LAW SCHOOL Master Thesis for International Business Law LL.M

A Study on China’s Insider Trading Regulations Enforcement Compared with the U.S. Experience

Kaishen Lin Emp. U1252321, ANR. 297414 Supervisor: Mphil. Jing Li

Academic Year 2012-2013 6/14/2013

CONTENT

KEYWORDS∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙1 ABSTRACT∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙1 1. OVER VIEW ON INSIDER TRADING AND LEGAL BACKGROUND IN CHINA∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙2 1.1 Brief Introduction of Insider Trading Research in China∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙2 1.2 A Brief Introduction of Securities Markets in China∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙2 1.2.1 A Brief History of Chinese Securities Markets∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙5 1.2.2 Shanghai Stock Exchange and Shenzhen Stock Exchange∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙5 1.2.3 China Securities Regulatory Commission∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙6 1.3 Characteristics of the Insider Trading in China∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙7 2.THE RELATIONS BETWEEN THE FEATURES OF CHINESE LISTED COMPANIES AND INSIDER TRADING∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙9 2.1 Ownership Structure and Insider Trading∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙10 2.2 The Influence of Split Share Structure Reform in China∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙12 3. COMPARISON OF INSIDER TRADING LAWS IN CHINA AND THE U.S. ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙14 3.1 The U.S. Insider Trading Law Theories∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙15 3.1.1 “Equal Access” Theory∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙17 3.1.2 Fiduciary Duty and Tipping Liability∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙18 3.1.3 Misappropriation Theory∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙19 3.2 The Theories Adopted by China’s Insider Trading Regulations∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙19 3.2.1 A Brief Legislative History of Insider Trading Regulations in China∙∙∙∙∙∙∙∙∙∙∙∙∙∙19 3.2.2 The Theories Adopted by China’s Insider Trading Regulations∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙20 4. THE PUBLIC ENFORCEMENT CHINA AND THE U.S∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙21 4.1 Comparison of Two Countries’ Administrative Investigation∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙21 4.1.1 Triggers of the Investigation∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙21 4.1.2 Informal Investigation and Formal Investigation∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙23 4.2 Comparison of Two Countries’ Administrative Enforcement∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙24 4.3 Comparison of Two Countries’ Criminal Enforcement∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙29 5. LATEST ENFORCEMENT TRENDS AND PROBLEMS IN CHINA AND THE U.S∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙31 5.1 Insider Trading through Expert Networks in the U.S. ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙31 5.1.1 Expert Network Industry∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙31 5.1.2 Insider Trading Cases Conducted by Expert Network Firms∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙33 5.2 “Stop Trading on Congressional Knowledge Act” and the Similar Matters in China∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙36 CONCLUSION∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙39 BIBLIOGRAPHY∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙ ∙∙40

KEYWORDS Insider Trading Regulations, Enforcement, Administrative Sanction, Criminal Sanction, Securities Market

ABSTRACT Chinese economy has grown rapidly during the past decades and its securities markets also accompany with this positive trend, becoming essential to the global financial market. In recent years, China has made a great effort on promulgating new regulations and laws to facilitate its further development in financial industry. However, the functioning of such new regulations could be exerted only when such regulations are enforced well. The success of Chinese financial market will rely on the efficacy of its law enforcement. This thesis indicates that the current enforcement of illegal insider trading in China is far from efficient and the Chinese authority should focus more to enhance its future enforcement. First, it finds that both the numbers of administrative proceedings and criminal prosecution were small and the deterrence effect of such cases was feeble. Second, the investigation procedure was not ideal and the cases enforced by the CSRC were selective. Last, in order to learn better why the U.S. has an efficient enforcement, two related issues, namely the expert networks and the enactment of STOCK Act which are discussed in the U.S. recently are examined and compared with their counterparts in China. The analysis once again shows that the enforcement of insider trading regulations in China is still far from satisfaction.

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1. OVER VIEW ON INSIDER TRADING AND LEGAL BACKGROUND IN CHINA

1.1 Brief Introduction of Research on Insider Trading Enforcement in China Many researchers have been focus on the substantive insider trading laws. They have discussed the theories of which group of persons can be violators, what is the scope of breaches, and the liabilities for such breaches. Charles Zhen Qu (2001) indicated the definitions of insider information and insiders are too narrow to protect the investors form the illegal insider trading in China. Hui Huang (2005) analyzed the theories of insider trading regulations transplanted into China, and found the theories behind the regulations were not congruent but confusing. He advocated that in order to further enhance the enforcement quality, China should learn from Australian experience. Although some of them have critically analyzed the substantive laws of insider trading, until now not many of the current researches have deeply probed into the area of enforcement.1 Some articles have critically analyzed the substantive insider trading laws, and have already realized the lack of discussing the procedure of insider trading regulation enforcement makes the procedure vague and ambiguous for the defendants.2 Therefore, more researches which focus on the enforcement should be conducted to explain why the current enforcement in China is inefficient and what should the regulators do to redress the flaws of the current enforcement system. In order to improve the efficacy of insider trading regulations, it is necessary to understand the nature and the extent of the underlying problems in insider trading law enforcement. Moreover, since Chinese securities market is under the context of a transitional economy with a rapidly growth rate, insider trading exhibits some interesting features different from that in the developed markets.3 These features should be analyzed under China’s special emerging market environment, including the development of securities markets, the legal transplantation history and so on.

1.2 A Brief Introduction of Securities Markets in China

Before discussing insider trading enforcement in China, it is necessary to have a general understanding on the development of Chinese securities markets. Hence, this subsection aims to probe into the past and the presence of Chinese securities market. The establishment of two stock exchanges and the administrative of securities in China will be slightly introduced.

1.2.1 A Brief History of Chinese Securities Markets

At the beginning of the last century, China once had Asia’s largest securities market, the Shanghai Stock Exchange, a highly active securities market with mature management on stock transactions.4 However, the foundation of the People’s Republic of China brought a

1 See Huang Hui, The Regulation of Insider Trading in China: a Critical Review and Proposals for Reform, (2005), available at http://ssrn.com/abstract=753745. 2 Id. 3 See Hui Huang, An Empirical Study of the Incidence of Insider Trading in China, (May 2007), available at: http://ssrn.com/abstract=993341 4 See Jiangyu Wang, China's Securities Experiment: The Challenge of Globalization, at http://www.eas tlaw.net/researchlsecurities/securities-nol.htm (last accessed 12 May, 2013).

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centrally planned economy and all market-related activities were replaced by the governmental plans. During 1950 to 1976, most of the private economic activities were forbidden.5 The authority nationalized or ‘confiscated’ nearly all economic entities and organized economic activities under a central planned system.6 No private property right existed during that time in China7 not mention to the existence of securities market and shareholding right. Therefore, contrast to the splendid history of the U.S. market-oriented economy, China has only deployed market as an allocation mechanism of social resources for a very short period of 30 years.8 Under the influence of the Communism, the Chinese government rejected the securities market as many of the former socialism countries did. Most of the participants and materials in the economic activities are governmental belongings. Hence, capital raising was not necessary. Any idea of the capitalism was forbidden and indeed they considered securities market was a typical creation of capitalism and should not be allowed in China.9 However, after decades of the undesirable operation of Chinese economy, in 1979, China finally abandoned its inefficient economic policy and launched an economic reform ever since. 10 At the beginning, China heavily relied on the foreign capital, but later the government realized the importance of securities market for capital raising. In order to effectively allocate more capital for business and to facilitate greater economic efficiency, scholars and experts proposed that securities market should bring back to life.11 As a result, Shanghai Stock Exchange and Shenzhen Stock Exchange were established respectively in November 1990 and July 1991. 12 The Chinese government endowed these two stock exchanges self-regulated powers, hoping to make them into more economic oriented mechanisms to assist companies to raise capital. Apart from the purpose of facilitating capital raising, the Chinese government established these two exchange markets with two more objectives: establishing a modern corporate governance system in listed companies and maximizing employment of idle capital.13 At the same time, the reform of the ‘economic entities’ have been undergoing rapidly in China. Many large state owned enterprises have been transformed into shareholding companies and gradually went public as listed companies.14 These companies issued shares

5 See Xiaohuan Su and Xiaozheng Zhou, China Focus, (China International Press, 2007), at 34. 6 See Pan Shi, China’s Accumulation of Capital, (Beijing: Tsinghua University Press, 2005), at 52. 7 See Steven N. S. Cheung, Further Discussion on China, in Chinese, (Hong Kong: Arcadia Press, 2002), at 136. 8 See McMillan, J., & Naughton, B. (1992). How to reform a planned economy: lessons from China. Oxford Review of Economic Policy, 8(1), 130-143. 9 See Ruihui Yang and Wenguang Mo, A Perspective View on Chinese Securities Market, in China, (Hong Kong: The Chinese University of Hong Kong, 1997), at 6. 10 See Lin, J. Y., Cai, F., & Li, Z. (2003). The China miracle: Development strategy and economic reform. Chinese University Press, at 195 11 See Hui Huang, Supra note 1 12 See Jianxun Chen, Hui-Tzu Shi, The Evolution of the Stock Market in China's Transitional Economy, (Edward Elgar Publishing Limited, 2002), at 25. 13 See Anderson, D. M. (1999), Taking stock in China: company disclosure and information in China's stock markets. Georgetown Law Journal, 88, 1919. 14 See China Stock Market Handbook Editorial Board, China Stock Market Handbook, (Javvin Press, 2008), at 2.

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and debt bonds in the securities markets, accelerating the growth of the securities markets in China. After the wave of state owned enterprises becoming listed companies, Chinese government started to test the possibility of establishment of the Growth Enterprise Market.15 In 2009, disregard of the failed experience of the worldwide unsuccessful Growth Enterprise Market, China went further to establish its own Growth Enterprise Market Board, the ChiNext market, dubbed as China’s NASDAQ, with the aim to facilitate capital raising for the small and medium companies with potentially high growth competence.16 The economic reform and opening-up policy was beneficial to Chinese economy. Moreover, China’s accession to the World Trade Organization stimulated its economic growth and its transition from communism to ‘social market capitalism’ has been proved successful with the average GDP growth of 8.9 percent in 2001 to 2005 and 8 percent in 2006 to 2010.17 In the background of this rapid economic development, the introduction of the securities markets in China is extraordinarily successful. The strong impetus of the Chinese government to develop the stock markets for whatever motives or reasons has generated good result.18 Only with 20 years’ growth, the total capitalization of two stock exchange markets has risen to RMB 25040.401 billion (USD 4173.4 billion) on 15 February 201319. In 2007, it even once surpassed Japanese market, making it the second largest securities market in the world. Since more and more medium-sized companies become aware of the advantages of being listed on the exchange, the total number of the listed companies has witnessed a burst during the past decade, of which the latest number is 1541 on 15 February 2013.20 Recently, there are about a hundred of corporations waiting for IPO.21

Table 1: Numbers of the Listed Entities in China Securities Type Shanghai Shenzhen Total A Shares 944 484 1428 B Shares 54 59 113 Shares Small and Medium 0 701 701 Enterprise Board ChiNext 0 355 355 Investment Funds 42 234 276 Source: Shanghai Stock Exchange, Shenzheng Stock Exchange, February 2013.

15 See Wang Yi Finance, the Historic Mission of ChiNext, http://money.163.com/09/0831/08/5I1JNQ630 0253AOM.html, (in Chinese, last accessed on May19, 2013) 16 See Rebecca A. Fannin, Startup Asia: Top Strategies for Cashing in on Asia’s Innovation Boom, (Singapore: Wiley & Sons Asia, 2012), 17 See The Food and Agriculture Organization of the United Nations, Rapid Growth of Selected Asian Economies: Lessons and Implications (Bangkok: RAP Publication, 2006), at 28, 18 See Steven N. S. Cheung, supra note 7. 19 Data collected on 15-2-2013, at http://www.sse.com.cn/, and http://www.szse.cn/. The current total capitalization shrunk to three-five compared to its highest in 2007. 20 Data collected from the official website of Shenzhen Stock Exchange and Shanghai Stock exchange. Collected from www.szes.cn and www.sse.com.cn 21 See Zuo Yonggang, IPO Waiting Companies Want to Go Listed Aboard, 30 January 2013, Securities Daily, China.

