investor interest in the securities market. There were five main features, as follows:
(I) Voluntary civil reconciliation. Ping An Securities solely contributed fund to set up the special compensation fund to compensate eligible investors for their losses and reached reconciliations therewith, creating a new channel of voluntary reconciliation among civil subjects in the capital market, besides the existing judicial channel, providing investors with options between compensation through reconciliation and damage claim through litigations, and solving market issues through market mechanism.
(II) Compensation first and recourse later. Setting aside disputes over complex determination of responsibility, Ping An Securities, as one of the joint liability parties, solely and in advance, reached reconciliation with eligible investors and compensated for their losses, and then carried out recourse against other joint liability parties with respect to the compensation amount beyond its liabilities, exempting investors from complex procedures of claiming compensation through lengthy legal proceedings against multiple joint liability parties.
(III) High efficiency and low cost. On one hand, investors could quickly reach reconciliation with Ping An Securities and receive compensation without involvement in complex legal proceedings of class action and litigation against multiple parties, and on the other hand, related parties could take the advantage of highly advanced online platform of China’s securities market to sign reconciliation agreement online, confirm compensation amount through online voting system and transfer compensation fund through securities settlement system, allowing investors to receive compensation fund within a short period of 60 calendar days without any cost.
(IV) Full protection of investor interest. Under the current legal framework and with the goal of maximizing protection of investor interest, it carried out elaborate argumentation and design on the scope and calculation method of compensation, and adopted the methods that could best protect investor interest under the current legal framework. It engaged an independent third party to serve as the manager of the fund to take charge of specific compensation work of the special compensation fund.
(V) Favoring public benefit, independence and neutral. Firstly, as the fund manager, the Investor Protection Fund Company would abide by the rule of public benefit and it would not charge any fee with respect to the commission matters under the commission agreement with Ping An Securities. Various expenses including traveling cost incurred by its staff in carrying out related work would be borne by the Investor Protection Fund Company itself, and would not be listed as costs to the fund. Secondly, appointment of custodian bank for the fund, engagement of third-party intermediaries and independent management by the Investor Protection Fund Company would ensure absolute independence. Finally, abiding by the neutral rule, the Investor Protection Fund Company only managed and operated the fund on a commissioning basis in the process of fund management and operation, and would not take side of either Ping An Securities or the investors.
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