Shareholder initiated Enforcement Derivative Suit and Class-Action

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					 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?

   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

   Strengthen shareholder‟s rights
       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               2002
   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%)        3% (1.5%)
   Making a shareholder proposal                                  1% (0.5%)        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%)        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
                           Korea
Minority SH Right
                            public co. (large co.)
                                                     Japan
Action to remove          0.5% (0.25%)
                                                     3.0% voting rights
directors and auditors    outstanding shares
                                                     Auditors may request
Seeking injunction        0.05% (0.025%)
                                                     that director cease
against illegal acts      outstanding shares
                                                     illegal acts
Bringing shareholder      0.01%                      Any contemporaneous
derivative suit           outstanding shares         Shareholder
Limitation on directors                              Permissible under
                          Not permissible
liability                                            Certain conditions

Compelling inspection     0.1% (0.05%)
                                                     3.0% voting rights
of financial records      outstanding shares
        Minority Shareholders‟ Rights
              Korea and Japan


Minority SH Right          Korea public co. (large Japan
                            co.)

Convening special         3.0% (1/5%)
                                                3.0% voting rights
shareholders’ meeting     outstanding shares
Making a shareholder      1.0% (0.5%)           1.0%
proposal                  outstanding shares     or 300 voting shares
                                                Any shareholder,
Requesting cumulative     3.0%
                                                unless certificate
voting                    outstanding shares
                                                provides otherwise
Appointing inspector to
                          3.0% (1.5%)
examine corporate                               3.0% voting rights
                          outstanding shares
affairs and records
Why Shareholders are not Active?
   Individual Shareholders
     Information access is limited
     High cost and complicated legal procedures
     Short term investment horizon
     Reward and incentive is limited

   Institutional Shareholders
     Lack of corporate governance risk management
     Lack of internal Chinese wall
     Lack of long-term commitments
How to Empower Shareholders

   Lower barriers in exercising rights
     Procedural complication
     High cost

   Provide incentives to be active
       Private benefits
   Enhance accessibility to 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)
   Reward paid to the company, not to shareholder
   Ruling applies only to shareholders participated
    the lawsuit
   Legal cost should be paid by the shareholders.
       If shareholders win, the cost can be claimed against
        the company. If shareholders lose, shareholders pay
   Management is friendly to director defendant
       No action taken even when plaintiff wins
            Class-Action Lawsuit

   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
       Lawyer's fee is usually contingent on outcome
   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
       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
   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

       Federal Court   State Court   Total
1991       156             46         202
1992       194             31         225
1993       154             47         201
1994       225             64         289
1995       185             10         195
1996       122             25        147*
1997       169             13         182
1998       247             13         260
1999       207             -**        207
2000       201              -         201
Number of Class-Action Lawsuits
          Filed in US


                       Number of Listed Proportion
         1999   2000   Companies in 2000 in 2000
NYSE      67     62         2,862            2.2%
NASDAQ    122   131         4,734            2.8%
AMEX       9     3
Others     9     5
Total     207   201
Derivative and Class-Action Lawsuits
            Korean Case

   Derivative Lawsuit
       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
       It was adopted in December 2003
       It will go in effect from January 2005
     Derivative Suits: Korean Case
   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
   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
   Suit filed in October 1998
   Court ruled in favor of plaintiff
       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
        Chairman KH Lee: $5.6 mil / $5.4mil
2.   Related party transaction at transferring
     price
        6 directors: $46.4 mil / 11.6 mil
        purchased at 10,000 won/share sold at 2,600
         won/share
3.   Investment “without business judgments”
        8 directors: $20.4 mil / rejected
        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
   Only three suits are filed by NGO due to lack of
    incentives for shareholder and lawyers
 Unlawful Transaction Monitored
    by Korea Stock Exchange


                  1996   1997   1998   1999 2000 July
Price Fixing       37     34     21    77       38
Insider Trading    18     35     72    71       33
Total              55     69     93    148      71
Securities Class-Action Lawsuit
          Korean Case
   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
   The law will go in effect from
       Stock price manipulation: Jan. 2005
       Other case : Jan. 2005 for large firms
                     Jan. 2007 for small and medium firms
            Companies with asset size over $1.7 billion (2 trillion KRW)
   Eligibility
       Fifty or more shareholders
       The class as a whole hold 0.01% or more shares
    Securities Class-Action Lawsuit
              Korean Case
   Features to prevent abusive litigation
       Court sets pre-hearing and approve on
        commencement
       Court‟s approval should be obtained on
            Settlement
            Cancellation of Suit
            Give-up of appeal to higher court
            Give-up of collection of award
   Features to prevent „professional plaintiff‟
       Limit lead plaintiff and attorney participation to 3
        times in 3 years
    Minority Shareholder Activism
           in Korea: PSPD
   People‟s Solidarity for Participatory Democracy
     Independent civil rights advocacy NGO
     Watchdog on government, legislator, judiciary,
      business
     Activities
            Anti-Corruption
            Advocacy of civil rights
            Reform legislation
   Participatory Economy Committee (PEC)
       Minority shareholder activism under PSPD
       Since January 1997
        Minority Shareholder Activism
               in Korea: PSPD
   Who are PSPD-PEC activists?
       2 full time staff
       25 professional volunteers: professors, lawyers, CPAs
   How is it funded?
       100% individual donations
       No government, no invitational fund
   How does it maintain independence
       Does not represent any interested party
       Members do not hold outside directorship or
        government related positions
         PSPD: Target Companies

   Conglomerates: Chaebols
    •   Samsung Electronics           Samsung Group
    •   SK Telecom                    SK Group
    •   Hyundai Heavy Industry        Hyundai Group
    •   Dacom                         LG Group
    •   Daewoo Corp.                  Daewoo Group (dissolved)
   Financial Institutions
    •   Korea First Bank
    •   Hyundai Investment Trust Co
    •   Hyundai Securities Co.
                   PSPD Activities
   Monitoring and reporting corporate activities
   Constructive talks with management
   Attending shareholder meetings
   Exercise shareholder rights
   Legal actions
       Lawsuit
       Filing criminal investigation
   Legislative proposals
   Corporate governance information service
             PSPD: Legal Actions
   Lawsuits
       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

   Filing Criminal Investigation
       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

   Requesting Investigation on Accounting Firm
      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
       Record of in-house asset transactions: Hyundai ITC
        PSPD: Proposal of Legislation
   Strengthen minority shareholder rights
       Amendment of Commercial Code & Security
        Exchange Law
       Lowering legal requirements on shareholder rights
       Mandatory cumulative voting (not succeeded)
   Regulation on related party transaction
       Amendment of Fair Trade Act
       Corporate governance guideline
   Governance on financial institutions
       Regulation on bank ownership
       Disclosure and voting of investment trust company
   Securities Class Action Suit