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Chart 1: The number of companies listed on Shenzhen Stock Exchange and Shanghai Stock Exchange from 1990-2012

Number 3000

2500

2000

1500

1000

500

0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Source: Xinlang Finance, available at http://finance.sina.com.cn/worldmac/compare.shtml?indicat or=CM.MKT.LDOM.NO

1.2.2 Shanghai Stock Exchange and Shenzhen Stock Exchange

Back to the summer of 1985, James Tobin, a Nobel prize-winning economist, claimed at an international conference on China’s economic policies that “China should not set up stock markets within the next 20 years.”22 His opinion was shared by many experts at that time. However, regardless of the pessimistic view on the establishment of stock exchange market in China, the Chinese government decided to launch and experiment the stock exchange. The Shanghai Stock Exchange (SSE) was its first experiment, which was founded on 26th November, 1990 and started to operate on 19th December in the same year.23 After 24 years’ operation, the SSE has become the most preeminent stock exchange in Mainland China in terms of number of listed companies, number of shares listed, total market value, tradable market value, securities turnover in value, stock turnover in value and the T-bond turnover in value.24 Besides, the SSE is a nonprofit institution governed by the China Securities Regulatory Commission, which means it has a slight difference from the private model in the U.S. and the U.K., since the core aim of its operation is not to generate interests.25 At the end of April 2012, there were 951 listed companies on SSE, with a total market capitalization of RMB 16, 0790.74 billion. To date (17 May, 2013), the total share capital of

22 See Martha Avery et al., China’s Emerging Financial Markets: Challenges and Global Impact, (Singapore: John Wiley& Sons Asia), at 237. 23 Id. 24 See Shanghai Stock Exchange, A Brief Introduction of Shanghai Stock Exchange, (last accessed 20 May 2013), available at http://english.sse.com.cn/aboutsse/sseoverview/brief/ 25 See Slih N. Neftci et al., China’s Financial Markets An Insider’s Guide to How the Markets Work, (Burlington: Elsevier Academic Press, 2007), at 190.

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all the listed companies reached 2,483.627 billion shares, of which 1,990.978 billion shares or 80.16% of the total shares are tradable. A large number of companies from key industries, infrastructure and high-tech sectors in China are listed on Shanghai Stock Exchange.26 Like many stock exchanges around the world, the SSE is endowed with power of regulating listed companies, monitoring securities trading and managing and disseminating market information.27 On 5th November, 2010, the SSE administrative published an article which declared five measures to curb insider trading of the listed companies on the SSE. 28 The five measures are:29 1) The SSE would enhance and ensure the operation of the information disclosure administrative system; and 2) The SSE would cooperate with the CSRC to supervise the abnormal fluctuation of stock prices and information disclosure; and 3) The SSE strengthened the supervision over the stock trading of listed companies directors, supervisor, senior executives and major shareholders; and 4) The SSE would pay special attention to insider dealing in the merger and acquisition(M&A) and reorganization; and 5) The SSE would strengthen the listed companies’ training and guide the standardized operation of the listed companies and relevant parties. The central government mandates the Shenzhen Stock Exchange a different role in the capital market. As mentioned above, the average size of companies listed in SZSE is smaller than that in SSE. Apart from the Main Board, The Shenzhen Stock Exchange contains a Small and Medium Board and the ChiNext both of which aim at serving the capital need of the small and medium companies and those high growth enterprises.30 Insider trading in these two exchanges might be different since the companies listed in Shanghai Stock Exchange are more mature and have a relatively better corporate governance system, while the newly listed companies in Shenzhen Stock Exchange might lack of experience of competent corporate governance and have a weaker internal control system.

1.2.3 China Securities Regulatory Commission

The China Securities Regulatory Commission (CSRC) is mandated responsibility to supervise the securities markets by the Securities Law of People’s Republic of China. The two stock exchanges are directly subordinated to CSRC. Pursuant to the relevant laws and regulations, the CSRC generally have the power to 1) formulate policies and draft relevant laws and regulations on securities and futures markets; 2) exercise a vertical administration over the

26 Id. 27 Id. 28 See Shanghai Stock Exchange: Five Measures to Control InsiderDealing, (lasted accessed on 21 May 2013) available at http://english.sse.com.cn/aboutsse/news/c/28746.shtml 29 Id. 30 See SZSE, Products and Services, available at http://www.szse.cn/main/en/Products/Equity/Ashare/,(in Chinese, last accessed on May 21, 2013 )

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domestic security firms; 3) supervise the issuance, listing, trading, custody and settlement of securities; 4) supervise any misconduct by the market players.31 The CSRC has been experience several reforms during the past few years. To date, the commission consists of 18 departments, a general division of enforcement, 3 centers and a public offering review committee consisting of professionals and experts both inside and outside the commission. 36 regional bureaus have also been set up throughout the country, as well as 2 offices for securities regulation in Shanghai and Shenzhen.

1.3 The Characteristics of the Insider Trading in China

Before the non-tradable share reform which started from 2004,32 no insider trading cases had been enforced in China.33 Only since 2004 has the Public Safety Bureau started to prosecute illegal insider trading. Compared with 58 cases brought by the SEC against 131 individuals,34 there were only 11 cases brought by the CSRC during 2012. Although in recent years the number of enforcement brought by the CSRC has been ascended dramatically, it seems relatively small compared with its U.S. counterpart. The small number of the insider trading cases was due to the relatively loose enforcement environment.35 However, although the statistics of illegal insider trading provided by the authority seems relatively low, the actual number was by no means as low as they announced. This deduction could be proved both by the ascending number of insider trading enforcement later36 and the fact that many senior officers of the listed companies became extremely wealthy while the companies performed undesirably. The attitude of the society was impressively tolerant to the insider trading during this period.37 In Hui Huang’s research (2005), he interviewed securities lawyers, officers of some investment banks and the individual investors. One lawyer in interview responded that ‘it is essential to make quick profits to survive in the market. For quick profits, it appears necessary to possess inside information’, and another also relied that ‘it is almost impossible for

31 See CSRC, Introduction of CSRC, available at http://www.csrc.gov.cn/pub/csrc_en/about/who /intro/ (lasted accessed on 13 June 2013) 32 The non-tradable share system is unique in China and other socialism countries during its transitional period from a communist society to a market economy society. See Alice De Jonge, Corporate Governance and China's H-share Market, (Northampton: Edward Elgar Publishing, 2008), at 112. 33 The CSRC does not provide the data before 2007. It is hard for researcher to conduct empirical research without the related data which should be provided by the CSRC. In fact, although the Chinese criminal law has been stipulated provision to curb illegal insider trading, no cases had been really enforced by the authorities. 34 See SEC Enforcement Actions, Insider Trading Cases, available at http://www.sec.gov/spotlight/inside rtrading/cases.shtml (lasted accessed 12 June 2013) 35 See Hui Huang, International Securities Markets: Insider Trading Law in China, (Netherlands: Kluwer Law International, 2006), at 41. 36 After the CSRC made up its mind to against the insider trading, the number of insider trading raised dramatically with a growth rate around 30% to 40% from 2008 to 2011. See CSRC, The Next Step of the Implementation, available at http://www.csrc.gov.cn/pub/newsite/jcj/gzdt/201302/t20130222_221508.htm, (in Chinese, last accessed on 13 May 2013) 37 See Hui Huang, supra note 35.

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investors, especially large investors, to survive without doing misconduct.’38 In respects of the individual investors, they considered inside information as one of the key elements that could lead them to success. In another interview, one securities practitioner who was in possess of inside information was perplexed by his friends and relatives asking him for inside information.39 Hui Huang’s research showed not only the relevant professionals held a lenient attitude but also the ordinary individual investors were used to treat inside information as a quick approach to gain excessive interests. During 1990 to 2005, the insider trading cases had several salient characteristics in China. First, in most cases, the inside traders were generally the ones listed in the enumeration of the insider trading law, i.e. typical cases of insider trading conducted by the insiders and were not complicated as the tipee/tipper case.40 However, in U.S., the insider trading have been conducted more secretly and hence more complex. The major shareholders, the companies, the senior officers and the senior officers of the related companies were not involved in the cases directly but instead trade covertly by others to circumvent the suspicious link between him/her and the account holders. Since in China the insider trading regulations enforcement was not strict at all, Chinese insiders did not even need to borrow other people’s account to trade at this period. The second character was that insider usually not committed an independent illegal act but also conducted other illegal acts to facilitate their illegal insider trading. Hence, the inside traders not only breached the insider trading law, but also had other contraventions of obligations from other rules. For instances, the inside traders as the major shareholders did not disclose their proportion of the total shares, which breaches the requirement of major shareholder disclosure, or the employees of a private fund misappropriated the money from their client to serve for their own interest through insider trading.41 The third character was that the insider was not conducted illegal act individually and

38 Id., at 65. 39 Id., at 76. 40 In the amended Chinese Securities Law of 2005, the concept of insiders are enumerated in Article 74 which states that “Persons possessing inside information relating to securities trading include: (1) the directors, supervisors and senior managers of an issuer; (2) the shareholders holding 5% or more of the shares of a company and the directors, supervisors and senior managers of such shareholders, as well as the persons in practical control of a company and the directors, supervisors and senior managers of such persons; (3) a company held by an issuer and the directors, supervisors and senior officers of such company; (4) the persons with access to the relevant inside information by virtue of their positions in a company; (5) the staff members of the securities regulatory authorities and other persons who perform their statutory administrative duties in respect of the issuance and trading of securities; (6) the relevant staff members of the sponsors, securities companies engaged for underwriting, stock exchanges, securities registrar and clearance institutions and securities service institutions; and (7) such other persons as may be so prescribed by the securities regulatory authority under the State Council.” This list provides the prosecutors with a clear scope of the concept of insider and flexible criteria for enforcement. However, in practice it is not very adaptable in type of the tippee/tipper insider trading. 41 Decision of the China Securities Regulatory Commission on the punishment of the Shanghai branch of the Xiangfan Investment Company of Chinese Agricultural Bank for breaching the securitiesregulations (28 January 1994) See China Securities Regulatory Commission Official Bulletin,

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secretly, but with assistance from the institutions who were heavily involved within the insider trading. The institutions themselves also played a critical role in illegal insider trading. Among the early cases, there were 5 cases out of 9 which were conducted by the institutions, including the companies themselves and the institutional investors.42 Companies opened accounts of the individuals’ names and trade under those accounts. It was not uncommon that a company with advantageous information to trade its own stocks to earn excessive profit for itself, the company as the whole. However, since the listed companies in China seldom paid out dividend, the ultimate beneficiaries were not shareholders, but management of the companies. Once the companies got advantageous information, it might even release some opposite information in order to mislead other shareholders, creating a better transactional situation for themselves to conduct insider trading.43 This unique character was totally different from its American counterparts. The management was not afraid of the prosecution and private suit against its misbehavior because prosecution was rare and no private suit in terms of insider trading in China yet44 and usually they made the decision collectively to conduct illegal insider trading.45 Therefore, no particular person individually needed to be wholly responsible to the criminal act or administrative liability. The last distinguished character was that the securities firms were actively involved in insider trading. In 2007, 30% of their income of the securities firms was generated by their own investment in securities46. This created a high risk of conflict of interest regarding their role in the securities market. Moreover, since the securities firms had advanced experience in securities industry, they know much better than the ordinary insiders on how to circumvent the detection of the supervisors.

2. The Relations between the Features of Chinese Listed Companies and Insider Trading Empirical researches have already showed that ownership structure and board characteristics have a great influence on the corporate fraud in China.47 Hence, to better detect the insider trading and enforce insider trading laws, supervisors should concern the

42 Shanghai Stock Exchange and Shenzhen Securities Regulatory Bureau, A Study on Insider Trading Regulations Enforcement, (2010), in Chinese, available at http://www.sse.com.cn/researchpublications/j ointresearch/c/plan20110519l.pdf 43 Id, a typical case was the Southern Securities Firm Case, see the CSRC decision of the permanent market ban on Southern Securities Firm, in Chinese, available at http://www.csrc.gov.cn/pub/zjhpublic/G003 06212/200804/t20080418_14413.htm 44 To date, there is no private suit against insider trading because for some complicated reasons, class action on securities laws is still not allowed in China. 45 See Jess M. Fried, Insider Trading via the Corporation, available at SSRN 2122137 (2012). 46 See KPMG, Mainland China Securities Survey 2012, (2013), available at http://www.kpmg.com/CN/en /IssuesAndInsights/ArticlesPublications/Documents/China-Securities-Survey-201211-ec-v1.pdf 47 See Gongmeng Chen et al., Ownership structure, corporate governance, and fraud: Evidence from China, Journal of Corporate Finance, 12 (2006) ,424– 448

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characteristics of corporations, namely the ownership structure, board composition, internal risk control mechanism and other corporate governance related issues which may have a closed relationship with the insider trading. Better corporate governance could curb inside trading from the starting point and prevent an organized corporate act to conduct insider trading. It will reduce enforcement cost by eliminating the chance of illegal insider trading. If the corporate governance fails, or part of it which is relevant to monitor the behaviour of whom can access inside information fails, insider trading would occur easily. Therefore, even though enforcement is vital to curb illegal insider trading, an emphasis on internal control for reducing the corruptive and fraudulent act inside is also significant to make an enforcement system more efficiency. In this section, the ownership structure of Chinese listed companies will be discussed in the perspective of insider trading. The relationship between ownership structure and the occurrence of illegal insider trading will be probed into. By doing this, further suggestions could be made for the supervisor to better detect the potential illegal insider trading.

