Wuhan Zhongrong Trade Development Company v. Great Wall Securities, Zheng Mou, et al., Stock Sub-account Case

[2] I. Case Overview

On October 13, 2000, the plaintiff, Wuhan Zhongrong Trade Development Co., Ltd. (hereinafter referred to as Zhongrong Company), having obtained the original ID card of the third party in this case, Zheng XX, opened Shenzhen and Shanghai shareholder code cards (Shanghai code: A381350148, account name: Zheng XX) at the Wuhan Securities Registration Center for stock trading. On July 30, 2002, Zhongrong Company opened a stock account under Zheng XX's shareholder code card at the defendant's Shenzhen Dongyuan Road Business Department of Changcheng Securities Co., Ltd. (hereinafter referred to as the Dongyuan Road Business Department). As of August 7, 2002, the account held a total of 165,028 shares of Changjiu Co., Ltd. (with a market value of RMB 3,412,779.04).

On August 8, 2002, another third party in this case, Qian, without authorization from Zhongrong Company, submitted a false "Application for Cancellation of Designated Transaction," "Designation Application," and "Shareholder Transfer Authorization" bearing the seal of Zhongrong Company (the seal affixed was that of "Wuhan Zhongrong Trade Development Co., Ltd.," which was clearly inconsistent with the seal filed by the company with the defendant), and applied to Dongyuan Road Business Department to cancel the designation, register a new designation, and transfer the registration of Zheng XX's shareholder code card from Zhongrong Company's capital account to his own capital account. The following day, third party Zheng XX's Shanghai shareholder code card A381350148 and his 165,028 shares of Changjiu Biochemical stock were transferred and attached to the capital account opened by another third party in this case, Qian, at the Dongyuan Road Business Department. After Zhongrong Company discovered this and failed to recover the assets, it filed a lawsuit with the Futian Court in Shenzhen on January 8, 2003, seeking an order that the defendant compensate for economic losses of 3,412,779 yuan. Zhiming lawyer, as the attorney representing third party Zheng XX in this case, participated in the litigation of this case and, based on the provisions of the real-name securities registration system, argued that the disputed stocks in this case should belong to third party Zheng XX.

On October 23, 2003, the Shenzhen Futian Court ruled in the first instance [ (2003) Shen Fu Fa Min Er Chu Zi No. 357 ] that with respect to the claim of the third party Zheng XX:

“我国虽然对股票的权属实行实名制的登记制，但登记权利人的所有权人地位可被充分的反证予以推翻。换言之，当确有证据证明登记权利人与实际权利人不一致时，仍 应以实际权利人来确认权属关系。——以上种种，有充分证据表明可以认定原告系借用第三人郑XX身份证开立股东卡购买股票，诉争股票的实际所有人为 原告，其合法权益受法律保护。——第三人郑XX的相关述称，证据不足，理由不充分，本院不予采信。”

The Futian Court hereby rules on the plaintiff's claims as follows:

The first and third defendants, Qian Mou, shall compensate the plaintiff for economic losses of RMB 3,412,779 within ten days from the date this judgment takes effect.

Second, the Defendant, Dongyuan Road Business Department, shall bear joint and several liability for compensation for the aforementioned debts of the third party, Qian.

Third, when the assets of the Defendant Dongyuan Road Business Department are insufficient to satisfy the aforesaid debts, Defendant Great Wall Securities shall bear supplementary liability for such debts.

The Dongyuan Road Business Department appealed against the first-instance judgment. On February 12, 2004, the Shenzhen Intermediate People's Court rendered its second-instance judgment [(2004) Shenzhen Intermediate People's Court Civil Second Instance Final No. 233]: the appeal was dismissed and the original judgment was affirmed.

II. Focus of the Case

The core focus of the dispute in this case is how to confirm the attribution of property rights and interests in sub-accounts linked under a stock securities fund account.

(1) Plaintiff Zhongrong Company:

1. It is believed that the subject matter of the lawsuit in this case (165,018 shares of Changjiu Biochemical stock) belongs to it.

2. It is believed that the defendant, Dongyuan Road Business Department, infringed upon the plaintiff's ownership rights by privately transferring the shareholder card affiliated with the plaintiff's capital account to a third party, Qian (the plaintiff claims that Qian was not authorized), and the defendant is required to bear liability for the losses incurred as a result.

(2) Defendant: Dongyuan Road Business Department:

1. It believes that it has not infringed upon the plaintiff's rights and interests, and that the formalities it handled were completely lawful, because Qian Mou had the plaintiff's authorization.

2. The plaintiff does not hold ownership of the stocks subject to the lawsuit. According to the records, these stocks are under the Shanghai shareholder account A381350148 (account holder: Zheng XX), and the ownership should rightfully belong to Zheng XX.

3. Zhongrong Company's custody of the stocks under Zheng XX's name violates the provisions of China's Securities Law.

(III) Third Party Qian Mou:

No defense was submitted, nor was there an appearance in court.

