Criminal Liablity for Illegal Private Placement

In September 2016, the uproarious M&A scheme where Bai Chi Gan Tou Digital Entertainment announced to acquire XPEC Entertainment has defrauded as many as 20,000 investors with a total investment amount reaching NTD 5 billion. As a result, the law enforcement department initiated a criminal investigation. The main suspect Mr. Hsu is the responsible person of XPEC Entertainment. Apart from this case, Mr. Hsu had engaged in multiple illegal private placements since 2013, which is the prime focus of this article.

Case Background

From 2013 to 2015, Mr. Hsu repeatedly deceived XPEC Entertainment’s shareholders  by pretending to introduce strategic investors, causing the shareholders' meetings to pass resolutions approving the issuance of XPEC Entertainment’s stocks in the form of private placement at a discounted rate of 20% to limited pool of investors and authorizing Mr. Hsu to execute the plan. In fact, the so-called strategic investors were dummy companies controlled by Mr. Hsu with no genuine intention to invest XPEC Entertainment. The stocks acquired through these private placements were ultimately controlled by Mr. Hsu himself. By doing so, Mr. Hsu could acquire XPEC Entertainment’s stocks at a discounted price, which is 20% lower than the market value.

Relevant Legal Provisions

Such conduct is suspected of committing special breach of trust under Article 171, paragraph 1, subparagraph 3 of the Securities and Exchange Act (“SEA”) and the financial statement fraud under Article 20, paragraph 2 of the SEA.

The first issue is whether Mr. Hsu's fabrication of strategic investors and his acquisition of XPEC Entertainment’s stocks through private placements at a lower price constitute breach of duty that caused damages to the company. Additionally, according to relevant regulation, the company is required to file for recordation with the competent authority when commencing private placement. The second issue is whether filing documents  with misrepresentation of strategic investors fall under the definition of financial or business documents specified in Article 20, Paragraph 2 of the SEA.

Court's Ruling

In the first-instance judgment, the court held that the fact that Mr. Hsu fraudulently acquired XPEC Entertainment’s stocks by pretending to introduce strategic investors clearly violated his commitment to the shareholders and the board that the company will "ensure long-term cooperative relationship with the strategic investors." The court further held that if the private placement stocks could be arranged solely by the company's responsible person through complex personal contractual relationship and other source of funding without engaging individuals with investment intentions or strategic services, the principle of corporate governance and normal regulatory mechanisms of the security market would be destroyed. Therefore, the first-instance judgment convicted Mr. Hsu of special breach of trust (see Taipei District Court Criminal Judgment 106-Jin-Chung-Su-Zi 6).

However, in the second-instance judgment, the court took a different view and held that "Mr. Hsu indeed had the intention to act against his duty for his own unlawful profit. Nevertheless, the fact that XPEC Entertainment chose to raise funds through private placement was out of actual financial need. Compared to loans or public offerings, private placement incurred the lowest cost. Moreover, in this case, all the capitals have been paid and the discounted rate (approximately 20% lower than the reference price) aligned with general market conditions. It cannot be proven that XPEC Entertainment has suffered any damages consequently." Therefore, the second-instance judgment concluded that Mr. Hsu could only be convicted of attempted breach of trust (see Taiwan High Court Criminal Judgment 107-Jin-Shang-Chung-Su-Zi 4).

As to whether the misrepresentation of strategic investors in the filing documents constitutes financial statement fraud, both the first and second-instance judgements held that the filing documents for recordation do not fall under the definition of financial or business documents as specified in Article 20, Paragraph 2 of the SEA. Therefore, no financial statement fraud was involved. However, the Supreme Court took a different view and held that the filing documents for recordation should also be considered financial or business documents. Accordingly, whether the defendant constitutes financial statement fraud remains an issue to be determined (see Supreme Court Criminal Judgment 108-Tai-Shang-Zi 16).

In summary, to constitute the crime of special breach of trust under Article 171, Paragraph 1, Subparagraph 3 of the SEA, the company must suffer damages exceeding NTD 5 million.  Since XPEC Entertainment did receive capital and the share price was not lower than the general market conditions for private placement, XPEC Entertainment has not suffered any damages. Even though the private placements conducted by Mr. Hsu were illegal, it would be difficult to convict him of special breach of trust.  As to the financial statement fraud under Article 20, Paragraph 2 of the SEA, its legislative purpose is to ensure information disclosure and accuracy and safeguard public's trust in the financial and business documents announced by the companies required by relevant laws. Considering these documents typically would influence the public’s investment decisions, misrepresentation is not allowed. This is the reason why the Supreme Court held that the misrepresentation in the filing documents for recordation could also constitute financial statement fraud. This interpretation remained unchanged after the Supreme Court remanded the case to the High Court for retrial (see Taipei High Court Criminal Judgment 109-Jin-Shang-Chung-Geng-Yi-Zi 2).


(The article is originally in Chinese which can be found here.)

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Criminal Liablity for Illegal Private Placement