Transcript Shareholder initiated Enforcement: Derivative Suit and Class-Action Lawsuits Policy Dialogue on Corporate Governance in China Shanghai February 26, 2004 Hasung Jang Professor, Korea University Business School Director,

Shareholder initiated Enforcement:
Derivative Suit and Class-Action Lawsuits
Policy Dialogue on Corporate Governance in China
Shanghai
February 26, 2004
Hasung Jang
Professor, Korea University Business School
Director, Asian Institute of Corporate Governance
Chair, PEC-PSPD
Why Empowering Shareholders?
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In many emerging market countries, weak or
lack of enforcement is the problem, not the
regulation itself.
Shareholder’s legal action can complement
weak enforcements of regulations and laws
“…private rights of action are not only
fundamental to the success of our securities
markets, they are an essential complement to
the SEC's own enforcement program"
Remarks by Arthur Levitt, former chairman of the SEC
How to Empower Shareholders
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Strengthen shareholder’s rights
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Attending shareholder meetings
Inspecting financial record
Making shareholder proposal
Seeking injunction against illegal acts
Action to remove directors and auditors
Convening special shareholders’ meeting
Requesting cumulative voting
Filing lawsuits
Minority Shareholder Rights
Korean Case
1997
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Bringing shareholder derivative actions
Seeking injunctive action against illegal acts
Convening a special shareholders’ meeting
Making a shareholder proposal
Requesting cumulative voting
Requesting removal of directors & auditors
Compelling inspection of financial records
Appointing inspector to examine records
1% (0.5%)
1% (0.5%)
3% (1.5%)
1% (0.5%)
-1% (0.5%)
3% (1.5%)
3% (1.5%)
2002
0.01%
0.05% (0.025%)
3% (1.5%)
1% (0.5%)
3%
0.5% (0.25%)
0.1% (0.05%)
3% (1.5%)
The numbers in parentheses apply to companies with at least 100 bil won in paid-in capital. All rights
are subject to ownership more than six months
Minority Shareholders’ Rights
Korea and Japan
Minority SH Right
Korea
public co. (large co.)
Japan
Action to remove
directors and auditors
0.5% (0.25%)
outstanding shares
3.0% voting rights
Seeking injunction
against illegal acts
0.05% (0.025%)
outstanding shares
Auditors may request
that director cease
illegal acts
Bringing shareholder
derivative suit
0.01%
outstanding shares
Any contemporaneous
Shareholder
Limitation on directors
liability
Not permissible
Permissible under
Certain conditions
Compelling inspection
of financial records
0.1% (0.05%)
outstanding shares
3.0% voting rights
Minority Shareholders’ Rights
Korea and Japan
Minority SH Right
Korea public co. (large Japan
co.)
Convening special
shareholders’ meeting
3.0% (1/5%)
outstanding shares
3.0% voting rights
Making a shareholder
proposal
1.0% (0.5%)
outstanding shares
1.0%
or 300 voting shares
Requesting cumulative
voting
3.0%
outstanding shares
Any shareholder,
unless certificate
provides otherwise
Appointing inspector to
examine corporate
affairs and records
3.0% (1.5%)
outstanding shares
3.0% voting rights
Why Shareholders are not Active?
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Individual Shareholders
Information access is limited
 High cost and complicated legal procedures
 Short term investment horizon
 Reward and incentive is limited
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Institutional Shareholders
Lack of corporate governance risk management
 Lack of internal Chinese wall
 Lack of long-term commitments
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How to Empower Shareholders
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Lower barriers in exercising rights
Procedural complication
 High cost
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Provide incentives to be active
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Private benefits
Enhance accessibility to information
More disclosures
 Board activities, compensations etc.
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Derivative Lawsuit
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Shareholders file a suit against directors on
behalf of the company
Burden of proof lies with plaintiff (shareholders)
Reward paid to the company, not to shareholder
Ruling applies only to shareholders participated
the lawsuit
Legal cost should be paid by the shareholders.
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If shareholders win, the cost can be claimed against
the company. If shareholders lose, shareholders pay
Management is friendly to director defendant
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No action taken even when plaintiff wins
Class-Action Lawsuit
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Shareholder files suit against directors to recover
his/her loss
Burden of proof is on the defendant (directors)
Reward paid to plaintiff, not to company
Ruling applies to all shareholders unless opted
out
Legal cost paid by plaintiff
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Lawyer's fee is usually contingent on outcome
Possibility of lawsuit is a credible threat to
directors
Why Security Class Action Suit?
