The Judicial Application of the Causation Test of the False Statement Doctrine in Securities Litigation in China

I. INTRODUCTIONIn 2001, more than eighty listed companies in China's stock market were investigated and penalized by the China's Securities Regulatory Commission ("CSRC") for fraud, misrepresentation, or non-disclosure of material corporate information.1 The stock market in China underwent an unprecedented trust crisis,2 and numerous investors who had suffered losses started to question the existing model of the stock market.3 In August 2004, the Jinan Intermediate People's Court (the trial court) of Shandong Province issued its decision in Zhang He v. Bohai Group.4 This case brought about the first open trial in China involving a public investor seeking damages against a listed company under the false statement doctrine.5 In the same month, the Ha'erbin Intermediate People's Court made a judgment in Chen Lihua v. Daqing Lianyi Corporation on the same grounds.6 These two cases are representative of earlier judicial application of the false statement doctrine in civil securities litigation in China.Despite its short history, the stock market in China has experienced considerable ups and downs since its establishment in the early 1990s. By the end of 2005, the number of listed companies in the securities market had increased from fewer than twenty to 1,381.7 The total value of the stocks trading in the open market reached RMB 3.24 trillion (US$405 billion) in 2005.8 However, in spite of its early rapid development, there has been a downturn in the stock market since 2000. For example, the Composite Index of Shanghai Stock Exchange has declined from over 2,073 at the end of 2000 to 1,161 in 2005.9 The majority of public investors have suffered serious loss in recent years, including most institutional investors.10The large scale misconduct of listed companies played a significant role in the downturn of the stock market. The listed companies' constant false disclosures or major omissions of material information garnered broad attention, both within the stock market and among society generally. For example, cases of listed companies making false statements occurred every month in 2001." Pervasive misconduct as well as the poor performance of many listed companies exhausted investors' trust and confidence in the market.12 Many scholars have pointed out that the securities market cannot be revitalized without an effective mechanism to monitor and prevent such misconduct.13A system of civil compensation through judicial processes is often regarded as the most popular candidate for such a mechanism. Under current law, although a listed company that conducted fraud or made false statements might be fined by administrative agencies,14 or the directors of the company may be punished by criminal statutes,15 public investors who have suffered serious financial losses due to the companies' fraud or other misconduct do not have legal remedies. Public investors need greater protection, and the current legal system is woefully insufficient. To address the inadequacies of the system, in 2003, the Supreme People's Court of China ("SPC")16 issued its judicial interpretation under the title of "Some Provisions of the Supreme People's Court on Trying cases of Civil Compensation Arising from False Statement in securities Market" ("SPC Provisions").17 For the first time, a SPC judicial interpretation provided substance and procedures for aggrieved public investors seeking civil damages against a listed company that made false statements.The causation test in the SPC Provisions soon became the dispositive issue of the false statement doctrine after the SPCs promulgation of the SPC Provisions. The relationship between cause and effect can be very complicated in civil securities litigation.18 One cause might result in multiple effects while one effect may result from multiple causes.19 In a stock transaction, it is often very hard for a plaintiff investor to prove that the alleged false statement is the sole or significant cause of the investor's loss. …