2.1 Ownership Structure and Insider Trading

The corporate ownership is of significantly importance for corporate affairs and the study of illegal insider trading. First, the harm of insider trading could be brought by some shareholders to other shareholders.48 To study how ownership structure influences the shareholder’s behaviour to trade with their advantageous information could assist supervisor understand better where the insider trading stems from and how supervisors should grant penalties and what supervisor should urge the company to conduct a reform. It could contribute to enhance the entire legal environment with a more efficient enforcement force and act as a complementary measure for analyzing illegal insider trading. Second, ownership structure contains some valuable information for the law enforcers to better observe the illegal insider trading and also assist the legislators to better understand the insider trading model and improve the efficacy of the insider trading law. Third, by empirically studying the ownership structure of the serious insider trading cases, we can propose recommendations for those companies with similar structure to avoid the reoccurrence of such case. In a prominent research conducted by Professor Morris, he found the ability of insiders to engage in uninhibited trading encourages concentrated ownership structure. He also found tougher insider trading laws are negatively and significantly relative to the degree of ownership concentration.49 It implies a more concentrated ownership would bring higher risk in respect of insider trading, which is consistent with agency theories. From Professor Morris’ implication, enforcement authority in fact should focus more on the companies which have a more concentrated ownership. If an authority whose securities market is packed with companies of a highly concentrated ownership structure wants to break this situation, the solution to breakthrough its present situation is a stricter insider trading

48 Although options can also be the subject of insider trading, trading on shares is still a major way of insider trading. 49 See Morris Richard D, Signalling, agency theory and accounting policy choice, Accounting and Business Research 18, No. 69 (1987): 47-56.

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enforcement on such concentrated ownership companies. This also implies the maturity of the securities market is highly interdependent on the insider trading enforcement. Hence, bearing this on mind, we first need to know what the general picture of the ownership structure of the Chinese listed companies is and analyze how the insider trading will develop. Generally, the Chinese listed companies have developed rapidly and the ownership structure has been changed dramatically during three decades economic reform.50 At the early stage of the Chinese securities market, the Shanghai and Shenzhen Stock Exchanges – had operated under the so-called split share structure (SSS) or the separation of equity ownership (SEO)51 that encompassed the coexistence of tradable and non-tradable shares.

Chart 2 Total Market Value and Tradable Value of Shanghai Stock Exchange

Total Value

300000 Tradable Value 250000

200000

150000

100000

50000

0

1996 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Shanghai Stock Exchange, Data available at http://www.sse.com.cn/market/dealingda ta/overview/stock/ashare/asharedeal_index.shtml

Normally, a Chinese listed company has a mixed ownership structure with shares held by the state, legal persons and domestic individuals. Each of the three predominant groups of shareholders holds about 30 per cent of total outstanding shares respectively and the remaining 10 per cent goes to foreigners and employee shares.52 Among these three groups, shares held by the state and legal person are non-tradable, which means that only one third of the shares could be traded freely in the securities market.53

50 See Mathew Tsamenyi, Shahzad Uddin, Corporate Governance in Less Developed and Emerging Economies, (Emerald Group Publishing Limited, 2008), at 194. 51 See Tzu-Yun Tseng, Will China’s Split Share Structure Reform Mitigate Agency Problems, The Chinese Economic Association, (2012). 52 See Chen Ding, Corporate Governance, Enforcement and Financial Development: The Chinese Experience (Edward Elgar Publishing, 2013), at 70. 53 According to CSRC, the 2008 China Capital Market Development Report, by the end of 2004, 64 per cent of the total 7149 billion shares were non-tradable, among which 74 per cent was state owned.

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State shares are held by representative departments of the state who are supervised by the government, while legal person shares are held by domestic institutions.54 A legal person is defined as a non-individual legal entity or institutions which include stock companies, non-bank financial institutions, and SOEs that have at least one non-state owner.55 Like shares owned by the state, legal person shares are not tradable neither. It would be a misunderstanding for people to simply equate legal person shareholders to institutional investor in free market economies. Apart from the feature that legal person shares are non-tradable, more importantly, legal persons that hold shares of the listed companies are often also SOEs and only few cases are private firms, which means they are ultimately controlled by the state. The similarity between legal person shares and state shares could be further seen from the fact that state-owned legal person shares (the official sub-classification of non-tradable shares of many listed firms) were considered to be a subset of state shares prior to 2003, but after that date were reclassified as legal person shares.56 As a result, a legal person shareholder should not be considered as an institutional investor since the motivation and objectives that they have might be different from the market players of private sector. This complicated situation was due mainly to the fear of the government to lose control of Chinese economy. If all the shares could be traded immediately, the government would lose control of the large number and important state-owned enterprises which s at that time played a key role in China’s economy.57 And it also worried that a fully liquidity of securities market would bring serious fraudulent matters.58 Since the free float was relatively small and large number of shares was strictly forbidden to trade in the market freely, for some “big fish” insider trading was not the primary approach for insiders to tunnel the illegal benefits from the companies to the insiders’ own pockets. Instead of relying on insider trading, parent firms and controllers tunnel the resources out of its subsidiaries by related party transaction.59

2.2 The Influence of Split Share Structure Reform in China

Although the non-tradable shares under the split share structure might disable insiders to trade shares at an unequal price, it could not prevent them from other tunneling methods as mentioned above. The split share structure reform aims at solving the serious problems that hindered the development of the Chinese capital market. Before the split share structure reform, the Chinese market faced with the following challenges. First, the limited free float made domestic market extremely illiquid, volatile and thus prone to market manipulation. Second, the corporate control market could not be created

54 See Chen Ding, supra note 52. 55 See Xu, Xiaonian, and Yan Wang. Ownership Structure and Corporate Governance in Chinese Stock Companies, China Economic Review 10, no. 1 (1999): 75-98. 56 See supra note 46. 57 See Ross Garnaut and Ligang Song, The Turning Point in China's Economic Development, (ANU E Press and Asia Pacific Press, 2006), at 72. 58 See Xiaobing Jin, Concerns on the Fraudulent Acts after Split Share Reform, Global Business 10, ( 2006) in Chinese, available at http://file.lw23.com/1/17/17d/17dd2b07-32ef-4f42-b5d7-590d01ce475e.pdf 59 See Tzu-Yun Tseng, Will China’s split share structure reform mitigate agency problems?,

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with limited tradable shares. Third, the inefficiency of the domestic capital market forced many valuable Chinese companies to seek capital overseas. This creates a vicious circle that domestic investors, who prevented invest in the best companies, were stuck with holdings the less performing local companies and the capital market become less attractive for both capital demanders and providers.60 Moreover, the fact that the shares held by state and legal persons could not trade on stock markets had not only induced high stock market distortion, but also had to some extent disallowed ordinary people to share the fruit of the development of Chinese economy. Furthermore, this unequal arrangement hindered the reform goals of the state-owned enterprise, among which were the higher productivity and competitiveness as well as an advanced degree of corporate governance.61 The split share structure reform is an important institutional change of Chinese capital market.62 As the plan set by the founder of China’s economic reform, the liquidity of securities market should be gradually enhanced and finally individuals could share the development of Chinese economy by holding the shares of the listed Chinese companies.63 To achieve this aim, the government and the CSRC proposed several reform schemes to solve the problems of non-tradable shares and emancipated them from the trading restrictions. Chinese government has tried to solve the problem of non-tradable shares on several occasions, particularly in 1999 and 2001. In the first attempt, the CSRC selected two companies for experiments. Non-tradable shares were sold their state shares to free market. The experiments were failed since within 15 days from the announcement of the transfer program the share price of the two companies fell about 40 percent. The second attempt failed as well in 2001 because the holders of the tradable shares against the proposal which envisaged an equal pricing for tradable and non-tradable shares. On April 29, 2005 the CSRC announced a new pilot program, inviting a first batch of four companies to transform non-tradable shares into tradable shares by compensating existing shareholders through various ways like bonus shares, cash, and options to comfort their discontent on different original price of the shares. The main difference from previous attempts is that the new reform invites non-tradable and tradable shareholders to bargain over the transfer of non-tradable shares. In June 2005, the CSRC initiated the second pilot the program involving 42 companies that worth 10% of overall stock market value.64 This program was successfully accomplished on August 19 and few days later the government issued guidelines to promote the reform of

60 See Beltratti, Andrea, and Bernardo Bortolotti, The Non-tradable Share Reform in The Chinese Stock Market, Fondazione Eni Enrico Mattei Note di Lavoro Series Index 15 (2006), available at http://pape rs.ssrn.com/sol3/papers.cfm?abstract_id=944412, also see United Nations, International Accounting and Reporting Issues: 2007 Review, (United Nations Publications, 2008), 61 See Annette Kleinbrod, The Chinese Capital Market: Performance, Parameters for Further Evolution, and implications for Development, (Springer, 2006), at 97. 62 See Mark Zhou, Education and Management: International Symposium, ISAEBD 2011. 63 See Hao Bing, Capital Market and the Development of Chinese Economic Society, in Chinese, available at http://www.csrc.gov.cn/pub/newsite/yjzx/zbscycx/yjbg/201303/t20130305_221873.htm. 64 See Xin Hua News, The CSRC Selected 42 Companies for Split Share Reform, (19 May 2005), available at http://news.xinhuanet.com/stock/2005-06/19/content_3106405.htm (lasted accessed 1 June 2013)

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the rest of companies. In order to encourage companies to implement the reform scheme, the CSRC indicated that reform-compliant companies would be given priority to raise new capital (Seasoned equity offerings and IPOs had been suspended since the launch of the first pilot program).65 The CSRC set the end of 2006 as the deadline of the accomplishment of the reform. At the end of April 2006, 868 listed companies had either completed their non-tradable shares reform, which constituted 70% of the total number of the listed companies.66 Currently, in the Shanghai Stock Exchange the free float consist of 80% of the total shares and in Shenzhen Stock Exchange the percentage of the free float is 68%.67 From perspective of the insider trading law enforcement, there are at least two implications on the success of the split share structure reform. First, since the previous non-tradable shares has become liquid in tandem with the accomplishment of the reform, the holders of previous non-tradable shares can trade their shares as well as other shareholder. And most holders of those shares are typical insiders, for instances, managers, majority shareholders and directors. This change might increase the risk of insider trading in the near future if the transparency of the market and the enforcement insider trading regulations were not improved. Second, the split share structure reform also brings the huge change on the ownership structure of the listed companies. The ownership of some listed companies become dispersed but still controlled by some relatively majority shareholders, which means before those shareholders owned higher than 50% and control the company, after reform they can still control the company with much less shareholding, for instance, less than 15%. This increases the chances of insider trading because of two reasons. First, the dispersed ownership structure discourages the monitoring of the misbehaviour of the majority shareholders and managers. Second, the relatively large shareholders can exert influence on the company more easily than before but also quit the company without too many difficulties since they hold less than 10 per cent of shares.

3. THE SUBSTANTIVE INSIDER TRADING LAWS IN CHINA AND THE U.S.

The securities laws of the U.S. have been a model for other countries’ legislation for nearly hundred of years. It is not exaggerating at all to say that the U.S. is the cradle of the

65 See Xinhua News, 7 times of Suspending IPOs in China, (11 April 2013 ), in Chinese, available at http://news.xinhuanet.com/fortune/2013-06/13/c_124847932.htm 66 See Xingting Jia, Corporate Governance and Resource Security in China: The Transformation of China’s Global Resources Companies, (Taylor& Francis, 2009), at 123. 67 See Shanghai Stock Exchange and Shenzhen Stock Exchange official website, http://www.sse.com.cn/, http://www.szse.cn/ (last accessed on 28 May, 2013)

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modern securities laws in the world.68 Viewed from the empirical studies,69 it has been proved that a good investor protection system with efforts of the administrative, the legislative and the court keeps the prosperity of the U.S. securities markets.70 Because of this reason, many emerging economies imitate the U.S. securities regulations, hoping to harness the latest experiences from the most advanced market without paying the cost for its own legislative experiments.71 China is not an exception and has become indulge of learning from the U.S. experience from the early stage of its establishment of modern securities market. In respect of the insider trading regulations, the U.S. regulations are among the strictest in the world, in terms of both the legislation and the enforcement.72 The theories why insider trading should be forbidden have been well discussed among the economists and legal scholars in the U.S.73 Moreover, the theories of insider trading laws in the U.S. has also developed more comprehensive and seems protect investors better than other countries.74 Therefore, in this section in order to understand why enforcement quality in China better, I first briefly review the theories of insider trading laws adopted by the U.S., and then analyze the model deployed by the Chinese authority and how Chinese regulations similar to U.S.

