Previously, we posted “Tonghuashun VS. Wind and the Judgment Standards for Software Copyright Infringement in China” to introduce the copyright dispute between Wind and Tonghuashun. According to a recent report, two lawyers based in Beijing filed a complaint to the China Security Regulatory Commission (“CSRC”) accusing Wind and its affiliated company of insider trading, which has made the dispute more complicated.
As shown by the currently available information, from the second quarter of 2011 to the third quarter of 2012, Wind’s affiliated company was a shareholder of Tonghuashun. When the rumor emerged that Wind would sue Tonghuashun, Tonghuashun’s shares experienced several major trades. As indicated in the report issued in the third quarter of 2012, Wind sold all the Tonghuashun shares it had held. Wind explained this situation by stating that its investment in Tonghuanshun was to use its rights as a shareholder to persuade Tonghuashun to cease infringement. Today’s post will provide analysis on this issue.
I. What is insider information and persons possessing inside information?
To determine whether Wind’s actions constitute insider trading, it is first necessary to clarify what is inside information and who are persons possessing inside information.
1. Wind’s lawsuit against Tonghuashun is within the category of inside information
Article 67 of the Securities Law regulates major issues that may influence the stock price of listed companies, which clearly includes “major lawsuits involving the company.” On the other hand, however, Article 75 of the law provides:
“Any unpublished information relating to the business or financial position of a company, or carrying significant effect on the market price of the securities of a company, shall constitute inside information. All of the following information falls into the category of inside information: (1) the major events specified in the second paragraph of Article 67 of this Law;”
Therefore, the lawsuit filed by Wind against Tonghuashun belongs to the category of inside information as provided in the above articles.
2. Does Wind constitute a person possessing inside information?
According to the Securities Law, if someone is not a “person possessing insider information” as defined in the law, his actions are not illegal insider trading, even he uses inside information in his transaction, such as when an average person buys or sells a small amount of stock using inside information. According to Article 74 of the Securities Law:
“Persons possessing inside information relating to securities trading include:
…
(2) the shareholders holding five percent or more of the shares of a company and the directors, supervisor,s 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;
…
(7) such other persons as may be so prescribed by the securities regulatory authority under the State Council.”
As can be seen from the above articles, the first condition to be a person possessing inside information is to hold more than five percent of the company’s stock. But, according to relevant reports, Wind does not reach this threshold. The Interim Guideline for Determining Insider Trading in Securities Markets provides further explanation of persons possessing inside information by adding another regulation for “other” categories. This obscure regulation leaves doubts as to whether Wind constitutes a person possessing inside information.
II. Could Wind’s actions constitute inside trading?
By the analysis above, knowledge that Tonghuashun would face a major lawsuit undoubtedly constitutes inside information, and there is also the change (whatever the probability may be) that Wind could be found to be a person possessing the inside information. So, does Wind’ behavior ultimately constitute insider trading?
From Wind’s point of view, as the plaintiff in the coming lawsuit against Tonghuashun, Wind is the creator of the inside information. For this reason, there was no illegal conduct in Wind’s acquisition of the inside information. Additionally, the purpose of the prohibition on the insider trading in law is to prevent illegal gains by others, and it is reasonable for the plaintiff to sell the defendant’s stock before filing the lawsuit. From this viewpoint, Wind has adequate reasons to sell its Tonghuashun stock because if it were prohibited by law, wouldn’t this force Wind to harm its own interests?
On the other hand, Wind is not completely without liability in this affair. It disclosed the filing of the lawsuit immediately after its sale of the shares, and this kind of rapid timing gives the appearance that Wind used inside information in its trading. Moreover, objectively speaking, Wind did sell its shares on knowledge of the fall of the stock price, which conforms to the features of inside trading.
In closing, whether or not Wind’s actions constitute insider trading stile requires further investigation and analysis, and we will continue to focusing on CSRC’s decision.
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