(IV) Third party Zheng XX:

Believes that they, rather than anyone else, should be the rightful owner of the subject matter in dispute in this case.

III. Analysis of This Case

This case is a securities dispute arising under special historical circumstances. At that time, China's procedures for stock account opening and designated trading were not as rigorous as they are now, and the trading system was not fully developed. Currently, one stock account corresponds to one capital account, with funds held in custody at a bank. This is unlike the previous arrangement, where multiple stock sub-accounts could be attached under a single capital account, and funds were held in custody with the securities firm.

The focus of the dispute in this case lies in:

(I) The issue of confirming stock ownership rights: whether it infringes upon the rights of the third party, Zheng XX.

(2) Whether Zhongrong Company's entrustment of the stocks under Zheng XX's name for custody violates the provisions of China's Securities Law. (Prohibition of legal persons opening accounts in individual names to buy and sell securities).

(3) Determination of liability of the Dongyuan Road Business Department.

(IV) The Issue of Determining the Nature of the Third Party Qian's Liability

Regarding the third and fourth issues, on the basis of respecting the facts confirmed by the court, Attorney Zhiming believes that the court's adjudication was not improper. In the case, during Qian's application to the Dongyuan Road business department for revocation of designation and registration of designation, the seal on the power of attorney was not the seal of Zhongrong Company and did not match the seal impression reserved by Zhongrong Company at the Dongyuan Road business department. Qian's conduct constituted infringement. The defendant also failed to exercise sufficient duty of care when handling the client's entrustment. Therefore, it was not improper to hold the defendant Dongyuan Road business department liable for joint and several liability.

Regarding the second focal point, Attorney Zhiming agrees with the view of the court of second instance, holding that it does not fall within the scope of handling in this case. If this provision is violated, consequences of violating administrative laws and regulations should arise, while ownership disputes arising from the act of borrowing purchased stocks constitute civil disputes.

Regarding the first focal point, Attorney Zhiming has reservations about the facts of the case as determined by the court. In fact, looking at the entire case, the most thought-provoking and discussion-worthy aspect lies precisely here: the plaintiff asserts that—

1. Zheng XX's ID card and shareholder card have been in the plaintiff's possession at all times.

2. All procedures such as transactions involving the affiliated account shall be handled and taken responsibility for by the plaintiff.

3. It is acknowledged that the plaintiff provided funds for the buying and selling of stocks.

From this, it is considered that it is the true rights holder of the stocks in question. The court held that although China's law adopts a real-name registration system for stocks, the registered rights holder's status as owner can be overturned by sufficient rebuttal evidence. However, what we actually see is that the plaintiff, from beginning to end, did not provide evidence that the disputed stocks were purchased with its own funds, sufficient to overturn Zheng XX's status as rights holder. As is well known, engaging in stock trading requires the establishment of two accounts: one is the stock account, which is what we commonly call the shareholder card number, used to record the trading and changes of the stocks. The other is a funds account, established at a securities firm, used to record changes in funds. First, the subject matter in this case is clearly shown to be registered under shareholder card number A381350148, which further indicates that Zheng XX was at least nominally the rights holder of the subject matter. When the plaintiff raised an objection, it should have presented sufficient reasons and evidence for this, and the most sufficient evidence would be for the plaintiff to explain that the stocks were purchased with its own funds; any other evidence would be insufficient to prove its claim of ownership. To further illustrate, we may take real estate registration as an example: under Chinese law, ownership of a house is determined by registration, unless there is sufficient proof that the house was purchased with funds from another person; otherwise, the law only recognizes the registered rights holder. In this case, all the evidence presented by the plaintiff fails to show that the stocks were purchased with the plaintiff's funds. Therefore, we believe that the court's adjudication is open to question.

At the second-instance trial, Lawyer Zhiming raised an objection on the grounds that the plaintiff's lawsuit was originally based on a tort claim but was changed to a breach-of-contract claim during the court hearing. According to legal provisions, a party may change its claims and the legal basis therefor, so the first-instance court should have tried the case on the basis of the breach-of-contract claim. However, in its judgment, the first-instance court ruled on the basis of the tort claim, which clearly violated the principle of "no trial without complaint." The second-instance court adopted Lawyer Wang's opinion and held that the first-instance court's legal basis was improper. Regrettably, however, it did not support the other requests and upheld the original judgment. Nevertheless, what is worth learning and studying is the issue of confirming the property ownership relationship between the master account and its subordinate sub-accounts in this case, especially under the conditions more than ten years ago when neither the securities nor the financial sectors in China had implemented a real-name system. Resolving the dispute and determining right from wrong under such circumstances required an exceptionally high level of cognitive ability. This case serves as an instructive analogy for other similar cases in the future.

(Compiled and commented by Sun Zhitao)

Zhiming Office

February 21, 2004