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Exploring New Model of Administrative Reconciliation in Regulation and Enforcement--Bylined article published by CSRC Chairman Xiao Gang on Administrative Management Reform
19-02-2014

To effectively protect lawful rights and interests of investors, on one hand, we need to adopt strict enforcement measures, carry out stern investigation and penalties on market violations and provide all-rounded protection of investor interests; on the other hand, it is imperative to make up for the economic loss suffered by investors as a result of violations and protect the interests of individual investors. According to existing enforcement system, the aforementioned objectives are mainly achieved through a combination of administrative prosecution and civil compensation and remedies. As two different legal procedures, public prosecution and private right remedy each have its own lacking. Administrative enforcement fails to resolve the compensation issue, which is the center of attention for investors; while in civil litigation, investors tend to encounter obstacles of high cost and burden of proof, which hampers the effectiveness of such remedies. In the face of these practical difficulties in investor protection, many countries and regions in the world have adopted administrative reconciliation as an effective enforcement measure, meeting the need of both the administrative enforcement of regulatory agencies and the compensation for loss suffered by investors. What makes this arrangement special is that the regulatory agencies may, in the enforcement process and in accordance with the law, reach a settlement with involved parties through negotiation, demanding such parties to voluntarily surrender improper gains or even a greater amount to be directly used to compensate investors for the loss they suffered.

 

  

I. Administrative reconciliation is in line with the fundamental values of modern administrative legal system

  

Based on the principle of conferral and the principle of no disposition of administrative authority at will, both the academic and practice community of administrative law have always been prudent against administrative reconciliation. In fact, since the law is unable to cover all details, it is rather common for administrative authorities to exercise discretionary power, which in a way shows that disposition of administrative power cannot be totally excluded from the administrative enforcement process. As market economy and technology further develop, modern administrative legal system starts to shift from the single objective of regulating and restricting administrative authority to a diverse range of objectives including efficient, democratic, procedural and harmonized administration. In the same breath, on top of the mandatory administrative management method, a variety of modern administrative management approaches start to emerge, including administrative contracts, administrative guidance and administrative negotiations. Coping with the changing need for administrative discretionary power and the changing values of administrative legal system, administrative reconciliation is getting increasingly popular in many countries and regions as a key administrative arrangement and practice. Meanwhile, modern securities regulation is transforming from the passive administration of the past to the proactive administration, and from confrontational administration to cooperative administration. Instead of being monotonous and mandatory, securities regulation and enforcement is becoming more diverse, interactive, negotiable and more in line with the increasingly popular diverse dispute resolution mechanisms. Administrative reconciliation is being more extensively used in the regulation and enforcement of the capital market. Both the Anglo-American legal system (including the United States, the United Kingdom and Hong Kong SAR) and the continental legal system (including Germany and Taiwan) have set for unified and specific regulations regarding administrative reconciliation in their respective administrative procedural law. In some countries and regions, the cases settled through administrative reconciliation by regulatory agencies account for as high as 80% of all enforcement cases, among which are some major cases with a massive amount of money involved and extensive influence. It is rather evident that the increasing use of administrative reconciliation in the regulation and enforcement of the capital market is not only in line with the fundamental values of modern administrative legal system, but also in accordance with the special principles of capital market regulation. The new enforcement model can:

  

1) help investors promptly obtain compensation for their financial losses

  

With conventional administrative enforcement models, regulatory agencies can only impose administrative sanctions such as fines on violations of the rights and interests of investors. Although this model is effective in holding violators liable for legal consequences, it fails to help investors get compensations they deserve. Between 2006 and 2012, the CSRC officially processed 122 false statement cases. However, according to incomplete statistics, within the same period, only a limited number of investors filed civil claim suits against 46 listed companies, demanding RMB 384 million and merely obtaining awards of RMB 67 million in compensation. Furthermore, there was no precedence in China where investors filed civil damages suits and successfully obtained awards of compensation in insider trading cases or market manipulation cases. By using reconciliation payment, confiscated fund and other collected fine to compensate investors for losses, we can explore a new approach where administrative regulation can directly provide investors with effective remedies. Via administrative reconciliation, on one hand, we will require related parties to make "reconciliation payment", thus bearing legal consequences of financial penalties; on the other hand, we will use such "reconciliation payment" to provide investors who suffered losses with concrete financial compensations. Combining both punitive and remedial functions of administrative enforcement, administrative reconciliation is a more effective approach in protecting the lawful rights and interests of small investors.

