Empowering Shareholders Rights:Empowering Shareholders Rights:Derivative and Class-Action LawsuitsDerivative and Class-Action Lawsuits

OECD Asian Roundtable on Corporate GovernanceOECD Asian Roundtable on Corporate GovernanceNovember 11-12, 2002 November 11-12, 2002

Mumbai, IndiaMumbai, India

Hasung JangHasung JangKorea UniversityKorea University

Why Empowering Shareholders?Why Empowering Shareholders?

• Active shareholder is the most effective agent in iActive shareholder is the most effective agent in improving corporate governancemproving corporate governance

• Shareholder’s legal action can complement weak eShareholder’s legal action can complement weak enforcements of regulations and laws nforcements of regulations and laws

• In many emerging market countries, weak or lack In many emerging market countries, weak or lack of enforcement is the problem, not the regulation iof enforcement is the problem, not the regulation itself. tself.

“…“…private rights of action are not only fundamental to the private rights of action are not only fundamental to the success of our securities markets, they are an essential comsuccess of our securities markets, they are an essential complement to the SEC's own enforcement program"plement to the SEC's own enforcement program"

Remarks by Arthur Levitt, former chairman of the SECRemarks by Arthur Levitt, former chairman of the SEC

How to Empower ShareholdersHow to Empower Shareholders

• Strengthen shareholder’s rightsStrengthen shareholder’s rights Filing lawsuitsFiling lawsuits Inspecting financial recordInspecting financial record Making shareholder proposalMaking shareholder proposal Seeking injunction against illegal actsSeeking injunction against illegal acts Action to remove directors and auditorsAction to remove directors and auditors Convening special shareholders’ meetingConvening special shareholders’ meeting Requesting cumulative votingRequesting cumulative voting

How to Empower ShareholdersHow to Empower Shareholders

• Lower barriers in exercising rightsLower barriers in exercising rights Procedural complicationProcedural complication High costHigh cost

• Provide incentives to be activeProvide incentives to be active Private benefitsPrivate benefits No free-ridersNo free-riders

• Enhance accessibility to company informationEnhance accessibility to company information More disclosuresMore disclosures Board activities, compensations etc.Board activities, compensations etc.

Derivative LawsuitDerivative Lawsuit

• Shareholders file a suit against directors on behalf Shareholders file a suit against directors on behalf of the companyof the company

• Burden of proof lies with plaintiff (shareholders)Burden of proof lies with plaintiff (shareholders)• Award paid to the company, not to shareholdersAward paid to the company, not to shareholders• Legal cost should be paid by the shareholders. Legal cost should be paid by the shareholders.

If shareholders win, the cost can be claimed against the If shareholders win, the cost can be claimed against the company. If shareholders lose, shareholders payscompany. If shareholders lose, shareholders pays

• Management is friendly to director defendantManagement is friendly to director defendant No action taken even when plaintiff winsNo action taken even when plaintiff wins Possibility of lawsuit is no credible threatPossibility of lawsuit is no credible threat

Class-Action LawsuitClass-Action Lawsuit

• Shareholder files suit against directors to recover Shareholder files suit against directors to recover his/her losshis/her loss

• Burden of proof is on the defendant (directors)Burden of proof is on the defendant (directors)• Award paid to plaintiff, not to companyAward paid to plaintiff, not to company• Legal cost paid by plaintiffLegal cost paid by plaintiff

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

• Ruling applies to all shareholders subject to the Ruling applies to all shareholders subject to the same case unless opted outsame case unless opted out

• Possibility of lawsuit is a credible threat to directorsPossibility of lawsuit is a credible threat to directors

Why Security Class Action Suit?Why Security Class Action Suit?

• Private litigations and derivative lawsuits are Private litigations and derivative lawsuits are not not effective means for minority shareholders in effective means for minority shareholders in recovering loss from illegal and fraudulent acts recovering loss from illegal and fraudulent acts Legal cost far exceeds loss for small minority Legal cost far exceeds loss for small minority

shareholders in private litigationsshareholders in private litigations Loss for each shareholders is small,but the sum of loss Loss for each shareholders is small,but the sum of loss

is large.is large. Illegal transactions such as ‘stock price manipulation’ Illegal transactions such as ‘stock price manipulation’

is the easiest way to make a big moneyis the easiest way to make a big money

• Government’s enforcements of laws weakGovernment’s enforcements of laws weak

Possible Problems with Class-Action Possible Problems with Class-Action LawsuitsLawsuits

