"Heavy-handed" crackdown continues to combat financial fraud, combining punishment and prevention to strengthen the capital market's defense line

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On the evening of March 27, Shenzhen Derun Electronic Co., Ltd. (hereinafter “ST Derun (rights protection)”) and two other listed companies disclosed related announcements regarding administrative penalty decision letters received from local securities regulators. All the related violations involve financial fraud.

According to a reporter from The Securities Daily who compiled information from public sources, as of March 29, during this year 23 companies (including listed companies, delisted companies, and companies listed on the National Equities Exchange and Quotations) disclosed financial-fraud penalty tickets they received (including administrative penalty decision letters and administrative penalty advance notice letters), with a total fine amount of RMB 565 million.

In recent years, regulatory authorities have continued to impose tougher, heavier, and faster penalties on major illegal acts such as financial fraud. Zheng Yu, a professor at the International Finance and Financial Law School of East China University of Political Science and Law, told a reporter from The Securities Daily that, while intensifying accountability in a strict manner, law enforcement is increasingly focused on improving regulatory efficiency and governance effectiveness. Since the beginning of this year, on the basis of holding financial-fraud companies accountable and adhering to the principle of “punish the first wrongdoer without exception,” regulatory authorities have further strengthened “punishing accomplices without exception.” They have intensified supervision and crackdowns on situations where intermediary institutions, through intentional acts or serious negligence in their performance of duties, help with fraud or fail to properly review; and also on assistance in fraud through fabricated business and capital-circulation arrangements among companies in upstream and downstream relationships, achieving strict oversight across the entire chain.

23 companies were punished for financial fraud

In a single day, three companies were penalized for financial fraud, demonstrating that the “heavy-handed approach” to cracking down on financial fraud in the capital market is continuing. As enforcement efforts intensify, more financial-fraud methods have also been exposed.

For example, in the case of ST Derun, the company’s administrative penalty decision letter shows that the company’s controlling person, Qiu Mingen, “paid out of his own pocket” to provide funds to the company’s customers, its former subsidiary companies, suppliers, and others, so that the aforementioned parties could repay ST Derun historical debts. This led ST Derun to fabricate contract receipts of RMB 395 million in 2020 and RMB 113 million in 2021, and understate credit impairment loss by RMB 371 million and RMB 66.3931 million, respectively. In addition, Qiu Mingen also coordinated ST Derun’s subsidiary to indirectly provide funds to ST Derun’s equity-method investee in the form of advance payments for goods, so that, upon maturity, repayment could be made for the financial assistance received from ST Derun. This caused the company’s 2022 semiannual report to fabricate contract receipts of RMB 26.8369 million and understate credit impairment loss by RMB 5.061 million.

Ultimately, the Shenzhen Securities Regulatory Bureau, for the existence of false records in ST Derun’s 2020 annual report, 2021 annual report, 2022 interim report, and non-public offering documents, imposed a fine of RMB 7 million on the company, a fine of RMB 12 million on its controlling person, and a fine of RMB 3.5 million on two individuals, including the company’s president and chief financial officer, for a total fine amount of RMB 22.5 million. ST Derun’s controlling person was also subject to a 5-year ban from the securities market.

According to a compilation by the reporter, as of March 29 this year, 23 companies have already been subject to regulatory penalties for financial fraud, covering 19 listed companies, 3 delisted companies, and 1 company listed on the National Equities Exchange and Quotations. Among listed companies, Changjiang Pharmaceutical Holding Co., Ltd. and Lifang Digital Technology Co., Ltd. both triggered major-violation compulsory delisting indicators due to financial fraud; they have already received the exchange’s decision to terminate their listing, and their stock has entered the delisting consolidation period.

“Three companies received financial-fraud penalty tickets on the same day, reflecting the acceleration of regulatory enforcement and the expansion of coverage.” Wang Zhibin, a lawyer at Shanghai Minglun Law Firm, said in an interview with a reporter from The Securities Daily. From the perspective of penalty amounts, he said, the strength of penalties in individual cases has clearly increased compared with the past, which is consistent with the direction emphasized by regulators of “severely punishing fraud to create a strong deterrent.” Since the beginning of this year, more than 20 companies have received financial-fraud penalty tickets, indicating that the investigation and handling of financial fraud has shifted from case-by-case treatment to normalized governance, forming an ongoing high-pressure posture.

In addition, among the three penalized delisted companies mentioned above, Datang Gaohong Network Co., Ltd. (hereinafter “Gaohong 3”) and Yuanchen Environment Co., Ltd. triggered delisting indicators related to trading; they were removed from the exchange and delisted in November and December of last year, respectively. Shenzhen Yishang Display Co., Ltd. triggered a financial-related delisting indicator; it was removed from the exchange and delisted in July 2023. More than two years later, it was still issued a penalty ticket for financial fraud, further说明 that “delisting does not come with immunity from liability.”

