Resolving financial disputes over complex investor products

Resolving financial disputes is crucial for maintaining market order and protecting investor rights. As China’s economy rapidly develops, transactions among financial participants have become more frequent, increasing trading risks and complicating disputes. This presents substantial challenges for financial institutions and investors. This article outlines key issues and current trends for fair and reasonable financial dispute resolution.

Emerging challenges

Complex products. Financial innovation provides new drivers for economic development while meeting diverse investor needs. However, it has also led to the increasing complexity of financial products.

Instruments such as structured investment products, multi-layered asset management products and financial derivatives are designed with such intricacy that investors often struggle to accurately assess their true value and potential risks.

Information asymmetry remains a fundamental source of financial disputes, with market volatility and resulting investment losses acting as direct triggers.

As investment returns fail to meet expectations, the inherent risks in financial product design become increasingly evident. Financial institutions, including but not limited to banks, trust companies, insurance firms, securities companies, asset managers, investment managers, fund houses and online financial platforms are now facing risks of litigation and even legal defeats.

For instance, banks may face disputes in their lending operations if they fail to adequately disclose interest rate adjustment mechanisms, leaving borrowers unexpectedly burdened with high interest.

Similarly, investors in multi-layered private equity funds may find themselves unable to exit the fund due to a lack of legal standing in the principle of privity of contract. Also, when wealth management products fall below their net asset value, investors failing to secure guaranteed returns and suffering significant losses often initiate lawsuits or arbitration against managers, sales institutions, investment advisory firms and custodians.

Lack of applicable laws. The structure of novel financial products is often highly complex, involving multiple participants, diverse asset portfolios and intricate trading processes with sophisticated risk allocation mechanisms. This requires a more comprehensive legal framework defining rights and obligations, and allocation of risks.

Yet, in existing legislation, there might not be applicable rules or standards ready to use, leading to insufficient or ambiguous legal grounds during dispute resolution. Variations in interpretation and application of legal provisions by different courts and arbitration bodies result in inconsistent rulings, and even contrary outcomes in similar cases.

Systemic risks. As the financial market rapidly evolves and market participants proliferate, the surge of collective disputes has become more pronounced, ranging from securities fraud, bond defaults and missing private fund managers to inadequate risk disclosures in wealth management products and problematic insurance contract terms. The resolution of these financial disputes carries significant responsibility for mitigating systemic risks and ensuring financial security.

Adjudication rules

Protecting vulnerable consumers. In financial dispute resolution, courts tend to favour the interests of vulnerable investors and consumers.

For instance, in a dispute where a private equity fund investor accused the fund manager and/or sales institution and its salespersons of breaching investor suitability obligations, the defendant could only present a private equity fund risk disclosure statement, a standard document prepared by the fund manager and signed by the investor after reading.

Yet the arbitration tribunal ruled that this did not sufficiently prove the fund had fulfilled its suitability obligations, and that it failed to adequately inform the investor of the risks and potential losses, and had not conducted a necessary comprehensive risk tolerance assessment of the investor.

Ultimately, the tribunal upheld the applicant’s claim for compensation amounting to the total unexited investment principal and interest.

However, protection afforded to investors is not without limitations, with financial institutions’ exemption from liability contingent on legal and regulatory compliance.

In a recent ruling, the Shanghai Financial Court noted: “Investment losses often stem from market forces, rather than the actions of private fund managers. It would be improper to demand that private fund managers provide exhaustive records of their every action to prove due diligence whenever a loss occurs. This does not constitute a fair allocation of the burden of proof.”

Regarding the obligation of information disclosure, the court held that investors must first satisfy an initial burden of proof, demonstrating clear impropriety in the transaction outcomes rather than simply demanding that managers provide records to disprove investment errors whenever losses occur.

If investors have met this initial burden – and managers are evidently unable to produce the relevant records – only then can the managers’ potential breaches of their duty of diligence be determined.

Consequently, the court ruled that losses resulting from investments in accordance with the fund contract terms fell within the contractual exemptions, and claims for the managers to bear the investment losses were unfounded. Market-driven losses were properly borne by the investors themselves.

Principle of not readily invalidating contracts. Provided there is no violation of mandatory legal and regulatory provisions, courts generally respect the parties’ freedom of contract and do not lightly negate the validity of agreements.

In a recent dispute over a business trust heard by the Beijing Financial Court, the core contention was whether the structured trust arrangement constituted off-exchange margin financing, thus rendering the trust invalid.

Through a comparative analysis of the similarities and differences between structured trusts and off-exchange margin financing, the court established that while the structured trust had a leveraging function to provide financing for inferior beneficiaries, akin to margin trading, it did not exhibit the characteristics of “off-exchange margin financing” – namely, the absence of investment risk for certain beneficiaries, or breach of laws and regulations.

Therefore, the court concluded that the structured trust should not be identified as a form of off-exchange margin financing, and ruled against the previous determination of contract invalidity, reflecting a principle of moderate piercing of the trust structure.

The court also noted that side agreements between trust beneficiaries regarding deficit coverage represented independent re-allocation of trust returns and risks, which should not directly invalidate the trust contract itself.

Key takeaway

Resolving financial disputes fairly and reasonably within a balanced dispute resolution framework can effectively safeguard the legitimate rights and interests of both investors and financial institutions, reinforcing market confidence.

With clear legal guidelines in place, financial institutions can pursue innovation without undue concern over the uncontrollable risks of arising disputes.

Li Fang is a senior partner at Tiantai Law Firm. She can be contacted by phone at +86 10 6184 8228 and by email at lif@tiantailaw.com