In the first ever QFII-related lawsuit in China, Nanning Sugar, a company based in Guangxi province, has filed a lawsuit against Martin Currie Investment Management (MCIM) and Martin Currie Incorporated (MCI) with the Nanning Intermediate PeopleÆs Court for alleged breaches of article 47 under the Chinese Securities Law.

Nanning Sugar has successfully obtained court orders to freeze Martin CurrieÆs assets in China. A total of Rmb39.6 million ($6 million) under MCIMÆs QFII account will remain out of reach until the case is heard in court.

Article 47 states if a shareholder purchases and sells a stake of over 5% in a listed company in under six months, the company is entitled to the proceeds of the trade û a rule that Nanning Sugar claims Martin Currie has breached between August 2007 and January 2008. Nanning Sugar says Martin Currie should pay back the profit it made from trading the companyÆs stock, as well as accrued interested and incurred legal costs.

Lawyers say the rule was originally designed to deter short-term and insider trading.

This case is now attracting widespread concern. Particularly, it could affect the course of further reforms amid expectation for a coming QFII scheme expansion.

ôMartin Currie believes that the action that Nanning Sugar has taken is wholly unwarranted and there is no case to answer,ö says Scott White, spokesperson of Martin Currie in the UK. ôNanning Sugar has misunderstood how the current system works for foreign investors. They believe that Martin Currie companies owned more than 5% of the shares in issue and this is clearly incorrect."

According to White, MCIM has only held a maximum of 1.6% of Nanning SugarÆs shares in the period of the alleged breach. The rest of the stake that totals over 5% as Nanning Sugar has claimed belonged to four different clients and was invested across three different QFII accounts û some of which are advised by MCI û a separate legal entity from MCIM.

ôMartin Currie takes its compliance obligations very seriously and has never encountered any significant regulatory problems in its long history,ö White says, adding: ôThroughout its time in China, Martin Currie has been active in providing feedback to the CSRC (China Securities Regulatory Commission) and other regulators on QFII implementation and its share reform process.ö

MCIMÆs presence in China dates back to the early-90s.

Jun He Law Offices, a local legal practice, has been appointed as legal advisor to MCIM. The practice has signed a confidentiality agreement for the case. Sean Hu, managing director for China at Martin Currie, was out of the country as this story went to press. Chris Ruffle, fund manager for Greater China, is understood to have returned to Martin CurrieÆs Edinburgh head office. Nanning Sugar could not be reached for comment.

The Securities Law in China was first adopted in 1999 and was later revised in 2005. Given the asset management industryÆs young history in China û which has been in business for just 10 years û most of the rules remain untested and are subject to regulatorsÆ interpretation and revision as the market expands. Market punters have long warned of legal loopholes and overlapping regulations that will lead to later trouble.

According to Yang TieCheng, a counsel from Clifford Chance in Beijing, QFII investors are currently subject to regulation by the CSRC and rules on foreign exchange by SAFE. Given China's legal system is based on a civil law system, instead of case law, rulings follow the word of the law without reference to precedence.

Yang believes inconsistencies remain in the securities law and the country's regulation on disclosure of equity interest û a situation that could lead to potential conflicts when applied to foreign investors under the QFII scheme, until further clarified by the authorities.