  

2) help confirm and stabilize market expectation

  

The capital market, in a certain sense, is a market where transactions are done on the basis of expectation. Any information on the facts and incidents that tends to influence stock price is required to be promptly confirmed and disclosed according to the law. Therefore, administrative efficiency is of more significance in the capital market compared with other sectors. Violations, including false statements, insider trading and market manipulation, have great influence on the price of related securities transactions. When the leads of such cases are detected, investors, who are eager to protect their own interests, tend to have a high expectation for the efficiency and timeliness of regulatory agencies in finding facts and imposing sanctions. Without prompt handling, market risks may start to spread, which will not only hinder the stabilization of market expectation, but also undermine investors' confidence in the market and the normal functioning of the capital market.

  

The capital market is often challenged by both the pressing demand for speedy investigation and handling of violations and difficulties of such investigation and handling. Due to the intricate web of stakeholders and enormous interests involved, violations in the capital market are usually highly intelligent and involve extensive regions and a wide variety of market entities, making evidence collection and case investigation rather time-consuming. It takes even longer if the case is referred to the police, reviewed and prosecuted by the procuratorate and tried and sentenced by the trial court. Furthermore, in some special cases with highly suspected violations, the complexity of details and the difficulties in collections key evidence left the cases open for a prolonged period of time. Administrative reconciliation is the approach for much speedier case investigation and processing, making it a popular choice of overseas regulatory agencies. In administrative reconciliation, when facts are not clear and the finding thereof is difficult or requires investment of considerable resources, thus making it difficult to make decisions on relevant sanctions within a short period of time, regulatory authorities and involved parties can both make compromises based on negotiation, with involved parties paying necessary amount of reconciliation payment to be used to compensate investors involved, and a reconciliation agreement will be reached upon which regulatory authorities will impose no further sanctions. Under specific circumstances, such enforcement model can effectively punish violators, protect investors and restore market order in a much more swift and effective manner, making it a better approach for the capital market.

  

3) substantively reduce and mitigate administrative disputes

  

Although a unilateral act implemented by regulatory agencies, the result of capital market regulation and enforcement involves a range of bilateral and multilateral relations including administrative counterparts and investors. Modern administration requires administrative authorities, in fulfilling administrative duties, to meet the objectives of laws and regulations, as well as mitigate and resolve disputes. In the conventional approach, where unilateral and mandatory administrative measures were adopted, administrative authorities refused to negotiate with the administrative counterparts and ignored their engagement in the administrative procedures. As a result, it is not rare that the administrative counterparts refuse to accept the administrative decisions, and resort to administrative appeal or litigation for legal remedies. In order to substantively reduce administrative disputes, more emphasis should be placed on democratic consultation and involvement of the administrative counterparts in the administrative procedures.

  

Via negotiation mechanism with the participation of involved parties, administrative reconciliation allows opinions of involved parties and stakeholders including investors to be heard, turning unilateral acts by regulatory authorities into joint acts by two or more parties; transforming regulatory authorities' mandate on involved parties into consensus reached voluntarily by two or more parties, thus making it easier for involved parties to accept relevant enforcement decisions, disputes to be effectively resolved and market and social order to be restored.

  

4) help tackle practical challenges caused by the lack of proper or effective systematical arrangements

  

Financial innovation is the lasting theme of the capital market. In order to obtain illegal gains, violators tend to exploit a wide range of methods to avoid regulation. As China's capital market is in the emerging and transitioning stage and the legal system is gradually improving, conflicts between the ever-changing practices and the requirement for stability of the law are especially pressing. Take market manipulation as example, the existing Securities Law only covers several typical acts of market manipulation including pool operation, churning, wash trade and accommodation trading. However, in practice, a variety of new acts including scalping, beguiling trading[Translator’s note: Please kindly confirm our translation of “蛊惑交易” as we failed to identify a generally accepted term for it.], fraudulent order placement, etc, for which the law makes no specific stipulations despite the catch-all clause, making it extremely difficult to find such violations in administrative enforcement and judicial trial. In handling new types of violations, regulatory agencies often find themselves obstructed by the lack of specific legal stipulations, insufficient basis for determination of illegality, and the lack of grounds for enforcement. On one hand, failure to carry out prompt enforcement measures will lead to accuse of administrative omission and great pressure from the market and society; on the other hand, if enforcement measures are adopted, administrative authorities will need to answer questions about the grounds for such measures and respond to the challenge of abusive of administrative power.