3.1 The U.S. Insider Trading Law Theories In the U.S., although legal liability for insider trading is built upon on the federal securities regulation statutes, most notably the Rule 10b-5 under the Securities Exchange Act of 1934, the prohibition of insider trading exists and developed almost independently of the relevant statutes.75 Instead, as Bainbridge said, “the laws of insider trading have evolved through a number of judicial opinions in a process of assembling the common law adjudication rather than statutory interpretation and promulgation.”76 The formal prohibition of insider trading is only about three decades old; however, it has already seen more shifts in doctrine than most securities law rules have seen in the last

68 See Gerry Ferguson, Asia-Pacific Legal Developmen, (UBC Press, Jan 1, 2011), at 29. 69 See Richard A. Debs, The Development of International Equity Markets, 4 B.U. INT'L L.J. 5, 6 (1986). Also see James R. Doty, The Role of the Securities and Exchange Commission in an Internationalized Marketplace, 60 FORDHAM L. Rev., S77, S77 (1992). 70 See La Porta Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny. Investor protection and Corporate Governance, Journal of Financial Economics 58, No. 1 (2000): 3-27. 71 See Kehoe, James A. "Exporting Insider Trading Laws: The Enforcement of US Insider Trading Laws Internationally." Emory Int'l L. Rev. 9 (1995): 345. 72 See Paul G. Mahoney, Securities Regulation by Enforcement: An International Perspective, 7 YALE J. ON REG. 305, 307 (1990). 73 See Beny, Laura Nyantung. Do Insider Trading Laws Matter? Some Preliminary Comparative Evidence. American Law and Economics Review 7, No. 1 (2005): 144-183. Also see Beny, Laura Nyantung, Insider Trading Laws and Stock Markets Around the World: An Empirical Contribution to the Theoretical Law and Economics Debate, Journal of Corporate Law 32 (2006): 237, and Fernandes, Nuno, and Miguel A. Ferreira, Insider Trading Laws and Stock Price Informativeness, Review of Financial Studies 22, No. 5 (2009): 1845-1887 74 See La Porta Rafael supra note 70. 75 See Bainbridge Stephen, An Overview of US Insider Trading Law: Lessons for the EU?, (2005), available at http://ssrn.com/abstract=654703. 76 Id.

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century.77 Prior to the passage of the securities laws, the principal legal remedies for insider trading were based on the common law fraud.78 After the promulgation of Exchange Act of 1934, three major theories have been developed by local courts, the Circuit Courts and the Supreme Court, namely the equal access theory, the fiduciary duty theory and the misappropriation theory which derived from the fiduciary duty theory. Although the theories themselves developed independently from the statutes to meet the need of curbing illegal insider trading, still all of these theories have to be explained or supported by the so-called “catch-all” antifraud provision, the section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

Section 10(b) provides:

“[I]t shall be unlawful for any person, directly or indirectly by the use of any means or instrumentality of interstate commerce or of the mails, or of any national securities exchange: ... (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”79

And Rule 10b-5, promulgated by SEC under Section 10(b), makes it unlawful if:

“[A]ny person, directly or indirectly, by the use of any instrumentality of interstate commerce ... to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the sale or purchase of any security.”80

Initially, neither Section 10(b) nor Rule 10b-5 themselves on their face prohibit (or even speak to) insider trading. Instead, the initial Rule 10b-5 cases were limited to face-to-face and/or control transactions.81 Not until 1961 did the SEC finally conclude that insider trading on an impersonal stock exchange violated Rule 10b-5. It can be said “that the modern prohibition is a creature of SEC administrative actions and judicial opinions, only loosely tied to the statutory language and its legislative history.”82

77 Id. 78 See Strong v. Repide 213 U.S. 419 (1909). 79 See Securities Exchange Act of 1934 Section 10(b). 80 See 17 C.F.R. 240.10b-5. 81 See e.g., Speed v. Transamerica Corp., 99 F. Supp. 808 (D. Del. 1951) (Omissions in connection with what amounted to tender offer). 82 See Stephen M. Bainbridge, The Law and Economics of Insider Trading: A Comprehensive Primer, Working Paper Serious of UCLA, available at http://ssrn.com/abstract=261277

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3.1.1 “Equal access” Theory The early theory on illegal insider trading developed in the U.S. is the so-called “equal access” theory which the SEC emphasized the fairness of accessibility of information for all investors in the market. It is originated from Cady, Roberts & Co’, the first case that the SEC advanced its insider trading theory in its administrative proceedings against securities professionals who had access to insider information.83 The SEC contented that “a corporate insider must disclose all material nonpublic information known to him before trading, or if disclosure is improper or impracticable, abstain from trading.”84 This theory is also called the “disclose or abstain rule”. By disclosing the information held by the insiders or abstaining from the dealing, the counterparties in the transactions will not face an unfair situation and this will ensure confidence of market players. In Texas Gulf Sulphur,85 the theory was further explained. It was said that the essence of the theory was to preclude the holders of advantageous information from gaining excess profits by ‘embezzling’ the information which intents to be available only for a corporate purpose but not for personal interests.86 It also implied that all the investors should bear the same market risks and anyone relied on the inside information to escape the market risk is unjustifiable, taking advantage of uninformed other investors. Accordingly, under the principle set up by Texa Gulf Sulphur, if the would-be trader’s fiduciary duties precluded him from disclosing such information, abstention from trading was his only option.87 One crucial point in Texas Gulf Sulphur is that the scope of insider does not only include corporate insider but also other persons who get access to the material information of the corporation. The “equal access” focuses on the equality of the traders’ informational status, however, it neglects the foundation of disclose or abstain, namely the duty conferred to the insiders. The skepticism on this theory finally made the Supreme Court to reject the “equal access” theory in Chiarella v. US. The court reclaimed the opinion that in the common law, a person could be only imposed liability if he or she was subject to a duty. In insider trading cases, the requisite duty to disclose information or abstain from trading should arise out of a special relationship between the inside trader and the person with whom he/she trades. The fact that merely possessing confidential material information does not absolute confer holders of such information a fiduciary duty to obey the “equal access” theory. The rejection of the “equal access theory” seems to create a loophole for such person “unethically” get access to inside information but without owning any duty to his counterparty. It cannot forbid unfair trade well if a person does not have any relationship with the company and his counterpart in the trade. Therefore, shortly after the Chiarella decision, in order to curb the insider trading in the context of tender offers, the SEC promulgated Rule

83 See Stephen J. Choi and A. C. Pritchard, Securities Regulation: Cases and Analysis Third Edition, (Foundation Press, 2013), at 344. 84 See Cady, Roberts & Co., 40 S.E.C.907, 912 (1961). 85 See SEC v. Texas Gulf Sulphur, 401 F.2d 833 (2d Cir. 1968), cert. denied 394 U.S. 976 (1969). 86 See Stephen J. Choi et al., at 338. 87 See Stephen M. Bainbridge, Insider Trading: An Overview, Working Paper Serious of UCLA, available at http://ssrn.com/abstract=132529.

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14e-3 to restrict the use of confidential, material information relating to the offer. 88

3.1.2 Fiduciary Duty and Tipping Liability After the Supreme Court rejected the “equal access” theory, insider trading prohibition might be limited to a narrow scope even though the SEC promptly promulgated Rule 14e-3. Unlike insiders who have independent fiduciary duties to both the corporation and its shareholders, the typical tippee has no such relationships.89 Anyone other than the classical insiders, such as the directors, managers and large shareholders is hard to say that he or she owe the duty to disclose information prior to his trades or abstain from trading according to the existed theories. This called the need of establishing the duty for the tippee under the fiduciary theory. As mentioned 3.1.1, the Supreme Court rejected the “equal access” theory, since the court believed that to condemn a party conducting insider trading, it has to prove “a duty [of that party] to disclose arises from the relationship between parties…and not merely from one’s ability to acquire information because of his position in the market.”90 One justification for the judgment is that the court believe by strictly implement the “equal access” theory, the market efficiency might be detrimental in the end since the corporate value discovery process in the modern securities markets is heavily relied on the industrial analyzers who, by their study or inquiry on the corporations, hold advantageous information than the ordinary shareholders. Therefore, to make a tippee liable for his/her insider trading, certain duties, other than mere possessing information, have to be found. For instance, such duty might derive from the process of unlawful gaining the confidential material information which he/she relied on for his/her unfair dealings.91 Dirks v. SEC92came to answer the above questions. The Supreme Court explained the application of the tippee liability under the fiduciary duty framework, holding that a tippee’s liability was derivative of that of the tipper, “arising from[the tippee’s] role as a participant after the fact in the insider’s breach of a fiduciary duty.”93 A tippee therefore can be held liable when the tippee received the nonpublic information from the tippers who breached

88 See Sechistorical.org, Fair To All People: The SEC and the Regulation of Insider Trading (“Rule 14e-3 prohibits insiders of the bidder and the target from divulging confidential information about a tender offer, exactly the kind of tippee information the Supreme Court in Chiarella had found not to be a Rule 10b-5 violation. In addition, Rule14e-3, with narrow exceptions, prohibits any person who possesses material information relating to a tender offer by another person from trading in target company securities if the bidder has commenced to taken substantial steps towards commencement of the bid.”) available at http:/ /www.sechistorical.org/museum/galleries/it/resilience_a.php 89 See Stephen J. Choi et al., supra note at 354 90 See Chiarella v. United States, 445 US 222 (1980). 91 In Chiarella, The court said “We cannot affirm petitioner’s conviction without recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information. Formulation of such a broad duty, which departs radically from the established doctrine that duty arises from a specific relationship between two parties, should not be undertaken absent some explicit evidence of congressional intent.” See Chiarella v. United States, 445 US 222 (1980). 92 See Dirks v. SEC, 463 US 646 - 1983 93 Id.

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his/her fiduciary duty to do so. When the tippee knows or should know of the breach of duty and trade with such information he gained from the tipper, he or she would be held liable of insider trading. What Dirks proscribes thus is not merely a breach of confidentiality by the insider, but rather the breach of a fiduciary duty of loyalty to refrain from profiting on information entrusted to the tipper.

3.1.3 Misappropriation Theory The Supreme Court did not resolve the same question posed by Chiarella in Dirk v. SEC; namely, to what extent the insider trading prohibition should be applied where the defendant traded on the basis of material nonpublic information generated outside the traded firm.94 There are many other sources other than the issuers, where the misappropriators could get from. Certainly, a wide range of such traders banned from trading is impracticable since a large number of traders, mostly the analyzers, who hold with advantageous information by their analysis and research, will be considered as illegal insider trading. If they were held unlawful, the securities markets would lose a force which can adjust the stock prices to a more accurate level. Furthermore, it will also discourage people who are willing to do research for discovering the unreasonable stock prices. It is understandable that the advantages created by skill or effect should not be deemed as “unfair”. Hence, in US v. O’Hagan,95 the Supreme Court adopted the misappropriation theory as an alternative basis for insider trading liability. Accordingly, if a fiduciary use the information belonging to his principal, without disclosure of such use to the principal, for his or her personal interest, his or her trading would constitute fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5.

3.2 The Theory Adopted by China’s Insider Trading Law

3.2.1 Brief Legislative History of Insider Trading Regulation in China With the foreign experiences, in a relatively short period of time, Chinese regulators have made a remarkable achievement in setting up a modern securities law regime.96 In respect of the insider trading, the Chinese government was without any hesitate to ban it as an illegal act at the beginning of the establishment of its securities market. After that it has been active on transplanting insider trading regulations from the developed jurisdictions mainly from the U.S and also from Australia and Hong Kong. Insider trading prohibition was first stipulated in the Provisional Measures for Regulating Securities Companies (1990). 97 Later in April 1993, another Provisional Regulations on the Administration of Stock Issuance and Trading which related to insider trading issued and afterwards the CSRC promulgated a more specified provision, the

94 See Bainbridge Stephen, supra note 75. 95 See United States v. O’Hagan, 521 US 642 (1997). 96 See Hui Huang, The Regulation of Insider Trading in China: A Critical Review and Proposals for Reform, Australian Journal of Corporate Law, Vol. 17, 281-322, (2005) 97 See The Provisional Measures for Regulating Securities Companies (in Chinese: Zhenquan Gongsi Guanli Zanxing Banfa), Promulgated in October 1990, P.R.C.

