TYGlobe

In October 2024, against the fundamental backdrop of a host of favorable national policies, the A-share market has witnessed an accelerated upward momentum. The returns of a large number of private fund products have accordingly turned from negative to positive. However, data released by Simuwang (Private Equity Ranking Network) in August showed that the private fund index registered a return of -1.76% in August, with a year-to-date return of -7.84%. Most private fund companies have not only suffered a severe shrinkage in their assets under management (AUM), but also borne considerable pressure on investment returns, and private fund products posting losses of over 50% are ubiquitous. Among them, a total of 235 products managed by RMB 10-billion-level private fund managers have public performance disclosures, recording an average return of -0.05% and a median return of -4.86% from January to August this year. 74 products, accounting for 31.49% of the total, have achieved positive returns. These data fully demonstrate that private funds are high-risk products among wealth management products. There are certainly multiple reasons for such high risks, which are not only related to the economic environment and investment attributes, but more importantly arise from factors including the opaque information of private fund products and the uneven qualifications of private fund managers. Therefore, when a private fund product incurs losses, especially huge losses, it remains a pending issue whether investors shall bear the losses on their own under the principle of "buyer beware", or the issuer, distribution agency or service agency of the private fund product (hereinafter collectively referred to as the "seller institution") shall bear liability for failure to fulfill their due obligations. Putting aside the issue of investment capacity of private fund managers, most disputes revolve around whether the seller institution has effectively fulfilled its investor suitability obligation. On this basis, the author holds that under the current circumstances where disputes between investors and seller institutions are on the rise and no unified consensus has been formed in judicial judgments, it is necessary to conduct further discussions on the institutional system, legal nature, review criteria for obligation performance of private fund investor suitability obligations, as well as effective case representation approaches from the perspective of lawyers. This paper will carry out analysis on the aforesaid aspects one by one.

I. Institutional System of Investor Suitability Obligation

(I) Scope of Seller Institutions

Before clarifying the institutional system of investor suitability obligations, the scope of selling institutions in the private fund sector shall be defined first. According to the *Minutes of the National Working Conference on Civil and Commercial Adjudication of the People's Courts of China* (i.e. the Jiu Min Ji Yao), selling institutions refer to issuers of financial products, sellers and financial service providers. (As current disputes related to private funds are concentrated between investors, issuers and sellers, this paper focuses on the analysis of the first two types of selling institutions, and financial service providers are excluded from the scope of analysis for the time being.) As for private funds, it is relatively clear that the issuer of private fund products is the private fund manager. However, the definition of sellers remains controversial at present. According to the provisions of relevant laws and regulations on private funds, the types of private fund products that different qualified sellers can distribute on an agency basis vary.

In July 2023, the State Council promulgated the *Regulations on the Supervision and Administration of Private Investment Funds*, which adopts a fairly strict stance over agency sale activities of private funds. Article 17 of the Regulations stipulates that "A private fund manager shall raise funds on its own, and shall not entrust any other entity to raise funds, except as otherwise prescribed by the securities regulatory authority of the State Council." Meanwhile, pursuant to the *Measures for the Supervision and Administration of Public Securities Investment Fund Sales Institutions* promulgated by the China Securities Regulatory Commission (CSRC) in 2020, financial institutions that have obtained the fund sales business qualification, including commercial banks, securities companies, futures companies and independent fund sales institutions, are entitled to act as agents for the sale of private fund products. However, independent fund sales institutions may only act as agents for the sale of private securities investment funds. That is to say, financial institutions such as commercial banks, securities companies and futures companies may act as agents for the sale of all types of private fund products (including equity-focused and securities-focused products), while independent fund sales institutions may only act as agents for the sale of securities-focused private fund products. As for whether independent fund sales institutions can act as agents for the sale of other types of private fund products, no explicit definition is given in the *Measures for the Supervision and Administration of Public Securities Investment Fund Sales Institutions*. According to the author's research, some independent fund sales institutions, driven by performance pressure, are still acting as agents for the sale of equity-focused private fund products, with their reason based on Article 9 of the aforesaid Measures, which provides that "Independent fund sales institutions shall not engage in other businesses, except as otherwise prescribed by the CSRC." This provision can be extended to apply to relevant provisions on private funds issued by the CSRC and the Asset Management Association of China (AMAC). Among them, Article 2 of the *Administrative Measures on Private Investment Fund Raising Activities* promulgated by AMAC in 2016 stipulates that a private fund manager may either raise funds on its own, or entrust an institution that has obtained the fund sales business qualification and has become a member of AMAC to raise private funds. The provisions of the *Administrative Measures on Private Investment Fund Raising Activities* do not prohibit independent fund sales institutions from acting as agents for the sale of other types of private funds.