  

In the face of new phenomena and new issues in the market development, innovative enforcement philosophy and mechanism must be adopted to ensure the strictness and effectiveness of enforcement. In cases where there is a lack of specific or clear stipulations, and it is difficult to determine the legal nature of the acts of involved parties, it is unnecessary for regulatory authorities to make a clear determination of if the acts of involved parties are legal. Instead, based on the adverse social consequences of such acts, regulatory authorities can, via negotiation, conclude the case with involved parties paying certain amount of reconciliation payment. This pragmatic approach not only overcomes the enforcement obstacles in reality and complies with the market development trend, but also demonstrates the principle of administration by law, thus achieving the objectives of regulation and enforcement.

  

II. The key to securities and futures-related administrative reconciliation lies in investor remedy and restrictions on the reconciliation power.

  

Compared with conventional enforcement which often focused on administrative sanctions, administrative reconciliation exhibits significantly different characteristics in the system design, enforcement mechanism and working methods. In system design, the focus in not only placed on the financial sanctions imposed on violators, but also on compensation for the investors who fell victim to such violations, striving for an effective integration of administrative sanctions and civil compensation. In terms of enforcement mechanism, negotiation is adopted in administrative reconciliation, allowing more discretionary power for regulators and more freedom for related parties in voicing their opinions and pursuing their interests, which is likely to lead to moral hazard and conflict of interests. Therefore, in implementing administrative reconciliation in securities and futures-related regulation, it is imperative to set higher standards for regulatory authorities in enforcement capability, check and balance on exercise of power and fair and just handling of cases.

  

1) The scope of capability for administrative reconciliation should be strictly defined to prevent any abuse

  

Regulatory authorities should only adopt administrative reconciliation as a form of enforcement under specific circumstances, instead of applying it to all violations of laws and regulations. In Germany and Taiwan, only when the facts or legal basis of a case are not clear and are unable to be clarified or can only be clarified at considerable administrative cost, will administrative reconciliation be used. In the United States, administrative reconciliation does not apply to administrative disputes cases that may involve creation of administrative precedence, public policies and the necessity of public disclosure of information. Restricting the scope of applicability of administrative reconciliation, on one hand, stresses that regulatory authorities are not allowed to use administrative reconciliation at full discretion, but have to apply the procedure to suitable cases in accordance with the law; on the other hand, requires the execution of administrative reconciliation to be consistent with the legislative intent, has proper motive and be contributive to the proper allocation of enforcement resources, improvement of enforcement efficiency and the protection of investor rights and interests.

  

Under current market environment and social circumstances in China, the conditions and scope of applicability must be strictly defined in promoting administrative reconciliation. On one hand, cases to which administrative reconciliation is applicable should exhibit clear social hazard, yet lack definitive and specific regulations regarding the finding of causal links and constitutive elements due to new and hidden acts of violations, or are almost impossible to investigate and process due to the difficulty in the collection of key evidence. On the other hand, these cases should be ones where involved parties can effectively compensate investors for their losses through reconciliation payment, and voluntarily correct their violations, thus undoing or alleviating the hazardous consequences caused by such violations. Cases which can be clearly investigated, or are only in violation of administrative order but not involving investor compensation, or where involved parties do not make commitment for investor compensation, should not be included in the scope of applicability of administrative reconciliation. Based on the aforementioned considerations, we can firstly pilot administrative reconciliation on two types of cases: 1. insider trading and market manipulation cases involving market institutions; 2.cases of fraudulent sales and misleading investors involving securities firms, futures firms and fund companies.

  

2) Reconciliation payment should be carefully managed to maximize investor compensation

  

As the core of administrative reconciliation, reconciliation payment is charged at various rates and utilized in various manners in different countries and regions. Such fund is directly paid into the Treasury in some countries, but is specifically used to compensate investors and enhance investor education in others. At present, investors in China are faced with challenges of time-consuming, difficulties in evidence collection and high cost in civil suits. Relevant litigation arrangements still have a lot of room for improvement. Using reconciliation payment directly for compensating investors not only can enhance the efficiency of compensation process, but also can eliminate some of the barriers in investors' pursuit of compensation.

