The financial fraud committed by Nasdaq-listed Luckin Coffee Inc. (“Luckin Incident”) has sparked a heated discussion in the media and within relevant industries about whether the Chinese Securities Regulatory Commission (“CSRC”) will exercise long-arm jurisdiction pursuant to Paragraph 4 of Article 2^[1] of the new Securities Law, implemented on March 1 of this year (“Securities Law”).  In conjunction with the position taken by the CSRC following the Luckin Incident, we are of the view that the CSRC is currently more concerned with strengthening cross-border regulatory collaboration so as to support foreign securities regulatory agencies in carrying out investigations and penalties for financial frauds by public companies within their own jurisdictions, rather than utilizing the Luckin Incident to clarify the circumstances for extraterritorial application of the Securities Law as claimed by some observers.^[2]

The CSRC has mentioned the Luckin Incident twice this month.  On April 3, the CSRC website posted that they are highly concerned about the incident and strongly condemn the company’s financial fraud, adding that it would verify the situation in accordance with arrangements for international securities regulatory collaboration (“3^rd April Statements”).  On April 27, CSRC posted an update on its website, responding in a Q&A to questions on cross-border regulatory collaboration after the Luckin Incident (“27^th April Update”).  The following is a review and analysis of the 27^th April Update.

I. CSRC Initiated Contact with U.S. Securities and Exchange Commission (“SEC”)

The CSRC reported that, since the Luckin Incident, it initiated contact with the SEC regarding the matter of cross-border regulatory collaboration and has received a positive response from the SEC.

II. CSRC Support for Cross-Border Regulatory Collaboration

The CSRC emphasizes that it has always held a positive position towards cross-border regulatory collaboration and supported foreign securities regulatory agencies in carrying out investigations and penalties for financial frauds by public companies within their own jurisdictions.

III. CSRC Past Provisions for Assisting Foreign Regulators to Acquire Audit Work Papers

The CSRC cited its progress in providing audit work papers to relevant foreign regulators, including:

1. Under the International Organization of Securities Commissions (“IOSCO”) Multilateral Memorandum of Understanding and other collaboration frameworks, the CSRC has provided several foreign regulators with audit work papers for a total of 23 overseas listed companies, 14 of which were provided to the SEC and the Public Company Accounting Oversight Board (“PCAOB”);
2. In October 2019, the PRC and the US reached a consensus on the transfer of audit work papers for US-listed companies that are audited by Hong Kong accounting firms and stored on the Chinese mainland;
3. With regard to the PCAOB’s requirements for entry inspection of the PCAOB–registered Chinese accounting firms, the CSRC and PCAOB have been seeking an inspection plan acceptable to both parties.  In 2013, the CSRC and PRC Ministry of Finance signed a memorandum of understanding on law enforcement cooperation with the PCAOB, and provided the PCAOB with four companies’ audit work papers.  From 2016 to 2017, the PRC and the US conducted pilot inspections on PCAOB-registered Chinese accounting firms, where the Chinese party assisted the PCAOB in inspections of quality control systems of accounting firms and the audit work papers of three US-listed companies.  Since 2018, citing international practices for audit regulatory collaboration, the Chinese party has repeatedly proposed to the PCAOB a specific plan to carry out joint inspections of accounting firms, with the latest plan proposed on April 3 of this year.  Finally, the CSRC said it looks forward to receiving a response as soon as possible and to further cooperate with the PCAOB.

Our Observations

Firstly, from our point of view, the CSRC’s 27^th April Update focuses on emphasizing cross-border regulatory collaboration, especially the collaboration in the field of international audit regulation; it does not mention the extraterritorial provisions of the Securities Law.  In this regard, the 27^th April Update shall not be over-interpreted as an intention to exercise the “long-arm jurisdiction” under the Securities Law.  Secondly, the CSRC stressed that the date of their latest proposal for carrying out a joint inspection on accounting firms was proposed to the PCAOB by CSRC on April 3 of this year; and this date coincides with the release of the CSRC’s condemnation on the Luckin Incident.  To view the CSRC’s 27^th April Update and 3^rd April Statements together, the above positions further confirm that the CSRC’s enforcement actions are still motivated by cross-border regulatory  collaboration, rather than an attempt to invoke Securities Laws for extraterritorial enforcement.

We note that IOSCO formulated the Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information (“MMoU”) in May of 2002, and the CSRC officially signed the MMoU in 2007.  The three securities regulatory objectives established by IOSCO are to protect investors, ensure that the markets are fair, efficient and transparent; and reduce systemic risks.  That the CSRC, under the IOSCO MMoU and other collaboration frameworks, assists and supports the foreign securities regulatory agencies in carrying out investigations and penalties for financial frauds committed by listed companies within their jurisdictions is in line with the three securities regulatory objectives established by IOSCO.

Furthermore, it is noteworthy that in July 2019, the Ministry of Finance, together with the CSRC and Securities and Futures Commission signed the three-party memorandum of understanding on cooperation, which made arrangements for the transfer of audit work papers in relation to mainland HK-listed company that are audited by Hong Kong accounting firms, and further refined and improved the regulatory collaboration mechanism between Mainland China and Hong Kong.

We look forward to the next steps toward achieving more tangible results on cross-border regulatory collaboration between the CSRC and regulators in other jurisdictions.

We will continue to monitor the situation and keep our clients apprised of any important developments.

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[1]           Paragraph 4 of Article 2 of the Securities Law provides that “issuance or trading activities of securities outside the territory of PRC that disrupt the order of the market within the territory of the PRC or damage the legitimate rights and interests of the investors within the territory of the PRC shall be regulated and relevant legal responsibilities shall be pursued in accordance with this Law.”  This indicates that the Securities Law has certain extraterritorial jurisdiction, which based on our understanding would mean that the issuance or trading behavior occurred in an exchange or over the counter outside of the territory of PRC may be held liable under the Securities Law, if it disrupts the market order of the PRC or damages the legitimate rights and interests of investors of the PRC.

[2]           Article 177 of the New Law prescribes that the securities regulatory authority of the State Council may, in conjunction with the securities regulatory authorities of other countries or regions, establish a mechanism to conduct cross-border supervision and administration.  Foreign securities regulatory authorities shall not conduct investigations, evidence collection and other activities directly within the territory of the PRC.  Without the consent of the securities regulatory authority of the State Council and the competent departments of the State Council, no entity or individual may provide documents or materials relating to securities business activities to foreign authorities without approval.