QFII-Related Lawsuit in China

Today I've read a news article from Finance Asia about the first QFII-related lawsuit in China. Nanning Sugar, a company based in Guangxi province, has filed a lawsuit against Martin Currie Investment Management (MCIM) and Martin Currie Incorporated (MCI) with the Nanning Intermediate People's Court for alleged breaches of Article 47 under the PRC Securities Law. Nanning Sugar has successfully obtained court orders to freeze Martin Currie's assets in China, with a total of RMB 39.6 million under MCIM's QFII account, until the case is heard in court.

Article 47 stipulates that if a shareholder purchases and sells a stake of over 5% in a listed company within six months, the listed company is entitled to the proceeds of the trade. This rule was originally designed to deter short-term and insider trading. Nanning Sugar claims that Martin Currie should pay back the profit it made from trading the company's stock between Aug 2007 and Jan 2008, as well as accrued interested and incurred legal costs.

However, Martin Currie argues that:

• the action taken by Nanning Sugar is wholly unwarranted because Nanning Sugar has misunderstood how the current system works for foreign investors;
• the fact that Martin Currie companies owned more than 5% of the issued shares is clearly incorrect;
• MCIM has only held a maximum of 1.6% of Nanning Sugar's shares in the period of the alleged breach; and
• the rest of the stake that totals over 5% as Nanning Sugar has claimed belonged to four different clients and was invested across three different QFII accounts, some of which are advised by MCI (a separate legal entity from MCIM).

There is a widespread concern about its impact of this case on the further reforms amid expectation for a coming QFII scheme expansion. The PRC Securities Law in China was first adopted in 1999 and later revised in 2005. Given the short history of the asset management industry in China, most of the rules remain untested and are subject to regulators' interpretation and revision as the market expands. Market partitiorners have been concerned about the legal loopholes and overlapping regulations.

QFII investors are currently subject to regulation by the CSRC and rules on foreign exchange by SAFE. Given China's legal system is based on a civil law system, instead of case law, rulings follow the word of the law without reference to precedence. The inconsistencies between the securities law and the regulation on disclosure of equity interest could lead to potential conflicts when applied to foreign investors under the QFII scheme.

Let's see how this case is finally adjudicated by the PRC court.