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Provisional Measures for the Prohibition of Securities Fraud in September 1993, which was focused on typical securities fraud in China, including prohibition of insider trading.98 In October 1997, six years after China started its securities markets, insider trading was added into the Criminal Law by the National Congress of People’s Republic of China. Unfortunately, the then promulgated criminal provisions did not specify the required constituencies of illegal insider trading, but instead it stated that this crime had to refer to other laws and regulations with respect to insider trading.99 Finally, until July 1999, illegal insider trading act has its final specified definition which stipulated in the Securities Law of the People’s Republic of China (Securities Law).100 With five detailed articles pertinent to insider trading, the Securities Law stipulates the elements of illegal insider trading exhaustively. Although the enforcement efficacy at the first few years was far from the expectation, the promulgation of the Securities Law demonstrated the attitude of the authority to against illegal insider trading and paved its way for practical enforcement by the administrative.

3.2.2 The Theory behind the China’s Insider Trading Regulations Although the transplantation of regulation from an advanced jurisdiction does save some resource of researching the similar issue, reduce the cost of doing experiments domestically and legislate law efficiently, some defects will occur if the transplantation did not fit to the local environment and worse even legislators misunderstand the original thought from their parent jurisdictions. Since the Chinese regulators were too harsh to assimilate the U.S. regulations into Chinese law, eventually the theories behind the regulations seem not congruent and even to some extent conflict with each other. Article 73 requires generally that “Persons with insider information on securities trading are prohibited to take advantage of such insider information to engage in securities trading.”101 This article literally means that no person should be allowed to trade with advantageous information which suggests that equal access theory is adopted as theoretical support for the promulgation of this article. However, the Chinese regulator also denotes the scope of the insider by enumerating the genres of persons, hoping to clearly provide an easily applicable instruction for practice. The list provided covers directors, supervisory directors, senior managers, shareholders with more than 5% of total issued shares, the controllers of the corporation and any corporate employees who are capable to gain information due to their position. Apart from the corporate insiders, underwriters, accountants, consultants, lawyers are also recognized as the “constructive insiders”, being prohibited from trading with their advantageous information.

98 See Provisional Measures for the Prohibition of Securities Fraud, 2 September 1993, P.R.C. (Provisional Measures (in Chinese: Jinzhi Zhengquan Qizha Xingwei Zanxing Banfa) 99 See Criminal Law of People’s Republic of China Article 180. 100 See Securities Law of People’s Republic of China Article 73~80. 101 See Securities Law of People’s Republic of China, Article 73 (revised in 2005)

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4. THE ENFORCEMENT MECHANISMS IN CHINA AND THE U.S

In recent years, the number of insider trading cases grows in the U.S. and in China as well.102 Both of the countries pay a great attention to improve their insider trading law enforcement. The Chinese authority has added the enforcement regulations103 several times and announced on its official website that the insider trading was the main focus in the next few years.104 Compared with the past practice of the CSRC in implementing insider trading regulations, China to some extent has made a great progress. There were only 20 administrative sanctions in 2002, including cases on insider trading, market manipulation, inappropriate disclosure, short-wind transactions and other violations. Although still undesirable, the situation becomes much better than few years ago. The number of insider trading cases in the past was relatively small and it revealed that in China most cases violated securities regulations actually were not prosecuted.

4.1 Comparison of Two Countries’ Administrative Investigation

Both China and the U.S have endowed their administrative departments with relatively strong power than other departments of the government to conduct investigation into the suspected violation of the securities laws. An efficient investigation which collects and assembles evidences of facts and alleged violations is a necessary preparation for the following enforcement brought by the administrative. In this subsection, I compare the differences of investigatory powers of the administrative in China and the U.S. By comparing their differences, I conclude what Chinese regulators could do something to enhance its investigatory procedure.

4.1.1 Triggers of Investigation In U.S., the investigation is conducted by the Securities and Exchange Commission, which is endowed with extensive investigatory powers under the federal securities laws.105 The powers of SEC are exercised by the attorneys, accountants, and other professionals who constitute the Commission’s enforcement staff, most of whom work in the Division of Enforcement. The triggers of investigations are multiple. Normally, they are: staff reviews of SEC filings; news stories; periodic inspection of broker-dealers, investment adviser, and investment companies; public complaint; and regular market surveillance by SEC, and also

102 Over the last three years, the SEC has filed more insider trading actions (168 totally) than in any three-year period in the agency's history. During 2008 to 2010, the Chinese authority had investigated 590 cases which constituted 40% of the cases being investigated. 103 See 3.2.1. 104 See the CSRC, The CSRC Strengthens Enforcement Monitoring and Early Warning Mechanism Building, (12 April 2013), available at http://www.csrc.gov.cn/pub/csrc_en/newsfacts/release/201304/t20130426_2276 91.htm 105 See, eg., Section 21(a) of the Securities Exchange Act of 1934, and sections 20(a) and 19(b) of the Securities Act of 1933

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the “whistleblowers”, i.e. the employees within the companies. 106 If the Division of Enforcement believes that the information indicates violation of securities laws, then the Division of Enforcement will open an investigation procedure. In the U.S there are multiple sources provided clues of insider trading, each source makes a great contribution to discover insider trading. The advanced technologies are deployed to monitor abnormal stock price changes by stock exchange, for instance, the system NASDAQ relied on called SONAR.107 Monitor systems in the stock exchange play a crucial role on detection of the illicit transactions, but apart from it other sources are also contributive to alert the monitors. For instance, tips by internal whistleblowers have prompted many investigations in the U.S.,108 but in China, the number of cases triggered by the whistleblowers is relative small. The Chinese authority heavily relies on the surveillance software system which operated by the Shanghai Stock Exchange and the Shenzhen Stock Exchange. These two stock exchanges imported the advanced surveillance system from the U.S. which can monitor the abnormal price fluctuations and transaction volume since 2000.109 Since the CSRC only relied on this mechanism, the efficiency of illegal insider trading detection is questionable. First, although in recent year the Chinese securities market has developed in an amazing pace, it is unwise to say the Chinese securities market is as efficient as the markets in the U.S. and other developed countries. The efficiency of the market might not well reflect all the price related information through the price. Particularly, the price might not so sensitive to an illicit insider trading at a medium size. Second, the Chinese market has its unique features and among which is that the short-term transactions overflow the securities market. In fact, the so-called “noise transactions” are very popular in the Chinese securities market. It is not uncommon that investors make transactions frequently in a large volume. Hence, the current detection mechanism does discover some significantly serious cases, but it may be unable to catch those who deserve a liability while the insider trading is in a relative small scale.110 Viewed from this perspective, the inefficient efficacy of the monitor system in China might not able to impose the deterrence to some cunning and sophisticate investors. It is not difficult for them to circumvent the electronic detective mechanism. From the above analysis, it is crucial for the CSRC to increase its sources of information on insider trading. Like in the U.S., the CSRC could encourage the whistleblowers to inform the authority with a reward, keep their identities secretly and take other measures to protect

106 See Alan R. Palmiter, Securities Regulation 5ed., (Wolters Kluwer Law&Business, 2011), at 18. 107 See PR Newswire, Monitoring NASDAQ for Potential Insider Trading and Fraud: Artificial Intelligence Used for Market Surveillance (Sept. 17, 2003), available at http://www.aaai.org/Pressroom/Releases/releas e-03-0917.php. 108 Orrick, Herrington & Stcliffe LLP, SEC Investigations and Enforcement Actions: A Practical Handbook for Municipal Securities Issuers, (2011). 109 SZSE, Multi-Supervisory Mechanism to Curb Insider trading, (14 June 2010) available at http://www .szse.cn/main/investor/fxjy/39743144.shtml (last accessed on 1 June 2013) 110 The remarks here actually are in conflict with the later research I have done. Viewed from the empirical data, actually, the cases enforced by the CSRC involved a relative small amount of money compared with its U.S. counterpart. This may against the remarks here, but in fact explanation can be given that the CSRC staff might not want to fulfill its function fully to enforce those cases involved with high rank officers and high-profile businessmen in the current Chinese social environment.

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them from the retaliation.

4.1.2 Informal Investigation and Formal Investigation

There are two types of investigations conducted by the SEC, namely formal investigation and informal investigation. In the stage of informal investigation, SEC staff has not yet sought the authority to issue subpoenas for compelling documents and testimony111 and there is no mandatory obligation to cooperate with the SEC. However, anyone who is inquired to answer questions should not provide false information, because such behaviors will be considered as a criminal act.112 During informal investigation, the Staff can request documents which they need to analyze the case, interviews or other information from regulated persons are requested usually. Although in this stage the corporation is voluntary to provide the documents, as a practical matter, regulated persons seldom refuse to “volunteer” such information.113 The suspected subjects are usually willing to cooperate with the SEC staff because they do not want to trigger the formal investigation and bring higher authority concern on their case. The informal investigation allows the Staff to make a deliberate consideration on whether to further the procedure based on the rudimentary evidences. The Staff needs to hand in a short memorandum with enough reasons to the Commission explaining why they believes that an formal order is needed and formal investigation is needed.114 Then the memorandum will be reviewed and approved by senior official within the Division of Enforcement. If later the senior officials approve it, it will be transmitted to the members of the Commission and also other offices within the Commission.115 The benefits of an informal investigation are manifest. First, during the investigation, it can be more flexible regarding the investigatory scope and time. Moreover, it is easier to come to a close of an investigation if the primary evidences show that the triggers of the suspicious insider trading are not based on the facts. Compared with closing a formal investigation, closing an informal investigation involves less scrutiny by senior officials and less extensive justification.116 This procedure arrangement encourages the staff to initiate an investigation and make an appropriate consideration to get the formal order. With this arrangement, it reduces the cost and chance of starting an inappropriate case and ensures that the innocent companies will not be disturbed by the investigatory actions by the staff. After informal investigation, if the evidences suggest further information is needed, the SEC will issue a formal order of investigation outlining the scope of inquiry in its name.117 Then the informal investigation will be escalated into a formal investigation and as soon as it

111 See Orrick, Herrington & Stcliffe LLP, supra note 108. 112 18 U.S.C. §1001 113 See Richard M. Phillips, The Securities Enforcement Manual: Tactics and Strategies, (American Bar Association, 2007), at 46. 114 See Orrick, Herrington & Stcliffe LLP, supra note, at 47. 115 Id. 116 Id. 117 Id.

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becomes formal, the SEC staff could issue subpoenas nationwide against any person who hold information related to the suspected insider trading. A usual practice during formal investigation in the U.S. is to issue a “Wells notice” by the Commission which invites persons involved in an investigation to present a “wells submission.”118 It is a statement which sets forth the interests and positions of the person who is being under the procedure of the investigation. The objective of the “Wells notice” is, stated in the Wells Release, “… not only to be informed of the findings made by its staff but also, where practicable and appropriate, to have before it the position of persons under investigation at the time it is asked to consider enforcement action.”119 Normally, most potential respondents and defendant will cooperate with the Commission and submit the “Wells submission”, hoping the Staff and the Commission to consider their situation carefully. It is possible that the Staff will alter its recommendations to the Commission, reducing the severity of the proposed action and exempt certain person from liability. Another noticeable feature of the SEC investigation is that normally the proceedings are conducted privately in order to avoid unwarranted injury to the reputations of the companies and persons being investigated. This is fair to some innocent subjects and would not disrupt the operation and share prices of the companies being investigated. From 2006, the CSRC started to use informal investigation to investigate the cases and gradually make the informal investigation as the major approach to replace formal investigation.120 However, unlike the distinguished features between informal and formal investigation, for instances, as the “voluntary response” and “limited power” we discussed in the U.S. informal investigation, the CSCR does not make any significant difference between the formal and informal investigation. In the informal investigation, the CSRC staff could use any measure as in formal investigation, and the only difference is in informal investigation the cases are not required to precede the review by the CSRC Enforcement Division.121 Another defect of the investigation conducted by the CSRC is that before it closes or goes further to the administrative proceedings, the information about the ongoing investigation leaks. This leads a worse volatility of the share price of the targeted companies.122

4.2 Comparison of Two Countries’ Administrative Enforcement After completing its investigation (whether formal or informal), the SEC faces a number of options. The SEC can simply terminate the investigation. The SEC may also, in the case of

118 Actually, the Wells submission practice is a practice or custom that is not required under law. 119 See Securities Act of 1933 (“Securities Act”) Release No. 5310, “Procedures Relating to the Commencement of Enforcement Proceedings and Termination of Staff Investigations.” 120 Shanghai Stock Exchange, Insider Trading Regulations Enforcement Research( No.21 Research Project), (in Chinese, May 2001), available at http://www.sse.com.cn/researchpublications/jointresearch/c/pla n20110519l.pdf 121 Id. 122 Id.