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Private litigations and derivative lawsuits are
not effective means for minority shareholders in
recovering loss from illegal and fraudulent acts
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Legal cost far exceeds loss for small minority
shareholders in private litigations
Discovery of facts is difficult
Loss for each shareholders is small,but the sum of loss
is large.
Illegal transactions such as ‘stock price manipulation’
is the easiest way to make a big money
Government’s enforcements of laws is weak
Potential Problems with
Class Action Lawsuits
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Abusive Litigation
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Professional plaintiff: lawyer’s lawsuit, not
shareholder’s
Out of court settlement: lawsuit can be used as “green
mail”
Limited disclosure in a fear of litigation
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Passive projections by the management on business
perspectives
US Class-Action Lawsuit
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Federal Rules of Civil Procedure of 1938
Private Securities Litigation Reform Act of 1995
Liability exemptions on forward looking statement or
projections if meaningful cautionary warning is stated
 Restriction on professional plaintiff
 Most representative lead plaintiff.
 Limit lead plaintiff to 5 times in 3 years
 Sanctions for abusive litigation by levying legal cost
on plaintiff
Securities Litigation Uniform Standards Act of 1998
 Covered securities class action suits under Federal
jurisdiction
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Number Securities Related
Class Action Suit Filed in US
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Federal Court
156
194
154
225
185
122
169
247
207
201
State Court
46
31
47
64
10
25
13
13
-**
-
Total
202
225
201
289
195
147*
182
260
207
201
Number of Class-Action Lawsuits
Filed in US
NYSE
NASDAQ
AMEX
Others
Total
1999
67
122
9
9
207
2000
62
131
3
5
201
Number of Listed Proportion
Companies in 2000 in 2000
2,862
2.2%
4,734
2.8%
Derivative and Class-Action Lawsuits
Korean Case
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Derivative Lawsuit
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Allowed by Commercial Code and Security
Transaction Act
No suit filed before the crisis even if it had been
allowed
Only NGO has filed derivative lawsuits since the
crisis in 1998
Securities Class-Action Lawsuit
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It was adopted in December 2003
It will go in effect from January 2005
Derivative Suits: Korean Case
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Shareholder or group of shareholders should
have at least 0.01% of outstanding number of
shares
Shares should have been held for more than six
months at the time that suit is filed.
Shareholder should ask the company to file a
suit. If the management does not file a suit in a
month, then shareholder has a right to file it.
Suit stands as long as there is at least one
shareholder remains
Three derivatives lawsuits filed since 1997
Derivative Lawsuits:
Korea First Bank
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The first derivative lawsuit filed in Korea
Court ruled in favor of defendant
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$33.3 million awarded
Bank lowered the amount to $3 million due to legal fee
Suit filed in May 1997
District court ruling in July 1998
Higher court ruling in January 2000
Supreme court’s final decision in March 2002
Derivative Lawsuits:
Korea First Bank
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Plaintiff
 Small number of minority shareholders with an
assistance from civil activists group, PSPD.
Defendants
 Two former presidents and two directors
Case
 Illegal loans to failed company
 Taking bribery in return for loans
Successful in enhancing public awareness on
corporate governance, but the bank failed.
Derivative Lawsuit
Samsung Electronics
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The second derivative lawsuit filed in Korea
Suit filed in October 1998
Court ruled in favor of plaintiff
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District court: $72.4 mil awarded, Dec. 2001
Higher court: $16 mil awarded, Nov. 2003
Both plaintiff and defendant appealed to
supreme court
Plaintiff: Small number of shareholders (PSPD)
Defendant: Chairman Lee and 10 directors
Derivative Lawsuit
Samsung Electronics
1.
Illegal political contribution
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2.
Related party transaction at transferring
price
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3.