  

To be specific, comprehensive arrangements can be developed with regard to the collection and management of reconciliation payment and compensation mechanism. Firstly, on the basis of compliance and negotiation, the amount of reconciliation payment should be determined, taking into account the losses borne by investors due to the violations, corresponding fine and penalties to be imposed once violations are confirmed, illegal gains of involved parties from committing such violations, etc, making full use of the reconciliation payment in compensating investors. Secondly, reconciliation payment should be placed under the management of an independent third party charitable organization in special accounts, exclusively to be used for compensating investors and carrying out investor education. Thirdly, more reasonable arrangements should be made for investors' application for compensation, fully exploiting the professional advantages of stock exchanges, securities depository and clearing institutions, reducing the burden of proof of eligible investors, streamlining application procedures and shortening the application time. Fourthly, stakeholders' opinions should be heard and allocation plan of the fund should be released to the public, in order to strengthen the monitoring by investors of reconciliation payment allocation, ensuring the transparency, justice and equitableness of the allocation plan. Fifthly, linkage between compensation out of reconciliation payment and relevant civil claim suits should be established, on one hand, preventing the commencement of administrative reconciliation from obstructing the filing of civil suits by investors; on the other hand, avoiding acquisition of unfair and repetitive remedies through both administrative reconciliation and civil suits.

  

3) Reconciliation procedures should be standardized to ensure the authority and justice of administrative reconciliation enforcement

  

Although administrative reconciliation procedure requires the negotiation between regulatory authorities and involved parties and the signing of a reconciliation agreement, it differs in nature from civil action such as execution of business contracts and is still regarded as administrative enforcement which involves the exercise of public power. Therefore, it is essential for the administrative reconciliation procedure to be fair, just and strictly regulated. The procedures of administrative reconciliation include direct negotiation between regulatory authorities and involved parties, public hearing when necessary, participation of third party including stakeholders. These procedures can prevent regulatory authorities from using authority to mandate or force involved parties against their will, effectively protect the lawful rights and interests of involved parties and represent the rights and interests of the third party such as the victims, thus basing administrative reconciliation firmly on the equal and proper consideration of the interests of all involved parties.

  

In implementing administrative reconciliation in China, it is imperative to note the following points: 1. Regulatory authorities are not allowed to commence administrative reconciliation at their initiative. Administrative reconciliation can only be carried out if certain amount of case investigation has been conducted and involved parties decided to initiate the reconciliation process. 2. After accepting the reconciliation application from involved parties, regulatory authorities should carry on investigation and evidence collection, in order to prevent that the best timing for evidence collection is missed or evidence is damaged, lost, transferred or concealed due to the commencement of reconciliation process. Investigation should only be terminated when both parties reach a reconciliation agreement. 3. Clear deadline should be set for administrative reconciliation. Administrative reconciliation which fails to meet the deadline for reconciliation agreement must be terminated to avoid any variations that may adversely affect the rights and interest of investors. 4. With regard to the expression of opinions and the pursuit of interests by all parties, mechanisms including investor complaints, public hearing and expert consultation should be developed to take in a extensive range of opinions from all parties.

  

4) The intensity and effectiveness of regulation must be ensured to protect public interest

  

Although administrative reconciliation agreement is reached between regulatory authorities and involved parties, the purpose of such agreement is not to protect the interests of involved parties or regulatory authorities, but to safeguard the general interest of the market including the rights and interest of investors, in other words, the public interest. Therefore, public interest should always be the priority in deciding whether to initiate the reconciliation procedures, or the amount of reconciliation payment, the performance of reconciliation agreement and management and use of reconciliation payment. Administrative reconciliation should not provide excuses for regulatory authorities to relax enforcement, nor should it become a new approach for involved parties to reduce the cost for potential violations and "get away with violations by paying the reconciliation payment".

  

Upon successful completion of the reconciliation, administrative investigation will be terminated and involved parties will be subject to no further sanctions for their violations. Therefore, effective mechanism must be put in place to prevent regulatory authorities and involved parties to abuse the system. Firstly, the conclusion of cases via administrative reconciliation must be contributive to correcting violations in a prompt manner and reducing adverse influence of violations on the capital market, instead of harming public interest and the lawful rights and interests of others. Administrative reconciliation should not be carried out in cases where serious violations were committed and caused hazardous influence, or where involved parties refused to cooperate with the investigation and inspection by regulatory authorities. Secondly, in administrative reconciliation, involved parties shall undertake to rectify violations committed and actively eliminate and alleviate the hazardous consequences. Meanwhile, involved parties shall undertake not to use administrative reconciliation as grounds to exempt or defend themselves in civil claim suit concerning their violations. Thirdly, administrative reconciliation serves as an alternative to administrative sanctions. By making reconciliation payment, involved parties are essentially paying for violations they committed to a certain extent. Therefore, involved parties shall not, for the amount paid as reconciliation payment, seek insurance claim, tax deductible or other compensation, and shall not transfer the due legal consequences to others or the public. Fourthly, in cases where involved parties fail to fulfill their commitment made in reconciliation agreement, regulatory authorities shall continue to investigate and decide, in accordance with the law, whether administrative sanction should be imposed. Meanwhile, regulatory authorities shall document such failure to fulfill their commitment in the integrity database.