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a possible criminal violation, refer the investigation to the U.S. Department of Justice to commence criminal prosecution. The SEC may also choose to commence a civil enforcement where the SEC brings formal charges against the targets of investigation. Regarding to the civil enforcement, the Commission must authorize the initiation of enforcement proceedings with a majority vote.123 The U.S. Congress has authorized the SEC a wide variety of administrative power to enforce the insider trading regulations.124 First, the SEC can issue a temporary or permanent administrative cease-and-desis order against any person who violates the federal securities laws or a participant knowingly contributes to the violation. Second, the SEC can also impose monetary penalties against persons who are associated with regulated entities, for instances, broker-dealers, investment advisers, investment companies and etc. Third, the SEC can issue a temporary suspension or permanent bar order to individuals or firms from participating securities business. Forth, an accounting for and disgorgement of any profit made from certain violations of securities laws are usually employed by the SEC as well. Fifth, the SEC can, through administrative disciplinary proceedings, bar a firm from acting as a securities firm or an investment adviser, bar an individual from associating with any securities firm or investment adviser, or bar a professional from practice before the SEC.125

Table 2 SEC Sanctioning Powers

Section proceeding Sanction 21C Cease-and-desist -Temporary orders -Cease-and-desist order from violating securities laws -Disgorgement -Civil penalties -Officer and Director bar from public companies 12(j)&(k) Trading suspensions -Halt trading for ten days or indefinitely Source: Securities Exchange Act of 1934 Section 21C, Section 12(j), 12(k)

Although in China the government or the administrative branch is powerful, the power of the CSRC is not the case. The CSRC has a more limited power than its American counterpart regarding punishing illegal insider trading. Unlike the SEC, the CSRC can only bring the administrative proceedings; no civil penalties can be imposed. Since there are no civil penalties the deterrence function can only heavily relies on administrative liability and criminal liability. Criminal liability is serious and useful for deterrence. However, in the criminal

123 See Richard M. Phillips, supra note 113, at 184. 124 See Securities Exchange Act of 1934 Section 21C, Section 12(j), 12(k) 125 See Richard M. Phillips, supra note 113, at 183.

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procedure, the burden of proof is “beyond a reasonable doubt”.126 Since in tippee/tipper cases it is normally hard to prove the linkage between the tippers and tippee, criminal liability is not easy to establish if evidences of the linkage are not very convincing. If no criminal liability could be established, the authority could only rely on the current administrative penalty. According to the Article 202 and Article 233 of the Securities Law of PRC,127 the CSRC has the power to fine and forbid the violator entering into the securities markets. The highest fine the SEC could impose is five times of the illegal earnings. Besides, a measure of permanently forbid violators participate in securities market is available for the CSRC. These measures deem to be effective, from 2004 to today, few individuals had been punished with serious penalties and permanent banned order.128 For nearly 9 years, only 124 decisions of banning a violator entering into securities market, which is averagely less than 13 cases per year.129 The current system does allow the CSRC to fine the violators with an administrative penalty, and the CSRC has a highly free discretion to apply this measure. But a transparent guideline is not available and it’s unclear how the CSRC makes decisions and why the penalties had been insignificant compared that in the U.S.130 The following discussion will focus on the cases which conducted by the CSRC during the year of 2010 and 2012. From around 2007, the CSRC has been under the pressure of implementing the insider trading regulations. As we analyzed in the first section, the number of cases increased dramatically accompanied with this pressure and other relevant influenced factors. However, the increasing number of enforced cases does not mean anything if the enforcement quality is low and no deterrence generates. Hence, I choose 10 typical cases closed in 2010 which took place between 2008 and 2009 for detailed analysis.

126 See David C. Brody, James R. Acker, Criminal Law,(John and Bartlett Publishers, 2010),at 22. 127 See the Securities Law of PRC Article 202 (in Chinese),(“…the illegal earnings are to be confiscated, and they are to be fined for an amount between one and five times their illegal earnings or an amount not more than the value of the said securities of the illegal transaction”) 128 The data I relied on starts from June 2004 to 14 June 2013. Source: www.csrc.gov.cn 129 Id. 130 See Table 3, Enforcement cases in 2010, fines seems not to be so deterrent.

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Table 3 10 Typical Cases Enforced by the CSRC in 2010

No. Stock Type of Inside Profit or Proceeding Decision Name Insider Information Loss Time (in RMB) 2010(2) Sichuang Director& Interest 141955.80 2 years and 3 years Shenda CEO distribution, 11 months injunction; Limited. Interim Disgorgement Report Fine: 170346.95 2010(16) Dacheng Director Corporate 770,000 2 years and Fine: 50,000; Limited. restructuring 9 months (the defendant handed in the illicit gain) 2010(18) S*ST Director, Debt 98,632 2 years and Fine: 98632.32 Guangmin his wife, restructuring 5 months totally; g Vice Disgorgement CEO( the director’s sister) 2010(23) Shentianji CEO& Temporary 2964.80 2 years and Fine: 80,000 anLimited Director Report 5 months 2010(29) Yue Fuhua Vice CEO Interest 118,204 3 years and Disgorgement: Limited distribution 2 months 2010(32) Haixin Outsider Back door 112346.26 2 years and Fine on Tipper: Tech. listing 2 months 30,000; Limited Disgorgement Fine on Outsider: 112346.26 2010(40) ST XinYe Chair Corporate -2,086,747.96 2 years and Fine on the Limited Director Restructuring 3 months affiliate of the company: Affiliate 500,000 Company 2010(44) S*ST Vice Back door Shares had 4 years 5 years Jiqing president listing been not sold. injunction, of the Disgorgement; back door Fine 600,000 listing company

2010(53) Xintai Independ- Share 5039 4 years Fine: 35,000 Tech ent transaction director and his wife Source: China Securities Regulatory Commission, available at www.CSRC.gov.cn

From this table, we can learn a significant difference between the cases enforced by the SEC and those by CSRC. The amounts of insider trading profit are relatively small in China, compared with that in the U.S. It is normal that an insider trading case involves more than one

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million dollars in the U.S.131 The average illegal profit made in these 10 cases is RMB -170,067 since there is a case which the insider lost RMB 2,086,747.96 in their insider trading. If we remove this abnormal case, the average profit is still not high, only RMB 156,142. If remove the two highest profits, the average number will be much smaller, i.e. less than RMB 10,000. Moreover, compared the duration of the investigation conducted by two countries, the CSRC still need to make a progress. In the Xintai Tech. Case, the CSRC spent four years to conduct the investigation and then finally found the profit made by insider trading was RMB 5039.00. Among these cases, the number of tipee/tipper cases is not large and most of them were conducted by the traditional insiders, namely the senior officers or directors of the traded companies. From the prospective of insider trading profit and duration of the investigation, it is hard to make a conclusion that the insider trading enforcement in China is efficient and has competence to deter the illegal act for excess profit.

Table 4 Administrative Penalties Decisions made in 2012

No. Stock Type of Profit or loss Proceeding Decision Name Information avoided (in RMB) Time 2012(19) ST Huang Contract 1,390,308.65 1 year and 4 Disgorgement Tai months Fine: 60,000 Limited individually, 1440308.65 from the corporation 2012(23) Caihong Contract -4,765,612.09 1 year and 6 Disgorgement if Jinghua month profit exists. Limited Fine 600,000 2012(24) NingXian Reorganiza- 134,773.84 1 year and Disgorgement g Limited tion 10months Fine:1,050,000 totally 2012(31) Jiajing Contract 938,806.39 2 years Disgorgement, Limited Fine:1,000,000. 2012(37) Fushang Investment Zhuang Jiangyi: 3 years Disgorgement; Zhaoming Project 148,426.40 Fine Limited Zhang Mingzhi: Zhuang 9,622.54 Jianyi:200,000 Wang Jianghui: Zhou 62,286.18 Jiangping(tippee) Gao Jing Hua: : 100,000 3,572.76 Wang, Zhang: Zhou Xinfu: 50,000 23,726.06 Gao, Zhou: 30,000 2012(46) Hengtian Trust 15,695.62 1 year and 3 Disgorgement Group Operation months Fine:50,000 Limited

131 See SEC v. Longoria,et al., S.D.N.Y.2011, and SEC v. Li, et al.,D. Ariz. 2011

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2012(49) Yantai Dividen 19,498.93 9 months Disgorgement Longyuan Distribution Fine:50,000 Limited No. Stock Types of Profit or loss Proceeding Decision Names Information avoided (in RMB) Time 2012(51) Jingli Aquisition Xiong Zhaoyong: 1 year and 3 Disgeorgement Tech. 40,957 months Xiong Zhaoyong: Limited 40,957Zeng Zeng Junshen: Junshen: 84,243 84,243 Lin Xibin: 50,000 2012(52) Taiyuan Private 5,942.33 2 years and 4 Fine: 36,000 Tianlong Offering months Limited 2012(54) Shengli Investment - 13,654.67 2 years and Fine: 30,000 Group 11 months Limited

2012(55) Zhonghen Contract Li Lingjie: 2 years Disgorgement; g Group 149,345.05 Fine: Limited Tang Binghui: Li Lingjie: 93,838 149,345.05 Tang Binghui: 93,838

Source: China Securities Regulatory Commission, available at www.CSRC.gov.cn

Table 4 collected all the administrative penalties decision made during 2012. The data indicate that the amounts of money involved in the insider trading cases are still small compared to the cases enforced by SEC. Based on the above analyses, including the historical, empirical and legal analyses, there is no means that the U.S. enforcement and market environment is worse than those in China. Hence, the reasonable deduction is that CSRC might conduct selective enforcements.

4.3 Comparison of Two Countries’ Criminal Enforcement A supplement for SEC enforcement is criminal enforcement which is conducted by the U.S Department of Justice (DOJ) through its local U.S. attorneys. The criminal sanction intends to “provide stiff criminal penalties for insider trading to send a message to the community that the society and the government treat insider trading as a serious offense.”132 In China, the legislators consented with its U.S counterparts and made insider trading as criminal act in its criminal law amendment in 25th September 1999, at the very early stage after it established its securities markets.133 The SEC does not have authority to initiate criminal prosecutions for violations of

132 See Thomas C. Newkirk, Speech by SEC Staff: Insider Trading A U.S. Perspective, (19 September 1998), available at: http://www.sec.gov/news/speech/speecharchive/1998/spch221.htm (last accessed) 133 See the First Amendment of Criminal Law of People’s Republic of China

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federal securities laws.134 However, the SEC cooperates with the DOJ by referring the case which it believes the act has been constituted a criminal act to the DOJ for criminal prosecution. The SEC then transfers any necessary evidences to DOJ to support the criminal prosecution.135 The Chinese system is similar with that in the U.S., i.e. the CSRC does not have power to prosecute the insider’s criminal liability neither. Prosecution of insider trading is conducted by prosecutors or a parallel investigation may conducted by another department-the Economic Crime Investigation Division of Public Security Bureau.136 Both the DOJ and its Chinese counterpart confront a similar challenge when prosecute a criminal insider trading. For the standard of a criminal case, it requires prosecutors to prove beyond a reasonable doubt. The misappropriation and tipper/tippee theories require the investigators or prosecutors to establish a connection between the trader and the original source of the inside information. It is extremely difficult for prosecutors to achieve it, because indeed most evidences collected by prosecutors and investigators in insider trading cases are circumstantial evidences. Therefore, “almost all successful criminal insider trading prosecutions in the U.S. have rested at least, in part, on the testimony of cooperating witnesses.”137 This induces the SEC to grant accomplices with very tolerant penalties waiver in order to obtain their convincing testimony on culprits.138 In China, there is no such “settlement” between the prosecutors and the accomplice or defendants in insider trading.139 In criminal procedure, the Chinese authority relies heavily on the testimony from the accomplices or the confession of the person who committed insider trading but it does not need to seduce the accomplice to provide evidences for them or confession from defendants by grant criminal penalties waiver.140 Since the power of the Public Security Bureau is strong, 141 the Economic Crime Investigation Division can extend the detention for a long time even there is no necessity or no justification for an extra or extended detention.142 Another conspicuous feature of the criminal enforcement of insider trading law in China is that, as mention before, few cases investigated by the CSRC have been refer to prosecute their criminal liability. During 2008 to 2012, the CSRC had investigated 1458 only referred 125 cases to the Economic Crime Investigation Division, which not only included insider

134 See Ralph C. Ferrara,Herbert C. Thomas,Donna M. Nagy, Ferrara on Insider Trading and the Wall, (ALM Property Law Journal Press, 2006), at 4-13. 135 Id. 136 See Hui Huang, supra note 35, at 41. 137 See Thomas C. Newkirk, Speech by SEC Staff: Insider Trading –A U.S. Perspective,( 19 September, 1998), available at http://www.sec.gov/news/speech/speecharchive/1998/spch221.htm 138 See Morrison Foerster, 2012 Insider Trading Annual Review, (2013) available at: http://www.mofo.com/ files/Uploads/Images/130116-Insider-Trading-Annual-Review.pdf 139 It is unclear whether there are secret settlements between prosecutors and defendants. Under the current prosecution system, no settlement procedure has been established. 140 See Unknown, Analyses on Typical Cases(in Chinese, 2010), available at http://www.csrc.gov.cn/pu b/newsite/jcj/dxal/201108/W020110802482840935021.pdf 141 See Human Right Watch (author unknown), China: "walking on Thin Ice": Control, Intimidation and Harassment of Lawyers in China (Human Right Watch, 2008), at 20. 142 See Kam C. Wong, Police Reform in China, (CRC Press, 2011), at 317.