Chairman KH Lee: $5.6 mil / $5.4mil
6 directors: $46.4 mil / 11.6 mil
purchased at 10,000 won/share sold at 2,600
won/share
Investment “without business judgments”
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8 directors: $20.4 mil / rejected
Purchase of equities and provide debt guarantee
to failed company
Derivative Lawsuits
Daewoo Corporation
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The third derivative lawsuit filed in Korea
Suit filed in September 1999
Court hearing is in pending due to an absence of
defendant
Plaintiff: Small number of shareholders (PSPD)
Defendant: former chairman WJ Kim
$19.7 million claimed
Illegal subsidies from Daewoo corporation to
private companies owned by the family
Lessons Learned from Derivative
Lawsuits in Korea
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No private incentive neither to plaintiff
shareholders nor to lawyer
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Award paid to company, not the plaintiff
Plaintiff should pay for legal fee and claim it to
company when they win the case
Lawyer has to file another lawsuit to collect legal fee
from the company
Management is reluctant to collect award even
when shareholders won the suit
Only three suits are filed by NGO due to lack of
incentives for shareholder and lawyers
Unlawful Transaction Monitored
by Korea Stock Exchange
Price Fixing
Insider Trading
Total
1996
1997
1998
1999 2000 July
37
18
55
34
35
69
21
72
93
77
71
148
38
33
71
Securities Class-Action Lawsuit
Korean Case
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The law was passed in December, 2003
Subject cases
 Accounting manipulation and failed audit
 Price manipulation, insider trading
 Fraudulent and failed disclosure
 annual/semi-annul/quarterly reports
 prospectus
Securities Class-Action Lawsuit
Korean Case
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The law will go in effect from
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Stock price manipulation: Jan. 2005
Other case : Jan. 2005 for large firms
Jan. 2007 for small and medium firms
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Companies with asset size over $1.7 billion (2 trillion KRW)
Eligibility
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Fifty or more shareholders
The class as a whole hold 0.01% or more shares
Securities Class-Action Lawsuit
Korean Case
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Features to prevent abusive litigation
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Court sets pre-hearing and approve on
commencement
Court’s approval should be obtained on
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Settlement
Cancellation of Suit
Give-up of appeal to higher court
Give-up of collection of award
Features to prevent ‘professional plaintiff’
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Limit lead plaintiff and attorney participation to 3
times in 3 years
Minority Shareholder Activism
in Korea: PSPD
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People’s Solidarity for Participatory Democracy
 Independent civil rights advocacy NGO
 Watchdog on government, legislator, judiciary,
business
 Activities
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Anti-Corruption
Advocacy of civil rights
Reform legislation
Participatory Economy Committee (PEC)
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Minority shareholder activism under PSPD
Since January 1997
Minority Shareholder Activism
in Korea: PSPD
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Who are PSPD-PEC activists?
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How is it funded?
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2 full time staff
25 professional volunteers: professors, lawyers, CPAs
100% individual donations
No government, no invitational fund
How does it maintain independence
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Does not represent any interested party
Members do not hold outside directorship or
government related positions
PSPD: Target Companies
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Conglomerates: Chaebols
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Samsung Electronics
SK Telecom
Hyundai Heavy Industry
Dacom
Samsung Group
SK Group
Hyundai Group
LG Group
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Daewoo Corp.
Daewoo Group (dissolved)
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Financial Institutions
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Korea First Bank
Hyundai Investment Trust Co
Hyundai Securities Co.
PSPD Activities
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Monitoring and reporting corporate activities
Constructive talks with management
Attending shareholder meetings
Exercise shareholder rights
Legal actions
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Lawsuit
Filing criminal investigation
Legislative proposals
Corporate governance information service
PSPD: Legal Actions
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Lawsuits
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Derivative Lawsuits
Nullify agenda un-lawfully adopted at shareholder
meetings
Cancellation of CB & BW issued to controlling
family
Injunction to stop debt guarantee to affiliated
company
Injunction to prohibit listing of new equity issued
to controlling family
Lawsuit against auditing accounting firm for
manipulation
PSPD: Legal Actions
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Filing Criminal Investigation
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Stock price manipulation
Fund embezzlement
Off-shore paper company operation
Off-shore off balance sheet debt
Asset stripping using convertible bond, bond with
warrant
Unfair related party transactions
Falsified minutes of board
Illegal political contribution
PSPD: Legal Actions
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Requesting Investigation on Accounting Firm
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FSC: Financial Supervisory Commission
 Accounting manipulation, False disclosure
 Failed audit by accounting firms
 No report on off-shore option contact
 Delayed disclosure on correction of Net Income
Inspection of financial records
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Record of in-house asset transactions: Hyundai ITC
PSPD: Proposal of Legislation
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Strengthen minority shareholder rights
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Regulation on related party transaction
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Amendment of Fair Trade Act
Corporate governance guideline
Governance on financial institutions
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Amendment of Commercial Code & Security
Exchange Law
Lowering legal requirements on shareholder rights
Mandatory cumulative voting (not succeeded)
Regulation on bank ownership
Disclosure and voting of investment trust company
Securities Class Action Suit