  

III.Ensure the steady launch of the administrative reconciliation pilot programs in the securities and futures industry

  

At present, despite the lack of clearly-defined and unified stipulations in Chinese laws, administrative reconciliation has received extensive attention and recognition. In 2006, the General Office of the Central Committee and the State Council jointly released the Opinions on Preventing and Resolving Administrative Disputes and Improving Administrative Reconciliation Mechanism (Zhong Ban Fa [2006] No.27), clearly stipulating the plan to "raise the awareness of using negotiation and mediation to resolve administrative disputes" and "exploring and reinforcing administrative reconciliation". In recent years, relevant laws, in their own areas and from their own prospective, have set forth corresponding regulations on the negotiation between administrative authority and involved parties under certain circumstances. For instance, the Administrative Coercion Law set forth stipulations for the implementation of administrative reconciliation; the Anti-monopoly Law stipulates the scenario where parties involved in monopoly undertake to discard monopoly operation; the Regulations on Anti-dumping stipulates the situation where foreign exporters undertake to adjust price or stop exporting at dumping price; the Regulations on the Implementation of Administrative Reconsideration stipulated that administrative authority which received the application for consideration may reach reconciliation agreement with the applicants. Although still far from typical and well-rounded administrative reconciliation arrangements, the aforementioned stipulations demonstrate the internal philosophy and spirit of the rule of law in administrative reconciliation. Based on the reality faced by securities and futures regulatory authorities in China and drawing experiences from overseas markets, introducing administrative reconciliation into the field of securities and futures regulation is not only in accordance with the policy requirements of the Central Committee, but also in line with the trend of modern administrative enforcement reform. Considering the legislative basis, enforcement environment and public awareness at current stage in China, we should focus on exploring relevant arrangements of administrative reconciliation and ensure the steady launch of pilot programs in a prudent manner when time is ripe.

  

1) Effectively reinforce the legal basis for administrative reconciliation enforcement

  

At present, the amendment to the Securities Law and the enactment of the Futures Law has already been included in the legislation plan of the 12th NPC. In light of the lack of unified legal system for administrative reconciliation, we can take this opportunity to set forth administrative reconciliation arrangements in the Securities Law and the Futures Law, in order to provide adequate legal grounds for the implementation of such arrangement in capital market regulation and to offer legislative experiences for the further development of sophisticated legal system for administrative reconciliation.

  

2) Ensure the steady launch of the pilot of administrative reconciliation enforcement

  

Effectively going with the characteristics of the capital market, administrative reconciliation arrangement is of great significance in protecting the lawful rights and interests of small investors. Meanwhile, mature international markets are rich in relevant experiences which we can learn from. Therefore, before the official promulgation of relevant laws and regulations, administrative reconciliation can firstly be piloted via necessary review procedures. Based on the role of administrative reconciliation, we should set forth special rules for the pilot of administrative reconciliation in securities and futures-related administrative enforcement.The rules will include the scope of applicability of administrative reconciliation, working procedures, compensation following reconciliation, reconciliation agreement, effectiveness of reconciliation and reconciliation monitoring, serving as the fundamental basis for regulatory authorities in carrying out administrative reconciliation pilots.

  

3) Bolster the monitoring and control of administrative reconciliation pilots

  

As a new enforcement approach, administrative reconciliation by regulatory authorities requires reinforced monitoring to ensure steady development. 1. Strengthen public monitoring. In principle, the reconciliation agreement reached between regulatory authorities and involved parties should be made known to public for investors, the market, the general public and media to monitor, if not involving state secret, trade secret and personal privacy and not posing hindrance to enforcement. 2. Enhance internal control. Department in charge of implementing administrative reconciliation shall maintain relative independence. While observing clear division of responsibilities with department in charge of case investigation and sanctions, both departments need to cooperate with each other and check and balance each other. Special decision-making arrangements will be established to prevent and reduce improper disruption and influence on reconciliation decisions. 3. Establish the reporting system for administrative reconciliation pilots. All situations and issues identified in the pilot period should be summarized and promptly reported, in order for relevant departments to make proper adjustment and ensure the smooth progress of the pilot program.



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