In short, in accordance with the provisions of relevant laws and regulations of China and in combination with the agency distribution scale of private fund products in actual practice, the main distributors of private funds are commercial banks, securities institutions and independent fund distribution institutions. As for the specific types of private funds that different distributors are qualified to distribute on an agency basis, they shall be subject to further detailed rules or guiding provisions issued by the China Securities Regulatory Commission (CSRC).

(II) Relevant Legal Documents

Currently, provisions on the investor suitability obligation for private funds are issued by multiple regulatory authorities, scattered in form and inconsistent in requirements. From the two dimensions of the scope of selling institutions (including private fund managers, commercial banks, securities institutions and independent fund sales institutions) and China's legislative system (comprising laws, administrative regulations, departmental rules and self-regulatory rules), the main relevant legal documents involving the suitability obligation are listed as follows:

1. Law. The Securities Investment Fund Law of China.

2. Administrative Regulations: *Regulations on the Supervision and Administration of Private Investment Funds*.

3. Departmental Rules *Interim Measures for the Supervision and Administration of Private Investment Funds*, *Measures for the Administration of Suitability of Securities and Futures Investors*, *Measures for the Supervision and Administration of Publicly Offered Securities Investment Fund Sales Institutions*, *Interim Provisions on the Administration of Audio and Video Recording in Sales Areas of Banking Financial Institutions*, *Measures for the Supervision and Administration of Wealth Management Business of Commercial Banks*, *Interim Measures for the Administration of Personal Wealth Management Business of Commercial Banks*

4. Self-regulatory Rules: *Administrative Measures for the Fundraising Behaviors of Private Investment Funds*, *Implementation Guidelines for the Appropriateness Management of Investors by Fund Raising Institutions (for Trial Implementation)*, *Guidelines for Internal Control of Private Investment Fund Managers*.

5. Others. *Minutes of the National Working Conference on Civil and Commercial Trials of People's Courts* (commonly known as the *Nine Civil and Commercial Trial Minutes*), *Guiding Opinions on Regulating the Asset Management Business of Financial Institutions* (commonly known as the *New Asset Management Regulations*), *Notice of the China Banking Regulatory Commission on Regulating the Agency Sales Business of Commercial Banks*, *Notice of the General Office of the China Banking Regulatory Commission on Risk Alert for Relevant Businesses of Commercial Banks Concerning Agency Sales of Funds and Insurance Products*.

II. Contents of the Investor Suitability Obligation

Pursuant to regulatory provisions including the *Minutes of the National Civil and Commercial Trial Work Conference*, the *Measures for the Administration of the Suitability of Securities and Futures Investors*, and the *Implementation Guidelines for the Administration of Investor Suitability by Fund Raising Institutions (for Trial Implementation)*, investor suitability obligations mainly consist of four aspects, namely know your customer, know your product, matching of customers with products, and disclosure and explanation.

1. Know Your Customer. Seller institutions shall ascertain the basic information, financial status, investment experience, investment objectives, risk appetite, bearable losses and other relevant information of their customers.

2. Product Understanding Selling institutions shall be fully aware of the information of the products they sell, and classify the products into different risk ratings based on their risk characteristics and risk levels. When classifying risk ratings, factors such as liquidity, maturity period, leverage status, structural complexity, etc. shall be comprehensively considered.

3. Customer-Product Matching. Selling institutions shall sell appropriate products to appropriate customers, that is, the risk rating of a customer shall match the risk rating of the product.

4. Disclosure and Explanation. Selling institutions shall explicitly provide reminders and explanations on product attributes, characteristics, product liability, returns, risks, losses, redemption conditions and other relevant contents.

III. Procedures for Investor Suitability Obligations

Classified from the perspective of investor subjects, investors are divided into individual investors, institutional investors and product investors. Individual investors are further subdivided into retail investors, professional investors, and co-investing employees of private fund managers. Institutional investors are further subdivided into retail investors, professional investors and private fund managers. Pursuant to the relevant legal provisions on private funds, the procedures for performing suitability obligations applicable to different types of investors are not identical, with details set out in the table below:

Types of Investors

Certification Documents for Qualified Investors

Risk Assessment

Dual Recording (audio and video recording)

Cooling-off Period and Follow-up Visits

ordinary investor

√

√

√

√

Professional Investor

√

×

×

√

product investors

×

×

×

×

private fund manager

×

×

×

×

Employees of the Private Fund Manager

×

×

√

×