By Qi Lyu
The biggest legal challenge for China’s wealth management sector does not lie in suitability tests but in quasi-class actions.
I had the above recent discovery when I was preparing a training class for China Trust Society on the topic of consumer protection, where I found a top trust company was judged to be liable for 17 Tranche B holders for their breach of trust contracts. This was the Citic Trust. And as more case research is executed, more trust companies involved in such quasi-actions appear, with big names like Xinjiang Trust, Evergrande Trust,Minsheng Trust among them.
I consider it over and come to aconclusion that the quasi-class actions based on breach of fiduciary duty may be more potentially threatening to Chineserising wealth management sector than the ambiguous term “suitability” .
Dutyof suitability is formally adopted at the judicial level by the widely-known “Jiu Min Ji Yao” (Memo of the National Conference for the Work of the Court in the Trial of Civil and Commercial Cases, issued by the Supreme People’s Court) in November 2019. The basic requirements for suitability are on financial institutions, including knowing your customers, knowing your products, and matching them well, which was performed rather strictly and produced some unanticipated losses on banks’ side. The whole wealth management sector is busy building their suitability-compliance devices to defend themselves.
However, the non-compliance with suitability requirements causes only a particular problem with individual customers, while the quasi-class actions could be a whole disaster tothe product issuer.
China has built her own version of class action in recent years in the securities market called the representative litigation regime, which does not cover the wealth management sector yet. The reason why it could be named as a quasi-one is that they share some common features: the basic facts are similar, the lawsuits are advocated by attorneys, and the judgments are under a uniform scale.
This set of Citic-Trust cases is a typical one, conforming with these points well:
Citic-Trust was challenged in a case for his two collective trust schemes for his violation of fiduciary duty and eventually lost the case after the appellate proceeding in 2018. The other 17 cases flooded into the court, led by the same attorneys in 2019, and received all judgments on November 29, 2019 with each reference to the prior sample decision.
The facts are as follows: Mr. Cai invested 1 million yuan into Citic Trust No.27 Scheme to be a Class B subordinate holder in May 2015. N0.27 was to investin the securities market. The procurement process is not completed in a vis-a-vis manner; rather, the related documents are delivered to the plaintiff by a third party with Citic Trust authorization and posted back and forth after each signing.Seven months later, No. 27 liquidated with a net value of 89 and 89.63 each on June 26 and 29t. The litigation arises
Given the precedent case on the same verdict, the reasoning and analysis all follow the former template:There aretwo kinds of duty violations in the trustee’s performance: the first string is not with specific operation; this regards not reminding the product’s risk appropriately and did not making disclosure sufficiently; the other layer is closely related to the specific operation, where the trustee neither issues margin call before the forced closure nor liquidates timely, causing an enlarged loss. Mr. Cai recovered ¥153645.26.
All 17 cases were judged against the trustee with a calculated damage of nearly 15% of their investment, which could almost cure the investor’s loss on principal. The total Class B of N0.27 amounted to 87,900,000 with the unfortunate result that Citic Trust gained less than ￥140,000 under this product.
What could be worse is that this may not be a unique case with Citic Trust, but with other trust companies with malpractices. Such a problem could even be an industry disaster since some are embedded in the present business model: For those products sold through intermediary firms, who take a heavy part of the remuneration, flaws in the exercise of suitability duty and informative duty are always inevitable. As to strict compliance with the duty to fully disclose and timely inform and liquidate, it may still be too professional for Trustcompanies who are used to doing channel securities business (pass-through business) while having to burden liabilities themselves.