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trading cases but also other types of cases such as cases of market manipulation and cases of unduly information disclosure.143 Hence, we could surmise that a large number of persons who conducted illegal insider trading are not charged with criminal liability.

5. LATEST ENFORCEMENT TRENDS AND PROBLEMS IN CHINA AND THE U.S

In this section, two recent topical issues on insider trading enforcement in the U.S. will be discussed, namely the insider trading conducted through “expert network” and “congressional knowledge” being used by some congressmen for personal trading. The purpose of this section is to help to predict the future situation in China and also rethink about China’s current status on similar issues. These two issues are relatively new and might be happened in some countries or have already occurred in some countries as well. To examine the background and the reasons why they emerged will help us to have more knowledge to handle the similar happenings in China or other countries. Hence, I explore these two latest enforcement issues in my thesis, aiming at providing a perspective for the Chinese policy-makers in related fields.

5.1 Insider Trading through Expert Networks 5.1.1 Expert Network Industry In securities market, information equals to money, especially for those who want to profit with a quick return.144 To curb this problem, a usual approach is to provide a higher level of transparency of the market. The strong demand and the emphasis of equal access of information trigger the SEC to promulgate the Regulation Fair Disclosure (“Regulation FD”).145 The Regulation FD stamps out the unfair selective disclosure, which used to be blamed for its unequal treatment to individual investor. It brings more transparency and more timely communication between the corporations and their investors, making the hedge funds and other equity funds which focus more on short term interests become lack of the advantageous information. This situation strengthens the demand of the research by the expert networks firms.146 The expert networks firms refer to research consulting firms that similar to intermediaries who connect clients, mostly hedge funds and other institutional investors who are eager for extra information, with professionals who can contribute their own market

143 See The CSRC, A Report on Securities and Future Regulations Enforcement and the Future Enforcement Commitment, available at http://www.csrc.gov.cn/pub/newsite/jcj/gzdt/201101/t20110121_191069.htm 144 See Stephen J. Choi and A. C. Pritchard, supra note 83. 145 See OECD, OECD Reviews of Regulatory Reform Regulatory Impact Analysis A Tool for Policy Coherence: A Tool for Policy Coherence (OECD Publishing, 18 September 2009), at 176. 146 See Jeng, Daniel H., Expert Networks and Insider Trading: An Introduction and Recommendation (7May 2013), Review of Banking and Financial Law (forthcoming), available at SSRN: http://ssrn.com/abstract =2262103

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intelligence based on their expertise in the fields in the interest of their clients.147 The professionals in the network normally include professors, scientists, engineers, suppliers, and former employees in the related industries.148 The expert network firms operate with two advantages which might attract clients to pay for their services. First, unlike the financial analyzers, the experts in their own industries have a better understanding on a particular business field or a specific project since they know about the daily operation of the companies they served and even that of their competitors. Therefore, they may exceed the analyzers in respect of the accuracy and timeliness. Second, the expert networks are beneficial to combine knowledge and intelligence, selecting and compiling disparate but related information to generate advantageous information. 149 Therefore, some commentators consider the expert networks as “the Wall Street matchmakers who connect large investors with outside experts.”150 In fact, the aim of the expert networks is clearly enough-to help affordable investors to make a more accurate prediction of stock prices of his holding shares with a unique and insightful judgment of the professionals. Hence, the network assists those who afford to pay to have a better investment status than other ordinary investors who do not pay the premium. The SEC recognized the reasons of the existence of expert networks and also accepts that any collection and compilation of immaterial nonpublic information in order to reveal material information should be allowed since it is helpful with the research and the discovery of the accurate value of a specific company.151 The business of expert network firms is lucrative and growing quickly152 and it has even “become a mainstay in Wall Street”153 in a short period because the strong demand of “advantageous information” overflows the securities markets. It has been reported that the revenue of the expert network industry was $433 million in 2008, $364 million in 2009, and $400 million in 2010.154

147 Id. 148 See Bradley J. Bondi & Steven D. Lofchie, The Law of Insider Trading: Legal Theories, Common Defenses, and Best Practices for Ensuring Compliance, 8 New York University Journal of Law & Business, 151, 177 (2011) 149 The mosaic theory has been historically defensible, but discussions on the theory have not been finished. See Andrew Ross Sorkin, Just Tidbits, or Material Facts for Insider Trading?, NewYork TIMES (29 November 2010), (last accessed on 7 June 2013), available at http://dealbook.nytimes.com/2010/11/29/j ust-tidbits-or-material-facts-for-insider-trading/ 150 See Evelyn M. Rusli, Next Up, A Crackdown on Outside-Expert Firms, New York Times (May 11, 2011), (last accessed 10 June 2013) available at http://dealbook.nytimes.com/2011/05/11/next-up-a-crackdown-o n-outside-expert-firms/ 151 See David Becker, the General Counsel of SEC, Speech by SEC Staff, Remarks at the Practicing Law Institute’s Ninth Annual Institute on Securities Regulation in Europe, U.S. Securities and Exchange Commission, (25 January 2011, last accessed on 10 June 2013), available at http://www.sec.gov/news/ speech/2011/spch012511dmb.htm 152 See Integrity Research Associates, The Expert Networks & The ‘Most Lucrative’ Insider Trading Case Ever, (12 November 2012)(last accessed on 5 June 2013) available at http://www.integrity-research.com/c ms/2012/11/21/expert-networks-the-most-lucrative-insider-trading-case-ever/ 153 See Morrison Foerster, supra note 138. 154 See Boris Groysberg et al., Gerson Lehrman Group: Managing Risk 1 (Harvard Business School Publishing ed., 2012)

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5.1.2 Insider Trading Conducted by Expert Network Firms The first wave of “expert network” cases was led by the Primary Global Research LLC case of which the investigation was launched in November 2010.155 In the Primary Global Research (“PGR”) case, the insiders through the expert network tipped some hedge funds and other investment practitioners with the material nonpublic information.156 Longoria, DeVore, Jiau, and Shimoon were employed by their technology companies and at the same time served as consultants or “experts” in their respective fields, for the PGR.157 Longoria, a manager in AMD's desktop global operations group, had access to sales figures for AMD's various operational units. By tipping his clients with inside information, from January 2008 to March 2010, Longoria received more than $130,000 for consultant services to PGR and its clients. DeVore, a Global Supply Manager at Dell, was privy to confidential information about Dell's internal and information about the pricing and volume of Dell's purchases from its suppliers. From 2008 to 2010, he received approximately $145,000 for tipping to PGR and its clients.158 While Shimoon, a Vice President of Business Development for Components in the Americas at Flextronics, was privy to confidential information concerning Flextronics and its customers including Apple, Omnivision, and Research in Motion. Shimoon provided this inside information to PGR and PGR clients so it could be used to trade securities. From September 2008 to June 2010, Shimoon received approximately $13,600 for deliver oppinions to PGR and its clients. Jiau was a so-called “private” PGR expert, meaning that PGR made her available only to a small group of PGR clients. Jiau, who had contacts at Marvell and other technology companies, regularly provided certain PGR clients with inside information regarding Marvell and other technology companies. Jiau provided company-specific financial results that companies had not yet announced publicly. From September 2006 to December 2008, Jiau received more than $200,000 for her consultations with selected PGR clients.159 They were convicted of committing insider trading by tipping their clients, mostly the hedge funds with “the nonpublic information about sales, earnings, or performance data” of various public companies, enabling them to trade on the information. Based on the tips, the traders reaped profit or avoid losses, totally gained interests of $5.9 million.160 By doing that, the tipees received pecuniary compensation from PGR in return for providing the nonpublic material information.161 In the next significant case, the SEC’s complaint against CR Intrinsic, Martoma, and Dr. Gilman who made approximately $275 million in illicit gains or avoided losses in July

155 See Jonathan Stempel, Primary Global CEO tied to insider case: filing, (23 August, 2011), (last accessed on 11 June 2013), available at http://www.reuters.nl/article/2011/08/23/us-insidertrading-idUSTRE77M4W Q20110823 156 See SEC v. Mark Anthony Longoria, et al., Civil Action No. 11-CV- 0753 (SDNY) (JSR) 157 Id. 158 Id. 159 Id. 160 Id. 161 Id.

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2008.162 Dr. Gilman, a professor of neurology at the University of Michigan Medical School served as the chairman of the Safety Monitoring Committee (the “SMC”) overseeing the clinical trial. He was selected by Elan Corporation, plc (“Elan”) and Wyeth to present the final clinical trial results at medical conference on July 29, 2008, which was to coincide with the after-market hours public announcement of the trial results by the two companies.163 In fact, Dr. Gilman also moonlighted as a medical consultant in an expert network firm. It gave chance for Martoma, then a portfolio manager at CR Intrinsic, to perpetrate the scheme with Gilman. Mr. Gilman tipped Martoma with safety data and later details about negative results in the trial two weeks before the news were made public in July 2008. Knowing this nonpublic information, Matoma and CR Intrinsic then caused several hedge funds to sell more than $960 million in Elan and Wyeth securities in advance a little more than a week earlier than any other investors.164 At the end of 2008, Martoma received a $9.3 million bonus, a significant portion of which was attributable to the illegal profits that the CR Intrinsic and S.A.C. Capital hedge funds had generated in this scheme. Gilman received over $100,000 from the expert network firm for his consultations with Martoma and others at CR Intrinsic and S.A.C. Capital.165 The expert network cases reveal the evolvement of insider trading in the U.S. jurisdiction, a strictly regulatory regime. As mentioned in 5.1.1, the purpose of the establishment of expert network actually is to create informational advantages for clients of expert network firms. Otherwise, no client will be willing to pay for a short period of inquiry with incredible high level of fees166 which are much higher than the normal fee they pay for the research done by other analyzers. The aggressive enforcement activities against expert networks bring the industry uncertainty and speculation as to where was the line between permissible and impermissible. The frequent attacks from the SEC made some commentators to speculate about whether there was a “gray area”167 for this industry. However, viewed from the enforcement actions in 2011, it seems that there was not such a conspicuously overlapped area. The enforcement cases showed that the SEC only attacked the acts conducted by the “experts” which indeed were tipping as what happened in a typical insider trading case and such tipping information was generally easily recognized as material. The operation of expert networks is more or less a dilemma. Two inherent problems of the operation in this industry might induce insider trading. First, the experts provide information or recommendation which based on their individual understanding and

162 See SEC v. CR Intrinsic Investors, LLC, Mathew Martoma and Dr. Sidney Gilman, Civil Action No. 12-CV-8466 (20 November, 2012) 163 Id. 164 Id. 165 Id. 166 It is quite normal for an expert to charge with $5000 pre hour for his consultant service. See supra note 142. 167 See Steve Eder, “SEC Chief Draws a ‘Bright Line’ on Insider Trading,” Wall St. J., Oct. 21, 2011, available at http://online.wsj.com/article/SB10001424052970203752604576643474268068178.html.

