Empowering Shareholders Rights Derivative and ClassAction Lawsuits OECD

Empowering Shareholders Rights: Derivative and Class-Action Lawsuits OECD Asian Roundtable on Corporate Governance November 11 -12, 2002 Mumbai, India Hasung Jang Korea University

Why Empowering Shareholders? • Active shareholder is the most effective agent in improving corporate governance • Shareholder’s legal action can complement weak enforcements of regulations and laws • In many emerging market countries, weak or lack of enforcement is the problem, not the regulation itself. “…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 • Strengthen shareholder’s rights § Filing lawsuits § Inspecting financial record § Making shareholder proposal § Seeking injunction against illegal acts § Action to remove directors and auditors § Convening special shareholders’ meeting § Requesting cumulative voting

How to Empower Shareholders • Lower barriers in exercising rights § Procedural complication § High cost • Provide incentives to be active § Private benefits § No free-riders • Enhance accessibility to company information § More disclosures § Board activities, compensations etc.

Derivative Lawsuit • Shareholders file a suit against directors on behalf of the company • Burden of proof lies with plaintiff (shareholders) • Award paid to the company, not to shareholders • Legal cost should be paid by the shareholders. § If shareholders win, the cost can be claimed against the company. If shareholders lose, shareholders pays • Management is friendly to director defendant § No action taken even when plaintiff wins § Possibility of lawsuit is no credible threat

Class-Action Lawsuit • Shareholder files suit against directors to recover his/her loss • Burden of proof is on the defendant (directors) • Award paid to plaintiff, not to company • Legal cost paid by plaintiff § Lawyer's fee is usually contingent on outcome • Ruling applies to all shareholders subject to the same case unless opted out • Possibility of lawsuit is a credible threat to directors

Why Security Class Action Suit? • Private litigations and derivative lawsuits are not effective means for minority shareholders in recovering loss from illegal and fraudulent acts § Legal cost far exceeds loss for small minority shareholders in private litigations § 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 weak

Possible Problems with Class-Action Lawsuits • Abusive Litigation § 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 § Passive projections by the management on business perspectives

US Class-Action Lawsuit • 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

Number Securities Related Class Action Suit Filed in US

Number of Class-Action Lawsuits Filed in US

Derivative and Class-Action Lawsuits Korean Case • Derivative Lawsuit § Allowed by Commercial Code and Security Transaction Act § Three derivative lawsuits filed so far § No suit filed before the crisis even if it had been allowed § Qualification of plaintiff was too restrictive: 3% of outstanding shares held more than 6 months • Securities Class-Action Lawsuit § § Government submitted legislation proposal in 2001 It has not been passed yet

Derivative Suits: Korean Case • Shareholder or group of shareholders should have at least 0. 01% of outstanding number of shares which 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 do 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 • • The first derivative lawsuit filed in Korea Court ruled in favor of defendant § $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 • 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 • The second derivative lawsuit filed in Korea • Court ruled in favor of plaintiff § $72. 4 million awarded out of $283. 3 million claimed • Suit filed in October 1998 • District court ruled in December 2001 • Both plaintiff and defendant appealed to higher court • Plaintiff: Small number of shareholders (PSPD) • Defendant: Chairman Lee and 10 directors

Derivative Lawsuit Samsung Electronics • Illegal political contribution § Chairman KH Lee: $5. 6 million 1. Related party transaction at transferring price § § 6 directors: $46. 4 mil purchased at 10, 000 won/share sold at 2, 600 won/share 2. Investment “without business judgments” § § 8 directors: $20. 4 mil Purchase of equities and provide debt guarantee to failed company

Derivative Lawsuits Daewoo Corporation • • 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 • No private incentive neither to plaintiff shareholders nor to lawyer § 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 • It is a suit for public cause, not for private benefit

Unlawful Transaction Monitored by Korea Stock Exchange

Securities Class-Action Lawsuit Korean Case • • • Government submitted legislative proposal in 2001 Parliament has not passed the bill yet Resistance and lobby efforts from chaebols is a key obstacle in adopting the law. • Majority party (opposition party) is opposing the bill for a reason of possible abusive litigation • Out of three major presidential candidates, opposition party candidate who leads in poll opposes it.

Korean Securities Class-Action Lawsuit Proposed Version • Subjective cases § Failed audit § Insider trading § Price manipulation § Fraudulent and failed disclosure • annual/semi-annul/quarterly reports • prospectus • Companies with asset size over $1. 7 billion

Korean Securities Class-Action Lawsuit Proposed Version • Features to prevent abusive litigation § Plaintiff should be more than 50 shareholders § Court sets pre-hearing and certifies the case § Court’s approval should be obtained on settlement, cancellation, give-up of appeal to higher court and give-up of collection of award • Features to prevent ‘professional plaintiff’ § Limit lead plaintiff and attorney participation to 3 times in 3 years

What Will Expedite Changes in Emerging Market Countries • Peer pressure from international communities § § § Neighboring countries Regional dialogue. Governmental or private network International corporate governance rating • Active international institutional shareholders • Legal reform assistance from multilateral organization • Impose corporate governance standard conditionality on loans, investments and assistance from WB, ADB, IMF and OECD