Risks in Acquisitions, Restructurings by Listed Companies in China

Author:Du Lianjun,Chu Zhilin


The term “acquisition/restructuring” as carried out by a listed company means a rights assignment of corporate control carried out between a target company and an acquiring company. As acquisitions/restructurings carried out by listed companies are accompanied by massive capital operations, they will regularly give rise to serious criminal legal risks.

Raising funds. For the acquirer, relying on its own assets to complete the acquisition is usually not possible. Accordingly, the acquisition will be done by way of a “share swap”, or “share for asset swap”. Specifically, this will be accomplished by offering new shares, preference shares, bonds or other such securities, and using their combination as the consideration for the equity of the target company.

As there are multiple restrictions placed on financing through the offering of shares, certain companies, for the purpose of raising funds to complete an acquisition/restructuring, will often use such means as fabricating a transaction, fraudulently increasing assets or revenues, etc., in their prospectus, application for shares, company or enterprise bond offering measures, so as to embellish their performance results and satisfy requirements. Pursuant to article 160 of the Criminal Law and related judicial interpretations, when the proceeds of a fraudulent share or bond offering reach at least RMB5 million (US$793,000), or a fabrication of relevant documents, vouchers, etc., is involved, the person directly in charge will be guilty of the “crime of fraudulent offering of shares or bonds”.

If the acquirer has over-issued, or issued at a premium stocks or company bonds without the approval of the State Council’s securities regulator, then, pursuant to relevant judicial interpretations and the criteria for the opening and prosecution of cases, if the offering proceeds reach at least RMB500,000, or if the offering is made to 30 or more persons, or repayment cannot be promptly made, the “crime of unauthorized offering of shares or bonds” will be constituted.

The proceeds of a single offering of stocks or bonds by a listed company will usually far exceed the amount of proceeds required to constitute the above-mentioned crimes. So if a listed company, for the purposes of raising funds to carry out an acquisition, commits fraud, embellishes its results, or commits another such deceptive act, or breaches the relevant securities offering procedure, there is a strong possibility that a criminal offence will be constituted. Such listed company must stringently adhere to the statutory procedure when raising the funds.

Insider information. Insider information on a capital and share increase, company acquisition plan, etc., generated during negotiations for an acquisition/restructuring has a relatively major impact on a company’s share price, and if the directors, supervisors and management of the parties, and other persons in the know, fail to pay attention to maintaining the confidentiality of the insider information, or if the persons with access to such insider information exploit their information advantage to engage in arbitrage, there is a strong possibility that a crime will be constituted.

More specifically, this can be manifested in two ways. First, the insider information is transmitted in bad faith. If, in the course of an acquisition/restructuring being carried out by a listed company, a relevant person divulges information on the acquisition that the parties are proposing to carry out to a third party, allowing that third party to exploit such information to carry out securities manipulation, the “crime of divulging insider information” will be constituted if the circumstances are serious (e.g., if the securities transaction amount reaches at least RMB500,000 in the aggregate). If a relevant person modifies insider information after being privy to it, fabricating and transmitting false securities or futures trading information, and so causing a loss or reaping a gain of at least RMB50,000 in the aggregate, or causing an unusual fluctuation in trading volume or trading price, the same will constitute the “crime of fabricating and transmitting false securities or futures trading information”.

The second way is the abuse of advantageous information position. If a person with insider information exploits such information to directly trade securities or futures, or, based on such information, advises a third party to trade in the securities or futures, and the circumstances of this are serious, the “crime of insider trading” will be constituted.

Accordingly, a listed company must pay attention to keeping specific information relating to the acquisition plan, transaction structure, etc., strictly confidential, and prudently carry out securities trading during the sensitive period before the insider information is made public.

Design of transaction structure. If the two enterprises involved in an acquisition/restructuring need to carry out a restructuring of one of the enterprise’s assets, finances, tax matters, personnel, legal matters etc., to complete the final closing of the transaction, and there are some design flaws in the specific details of the transaction structure − e.g., a discrepancy in the valuation of the enterprise, or an erroneous assessment of the transaction risks, thereby resulting in an economic loss − the decision makers of the parties to the acquisition/restructuring, particularly the management of a state-owned enterprise, will often face the risk of prosecution for the “crime of dereliction of duty or abuse of authority in a state-owned company or enterprise”, or the “crime of committing irregularities by discounting shares or selling state-owned assets at a low price” or the “crime of breach of fiduciary duty causing harm to the interests of a listed company”.

The author finds that the risk of such malfeasance crimes in the commercial sector is seen most commonly in acquisitions by state-owned listed companies. In one case in which the author was involved, the judicial authority held that the chairman of the board of a certain state-owned enterprise had, due to omissions in the design of the acquisition/restructuring transaction structure and failure to carry out the relevant risk assessment, caused the restructured enterprise to go bankrupt and be deregistered, and, as a result, pursued his criminal liability.

In short, the prevention and control of criminal risks and compliance reviews has become important in the course of an acquisition/restructuring carried out by a listed company. In the course of the financing, the enterprise must carry out exhaustive due diligence and block any financial fraud.

In the course of the specific negotiations and discussions, attention must be paid to the confidentiality and management of sensitive information, and the transaction details. When crafting the specific transaction structure for the acquisition/restructuring, detailed analyses, fact finding and assessment need to be carried out. Once the acquisition/restructuring has been completed, it is necessary to strictly oversee the restructured enterprise so as to guard against potential dangers.

Du Lianjun is a partner and Chu Zhilin is a trainee in the criminal litigation practice group of East & Concord Partners


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