Shareholder initiated Enforcement Derivative Suit and ClassAction Lawsuits

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? n n n 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 n Strengthen shareholder’s rights n n n n 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 2002 n n n n 1997 Bringing shareholder derivative actions 1% (0. 5%) 0. 01% Seeking injunctive action against illegal acts 1% (0. 5%) 0. 05% (0. 025%) Convening a special shareholders’ meeting 3% (1. 5%) Making a shareholder proposal 1% (0. 5%) Requesting cumulative voting -3% Requesting removal of directors & auditors 1% (0. 5%) 0. 5% (0. 25%) Compelling inspection of financial records 3% (1. 5%) 0. 1% (0. 05%) Appointing inspector to examine records 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? n Individual Shareholders Information access is limited n High cost and complicated legal procedures n Short term investment horizon n Reward and incentive is limited n n Institutional Shareholders Lack of corporate governance risk management n Lack of internal Chinese wall n Lack of long-term commitments n

How to Empower Shareholders n Lower barriers in exercising rights Procedural complication n High cost n n Provide incentives to be active n n Private benefits Enhance accessibility to information More disclosures n Board activities, compensations etc. n

Derivative Lawsuit n n n 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. n n If shareholders win, the cost can be claimed against the company. If shareholders lose, shareholders pay Management is friendly to director defendant n No action taken even when plaintiff wins

Class-Action Lawsuit n n n 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 n n Lawyer's fee is usually contingent on outcome Possibility of lawsuit is a credible threat to directors

Why Security Class Action Suit? n Private litigations and derivative lawsuits are not effective means for minority shareholders in recovering loss from illegal and fraudulent acts n n n 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 n Abusive Litigation n 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 n Passive projections by the management on business perspectives

US Class-Action Lawsuit n n 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 n Restriction on professional plaintiff n Most representative lead plaintiff. n Limit lead plaintiff to 5 times in 3 years n Sanctions for abusive litigation by levying legal cost on plaintiff Securities Litigation Uniform Standards Act of 1998 n Covered securities class action suits under Federal jurisdiction n n

Number Securities Related Class Action Suit Filed in US

Number of Class-Action Lawsuits Filed in US

Derivative and Class-Action Lawsuits Korean Case n Derivative Lawsuit n n 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 n n It was adopted in December 2003 It will go in effect from January 2005

Derivative Suits: Korean Case n n n 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 n n The first derivative lawsuit filed in Korea Court ruled in favor of defendant n n n $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 n n Plaintiff n Small number of minority shareholders with an assistance from civil activists group, PSPD. Defendants n Two former presidents and two directors Case n Illegal loans to failed company n Taking bribery in return for loans Successful in enhancing public awareness on corporate governance, but the bank failed.

Derivative Lawsuit Samsung Electronics n n n The second derivative lawsuit filed in Korea Suit filed in October 1998 Court ruled in favor of plaintiff n n n 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 n 2. Related party transaction at transferring price n n 3. Chairman KH Lee: $5. 6 mil / $5. 4 mil 6 directors: $46. 4 mil / 11. 6 mil purchased at 10, 000 won/share sold at 2, 600 won/share Investment “without business judgments” n n 8 directors: $20. 4 mil / rejected Purchase of equities and provide debt guarantee to failed company

Derivative Lawsuits Daewoo Corporation n n n 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 n No private incentive neither to plaintiff shareholders nor to lawyer n n n 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

Securities Class-Action Lawsuit Korean Case n n The law was passed in December, 2003 Subject cases n Accounting manipulation and failed audit n Price manipulation, insider trading n Fraudulent and failed disclosure n annual/semi-annul/quarterly reports n prospectus

Securities Class-Action Lawsuit Korean Case n The law will go in effect from n n Stock price manipulation: Jan. 2005 Other case : Jan. 2005 for large firms Jan. 2007 for small and medium firms n n Companies with asset size over $1. 7 billion (2 trillion KRW) Eligibility n n Fifty or more shareholders The class as a whole hold 0. 01% or more shares

Securities Class-Action Lawsuit Korean Case n Features to prevent abusive litigation n n Court sets pre-hearing and approve on commencement Court’s approval should be obtained on n n Settlement Cancellation of Suit Give-up of appeal to higher court Give-up of collection of award Features to prevent ‘professional plaintiff’ n Limit lead plaintiff and attorney participation to 3 times in 3 years

Minority Shareholder Activism in Korea: PSPD n People’s Solidarity for Participatory Democracy § § § Independent civil rights advocacy NGO Watchdog on government, legislator, judiciary, business Activities n n Anti-Corruption Advocacy of civil rights Reform legislation Participatory Economy Committee (PEC) n n Minority shareholder activism under PSPD Since January 1997

Minority Shareholder Activism in Korea: PSPD n Who are PSPD-PEC activists? n n n How is it funded? n n n 2 full time staff 25 professional volunteers: professors, lawyers, CPAs 100% individual donations No government, no invitational fund How does it maintain independence n n Does not represent any interested party Members do not hold outside directorship or government related positions

PSPD: Target Companies n Conglomerates: Chaebols • Samsung Electronics SK Telecom Hyundai Heavy Industry Dacom Samsung Group SK Group Hyundai Group LG Group • Daewoo Corp. Daewoo Group (dissolved) • • • n Financial Institutions • • • Korea First Bank Hyundai Investment Trust Co Hyundai Securities Co.

PSPD Activities n n n Monitoring and reporting corporate activities Constructive talks with management Attending shareholder meetings Exercise shareholder rights Legal actions n n Lawsuit Filing criminal investigation Legislative proposals Corporate governance information service

PSPD: Legal Actions n Lawsuits n n n 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 n Filing Criminal Investigation n n n n 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 n Requesting Investigation on Accounting Firm n FSC: Financial Supervisory Commission n Accounting manipulation, False disclosure n Failed audit by accounting firms n No report on off-shore option contact n Delayed disclosure on correction of Net Income Inspection of financial records n n Record of in-house asset transactions: Hyundai ITC

PSPD: Proposal of Legislation n Strengthen minority shareholder rights n n Regulation on related party transaction n Amendment of Fair Trade Act Corporate governance guideline Governance on financial institutions n n n 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