Crack down strictly across the entire chain

While listed companies and “key few” individuals were being punished, accomplices in the fraud were also severely punished. In the above penalty ticket for Gaohong 3’s financial fraud, the CSRC plans to fine the third-party who cooperated in the fraud RMB 7 million. In addition, since the beginning of this year through March 29, three accounting firms have been fined and had penalties imposed totaling RMB 164.263 million by local securities regulatory bureaus because their annual audit reports provided to listed companies contained false records.

For instance, in the case of Zhongxinghua Certified Public Accountants (Special General Partnership), its audit reports for Jiangjin Technology Co., Ltd. for 2021 and 2022 contained false records, and during the audit of the company’s financial statements for 2021 and 2022, it failed to duly exercise due professional care and diligence. In January of this year, Zhejiang Securities Regulatory Bureau issued a decision to “impose a fine and confiscate earnings (one plus one)” totaling RMB 111.321 million, with the two signing certified public accountants each fined RMB 3 million.

“This undoubtedly sends a strong warning signal to the relevant parties: ‘Fraud will be checked without exception’ and ‘Fraud will be punished without exception.’ Currently, as audit institutions are auditing companies’ annual reports and as annual report disclosures are underway, all parties must not have any lucky or speculative mindset.” said Zhang Zhiwang, a partner and lawyer at Zhejiang Liuhe (Ningbo) Law Firm, in an interview with a reporter from The Securities Daily.

In Wang Zhibin’s view, this clearly conveys a definite signal that regulators are strictly pressing intermediary institutions’ “gatekeeper” responsibilities, and also marks that full-chain accountability and integrated crackdowns have become a norm of regulation in the current capital market.

Zheng Yu said that, as the “gatekeeper” in the securities market, intermediary institutions such as accounting firms cannot “check the wrong gate, take the wrong road, and loosen the wrong checkpoint” for their own private interests. Increasing penalties for accounting firms continues to convey regulators’ requirements for important intermediary institutions like auditors to “check the right gate, take the right road, and guard the right checkpoint.”

In addition, according to data from Tonghuashun iFinD, as of March 29 this year, 37 accounting-firm instances have already been subject to administrative regulatory measures by local securities regulatory bureaus. The reasons include inadequate execution of audit procedures, failure to maintain professional skepticism, and serious issues with audit working papers. Regulators are comprehensively reinforcing accounting firms’ “gatekeeper” responsibilities.

An all-round upgrade of the punishment and prevention system

In 2024, since the General Office of the State Council forwarded the CSRC and other departments’ “Opinions on Further Doing a Comprehensive Punishment and Prevention Work on Financial Fraud in the Capital Market,” regulators have continued to promote the establishment of a comprehensive punishment and prevention system for financial fraud.

This year, regulators will further consolidate and enhance the effectiveness of the comprehensive punishment and prevention system for financial fraud. On March 6, CSRC Chairman Wu Qing said the CSRC will further take seriously market discipline, and take multiple measures to improve punishment and prevention effectiveness.

Besides severely punishing fraud, Wu Qing also emphasized strengthening governance through strong prevention, including: promoting the introduction of regulatory rules for listed companies; quickly implementing the newly revised corporate governance rules for listed companies; effectively strengthening the oversight of sponsor representatives; accelerating the construction of a financial-fraud clue discovery center; and establishing third-party cooperation mechanisms for fraud monitoring and early warning.

In addition, in Wang Zhibin’s view, from the perspective of law enforcement, it is necessary to accelerate the building of more targeted law-enforcement mechanisms to improve the efficiency of penalties and stabilize market expectations. In terms of sanctions, it is necessary to strengthen effective linkage with criminal accountability to further raise the legal cost of financial-fraud violations. At the same time, it is also necessary to further improve the civil compensation mechanism for investors, so as to ensure that harmed investors can obtain timely and effective relief, and to accelerate the building of an all-round accountability system featuring the “three-in-one” approach of administrative, criminal, and civil accountability.

Zheng Yu said that, from the perspective of punishment, with the completion of the “four pillars and eight supports” construction of the capital market legal system, the punishment regime for relevant illegal acts has essentially taken shape; the key now lies in implementation and enforcement. From the perspective of prevention, on the one hand, it relies on continuing to advance the construction of a society-wide social credit system for commercial entities, striving to build a business environment characterized by integrity. On the other hand, in the “big data” era, it is still necessary to enable interconnection and interoperability of various core data, and to promote the establishment of a suspicious transaction early-warning information or query system. This will help regulators and intermediary institutions better identify—or “penetrate”—the fog around funds or transactions, and prevent and stop adverse market behaviors that conceal illegal transaction purposes through seemingly legal transactions.

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