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knowledge of the industry. However, the formation of the industrial knowledge and their business judgments are largely vested on the work what they have been done for their companies. It is hard to say their advices involve nothing related to the material information that they can obtain in the course of their work. Second, the supportive theory to justify the legality of expert network is the so-called “mosaic theory” which has been mainly used as defense by Rajaratnamin in his illegal insider trading trial.168 The basic idea of the “mosaic theory” is that an analyst combines tidbits of information which are not material individually, but which, taken together, can imply or indicate material insight into a corporation’s situation.169 This theory seems untenable inherently. First, the deemed-to-be immaterial information is not available for all investors and no evidence shows that the publication of such material information would not affect the share prices of the company. Instead, if we apply the “mosaic theory” stiffly, a client of an expert network can collect certain parts of a whole piece of material information separately immaterial from different experts, and then collect other parts from other experts and eventually assemble all the information to draw the whole picture of the business of the corporation. Although the theory seems defective to some extent and cannot justify the expert network very well from the above analysis, the SEC acknowledges that if an investor legally piece together the tidbits of immaterial nonpublic information, he or she should be allowed to harness the material conclusion produced by his or her own research effort. Hence, from the authority’s perspective, expert networks based on the “mosaic theory” are permissible unless they leak material information to their clients. Apart from the reasons the above text has given that explain why expert network cases burst during recent years, other new enforcement measures adopted by the SEC contribute to the increasing number of expert network cases, for instance, the using of wire tap.170 A solution for expert network companies to prohibit its experts from conducting insider trading is to establish compliance control system. Some expert networks might offer safeguards, for instance, requiring their experts to make record during their consultation. They might also offering chaperoning, allows their compliance staff (in house lawyers) from clients to listen during the consultations. These methods actually vest the power of curbing the chance of opportunities on the clients and it seems Many of an expert network’s compliance controls are client-dependent. The expert network offers safeguards, but it is up to the compliance staff and users of the expert network to utilize them. Many expert networks offer the ability to record consultations, but few clients utilize this feature. Most expert networks, including GLG, offering chaperoning, which allows

168 See US v. RAJARATNAM, No. S2 09 Cr. 1184 (RJH) (S.D.N.Y. Feb. 2, 2011). 169 See United States v. Rajaratnam, docket # 264 (S.D.N.Y. Apr. 18, 2011) (defendant’s proposed jury instruction no. 25). Also see Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 165 (2d Cir. 1980) 170 See Christopher L. Garcia & Boyd M. Johnson III, Defending Clients in Insider Trading Investigations and Enforcement Actions, from Defending Corporations and Individuals in Government Investigations,( Thomson Reuters, 2012), at §13:21, available at http://www.wilmerhale.com/uploadedF iles/WilmerHale_Shared_Content/Files/Editorial/News/Ch%2013_Defending%20Clients%20in%20Insider% 20Trading%20Investigations%20and%20Enforcemen....pdf

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compliance staff from a client to listen in on consultations on an announced or unannounced basis. Here again, the onus is on the client.171 The expert networks phenomenon to some extent shows that indeed the insider trading enforcement in the U.S actually is efficient and the theories behind the enforcement are well developed. However, no expert network insider trading case has been reported in China. The expert network cases exist only when the authority are strict to the traditional types of insider trading, and the market transparency has been highly achieved. This is probably not the case in China.

5.2 “Stop Trading on Congressional Knowledge Act” and the Similar Matters in China In 2011, trading by the Congressmen attracted a high level of attention after 60 Minutes aired an expose about a research conducted by Peter Schweizer, a researcher at Stanford's Hoover Institute.172 His research indicated that the members of Congress were trading on confidential government information and also they had been given opportunities to purchase the lucrative IPOs not generally available to the public.173 This finding put a high level pressure on the legislative to enact regulations to enhance supervising the Congressmen and governmental staff. In fact, before the broadcasting of 60 Minutes, a prototype proposal (H.R. 1148) similar to the “Stop Trading on Congressional Knowledge Act” (the “STOCK Act”) was introduced early in 2006,174 but it languished with only nine sponsors. It is understandable that without pressure, no one who in positions would be willing to limit his or her privilege or powers. In fact, the media created a misleading perception that trades by Congressmen relied on the advantageous information he gained in the course of his work could be purely legal under the U.S. laws.175 According to the fiduciary duty theory, which is the foundation of illegal insider trading liability, the Congressmen do own duty to the United States and the public when they trade securities based on their “congressional knowledge”. Hence, the STOCK Act to some extent is created to address such perception that the current insider trading regulations do not exempt or exclude the Members of Congress, congressional staff, or other federal official from illegal insider trading. Although the perception was wrong, some congressmen did take advantage of their insider knowledge for pursuing their personal interests revealed from their empirical studies.

171 See Expert Networks & The ‘Most Lucrative’ Insider Trading Case Ever, available at http://www.inte grity-research.com/cms/2012/11/21/expert-networks-the-most-lucrative-insider-trading-case-ever/ 172 See Peter Schweizer Throw Them All Out: How Politician and Their Friends Get Rich Off Insider Trading Stock Tips, Land Deals, and Cronyism Would Send the Rest of Us To Prison (2011) 173 See Congress: Trading Stock on Inside Information?, 60 MINUTES (Nov. 13, 2011, 7:06 PM), available at http://www.cbsnews.com/video/watch/?id=7388130n&tag=contentBody;storyMediaBox 174 See The112th Congress by Timothy Walz, H.R. 1148 (112th): Stop Trading on Congressional Knowledge Act (17 Mar 2011), available at: http://www.gpo.gov/fdsys/pkg/PLAW-112publ105/html/PLAW-1 12publ105.htm 175See Jack Maskell, The STOCK Act, Insider Trading, and Public Financial Reporting by Federal Officials, (18 April 2013), available at http://www.fas.org/sgp/crs/misc/R42495.pdf

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As the public pressure grew, it had more than 140 sponsors in the Capitol Hill. The President Obama’s also joined the growing support for the STOCK Act where he declared: “Send me a bill that bans insider trading by members of Congress, I will sign it tomorrow” at the 2012 State of the Union Address.176 With Obama’s support, it was passed in the Senate by a 96-3 vote, and later a 417-2 vote in House of Representatives and was signed into law on April 4, 2012.177 The main purpose of the STOCK Act was to rebuild public faith in the Congress and government by reaffirming trading stock by members of Congress is illegal if they based on certain nonpublic information in the course of their working for the congress.178 The measure the Congress deployed is to generate more transparency on this matter. It requires the staff work for the executive branches and legislative branches of the federal government to report within 30 days of receipt of a notice of a covered financial transaction. The related staffs, their spouses and dependent children need to file periodic reports with reference to any financial transactions of $1,000 or more in securities, but transactions in mutual funds or income-producing real property are excluded.179 The law also requires the government to establish an electronic filing system which contains financial information disclosure of the above mentioned transactions to allow public get access to it through Internet.180 However, with regard to such Internet disclosure involves financial information of nearly 30,000 federal employees in the executive and legislative branches of government, concerns on the risks of “data mining” for malicious purpose and safety of federal workers and their families finally let the Congress to delay the

176 See The White House, Statement by the President on Passage of the STOCK Act , February 02, 2012, “Last week, I called on Congress to pass a bill that makes clear that Members of Congress may not engage in insider trading. No one should be able to trade stocks based on nonpublic information gleaned on Capitol Hill. So I’m pleased the Senate took bipartisan action to pass the STOCK Act. I urge the House of Representatives to pass this bill, and I will sign it right away.” Available at: http://www.whitehouse.gov/the-press-offi ce/2012/02/02/statement-president-passage-stock-act 177 See Bill Text Versions112th Congress (2011-2012), S.2038, available at http://www.gpo.gov/fdsys/pk g/BILLS-112s2038pcs/pdf/BILLS-112s2038pcs.pdf 178 See Jack Maskell, The STOCK Act, Insider Trading, and Public Financial Reporting by Federal Officials, (April 18, 2013), available at http://www.fas.org/sgp/crs/misc/R42495.pdf, Also see Section 6 Amends the Ethics in Government Act of 1978 (EGA) to require specified individuals to file reports within 30 to 45 days after receiving notice of a purchase, sale, or exchange which exceeds $1,000 in stocks, bonds, commodities futures, and other forms of securities, subject to any waivers and exclusions. Lists such individuals as: (1) the President; (2) the Vice President; (3) executive officers or employees, including certain special government employees and members of a uniformed service; (4) appointed administrative law judges; (5) executive branch employees in positions excepted from the competitive service because of their confidential or policymaking character (except those excluded from such exception by the Director of the Office of Government Ethics); (6) the Postmaster General, the Deputy Postmaster General, each Governor of the Board of Governors of the U.S. Postal Service, and certain U.S. Postal Service officers or employees; (7) the OGE Director and each designated agency ethics official; (8) civilian employees of the Executive Office of the President (other than a special government employee) appointed by the President; (9) Members of Congress; and (10) congressional officers and employees. 178 See the Ethics in Government Act of 1978 of the United State has required the staff who worked in government and legislative to provide annual public reporting of their incomes. See supra note 179 Id. 180 See Section 11 of the STOCK Act.

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implementation of the requirement for Internet disclosure.181 From this recent trend in the U.S., we can learn that insider trading might be easily conducted by the staff of administrative branch and legislative branch. The staff of these two branches can trade stock with their “congressional knowledge” and even worse, accept investment opportunities of IPOs as political contribution from their supporters. In China, the similar cases happened frequently as well in recent years.182 Insider trading becomes a more covert means for those public servants who are able to access inside information to seek personal gains. There are few cases that public servants have involved in the illegal insider trading, but it does not demonstrate that the cases of insider trading by public servants are rare. The problem in China is serious because of several inherent defects of its current political and legal systems. First, the public servants do not need to disclose their financial status at all. The corruption of China is serious since its economy start to boost 30 years ago.183 The central government in Beijing acquiesces in this situation since many of high-profile officers also have incredibly enormous amount of gray incomes.184 They not only have nondisclosure advantage compared their U.S. counterparts, but also have a strong influence on investigators, since the Public Safety Bureaus are subordinated to the government. Moreover, courts are not fully independent neither but frequently influenced by the governments and the leaders of the Communist Party.185 Second, in some provinces in China, according to the current legal requirement, if a listed state-owned enterprise wants to precede a reorganization or acquisition scheme, it has to make applications to the local State-owned Assets Supervision and Administration Commission and wait for its approval order before it can conduct its project.186 Furthermore, since there are multifarious administrative approval requirements for doing business in China, the governmental officers have numerous opportunities to obtain inside information in advance and use them for private interests. Last, in regard to the IPOs projects, the public officers also have an advantage than normal investors since projects founders usually guarantee wives, dependent children or other

181 See e.g., the discussion of “informational privacy” in Congressional Research Service, Library of Congress, The Constitution of the United States of America, Analysis and Interpretation, S. Doc. 108-17, at 1778-1787 (2004); see also Duplantier v. United States, 606 F.2d 654 (5th Cir. 1979), upholding public financial disclosure requirement of the Ethics in Government Act for federal judges against privacy challenge. 182See Xin Hua, Public Officers in Insider Trading, (in Chinese, 14 May 2011), available at http://news.xinh uanet.com/2011-05/14/c_121414632.htm (last accessed on June 10, 2013). 183 See Melanie Manion, Corruption by Design: Building Clean Government in Mainland China and Hong Kong, (Harvard University Press, Jun 30, 2009 ), at 87. 184 In the latest case, Liu Zhijun, the former Minister of Railways Ministry of PRC had been accused of corruption. During the investigation, he was found that he owned 374 properties, RMB 18359565.81 in cash and 16 cars. See Huan Qiu News, (10 June 2013), http://china.huanqiu.com/politics/2013-06/4018 299.html 185 See Mo Zhang, Chinese Contract Law: Theory and Practice, (Martinus Nijhoff Publishers, 2006), at 18. 186 See Fulandelin Enterprise, Regulations for Listed Companies in China for Foreign Companies in China, (Jinlian Press, 2004), at 1537.

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relatives of the high-ranked officers in order to create a good relationship with the government. This is similar to the cases recently found in the U.S. Compared the situations in both countries, it is without doubt that the U.S. Congress and government showed a very quick reaction to the illegal insider trading conducted by the public servants. However, to date Chinese authority makes no response. The final remark to this issue in China could be pessimistic. In the current stage, it seems hard to enact a financial disclosure act to make the public servants’ assets disclose to the public annually, not mention to a continual disclosure system. The Chinese Congress would not enact such strict rules to limit their privilege and the present enforcement powers are not strong enough to curb such trading.

CONCLUSION Insider trading is a world-wide problem which eliminates the interest of other ordinary shareholders who do not have access to nonpublic information. Although nearly every country has their insider trading regulations to curb the acts, not many of them have an ideal enforcement. In my analysis, the insider trading enforcement in China is not desirable, especially regarding the administrative sanction and criminal sanction. As the Chinese market develops rapidly and play a more active role in the global financial market, the curbing of insider trading will be a determinative element for its further evolution into a more sophisticated and international securities market. Relying on a historical analysis, I found both the administrative and criminal enforcements by the CSRC and Public Safety Bureau are relatively weak and cannot impose deterrence on whom eager to commit illegal insider trading. Most cases enforced involves small amount of illicit profits or loss avoided compared with the U.S. cases, which implies probably the big case might be not caught on purpose in China. And this hypothesis could be supported by the current non-independent status of enforcement authorities. This Thesis also indicates that in respect of the enforcement procedure of insider trading regulations, Chinese authority need to make it more transparent, more specific and clearer for participants to prepare the entire procedure. The enforcement is vital to the efficacy and the purposes of insider trading regulation. In the last section, the discussion of expert networks and the STOCK Act indicates that the United States has a quick legislative reaction and public awareness of insider trading. In contrast, the Chinese public showed not much interest in this field, and the effort of curbing insider trading is more or less depended on the authority. In sum, the insider trading enforcement in China is still in its infant stage, and further improvement in enforcement procedure and transparency should be Chinese authority’s focuses in the near future.

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