• Abusive LitigationAbusive Litigation Professional plaintiff: lawyer’s lawsuit not Professional plaintiff: lawyer’s lawsuit not

shareholder’sshareholder’s Out of court settlement: lawsuit can be used as “green Out of court settlement: lawsuit can be used as “green

mail”mail”

• Limited disclosure in a fear of litigationLimited disclosure in a fear of litigation Passive projections by the management on business Passive projections by the management on business

perspectives perspectives

US Class-Action LawsuitUS Class-Action Lawsuit

• Federal Rules of Civil Procedure of 1938Federal Rules of Civil Procedure of 1938• Private Securities Litigation Reform Act of 1995 Private Securities Litigation Reform Act of 1995

Liability exemptions on forward looking statement or Liability exemptions on forward looking statement or projections if meaningful cautionary warning is statedprojections if meaningful cautionary warning is stated

Restriction on professional plaintiffRestriction on professional plaintiff• Most representative lead plaintiff. Most representative lead plaintiff. • Limit lead plaintiff to 5 times in 3 yearsLimit lead plaintiff to 5 times in 3 years• Sanctions for abusive litigation by levying legal cost on Sanctions for abusive litigation by levying legal cost on

plaintiffplaintiff

• Securities Litigation Uniform Standards Act of 1998Securities Litigation Uniform Standards Act of 1998 Covered securities class action suits under Federal jurisdictionCovered securities class action suits under Federal jurisdiction

Number Securities Related Number Securities Related Class Action Suit Filed in USClass Action Suit Filed in US

Federal Court State Court Total1991 156 46 2021992 194 31 2251993 154 47 2011994 225 64 2891995 185 10 1951996 122 25 147*1997 169 13 1821998 247 13 2601999 207 -** 2072000 201 - 201

Number of Class-Action Lawsuits Number of Class-Action Lawsuits Filed in USFiled in US

1999 2000Number of ListedCompanies in 2000

Proportionin 2000

NYSE 67 62 2,862 2.2%NASDAQ 122 131 4,734 2.8%AMEX 9 3Others 9 5Total 207 201

Derivative and Class-Action LawsuitsDerivative and Class-Action LawsuitsKorean CaseKorean Case

• Derivative Lawsuit Derivative Lawsuit Allowed by Commercial Code and Security Transaction Allowed by Commercial Code and Security Transaction

ActAct Three derivative lawsuits filed so farThree derivative lawsuits filed so far No suit filed before the crisis even if it had been allowedNo suit filed before the crisis even if it had been allowed Qualification of plaintiff was too restrictive: 3% of Qualification of plaintiff was too restrictive: 3% of

outstanding shares held more than 6 monthsoutstanding shares held more than 6 months

• Securities Class-Action LawsuitSecurities Class-Action Lawsuit Government submitted legislation proposal in 2001Government submitted legislation proposal in 2001 It has not been passed yet It has not been passed yet

Derivative Suits: Korean CaseDerivative Suits: Korean Case

• Shareholder or group of shareholders should have Shareholder or group of shareholders should have at least 0.01% of outstanding number of shares at least 0.01% of outstanding number of shares which have been held for more than six months at which have been held for more than six months at the time that suit is filed.the time that suit is filed.

• Shareholder should ask the company to file a suit. Shareholder should ask the company to file a suit. If the management do not file a suit in a month, If the management do not file a suit in a month, then shareholder has a right to file it.then shareholder has a right to file it.

• Suit stands as long as there is at least one Suit stands as long as there is at least one shareholder remains shareholder remains

• Three derivatives lawsuits filed since 1997Three derivatives lawsuits filed since 1997

Derivative Lawsuits:Derivative Lawsuits:Korea First BankKorea First Bank

• The first derivative lawsuit filed in Korea The first derivative lawsuit filed in Korea • Court ruled in favor of defendantCourt ruled in favor of defendant

$33.3 million awarded$33.3 million awarded Bank lowered the amount to $3 million due to legal feeBank lowered the amount to $3 million due to legal fee

• Suit filed in May 1997 Suit filed in May 1997 • District court ruling in July 1998District court ruling in July 1998• Higher court ruling in January 2000Higher court ruling in January 2000• Supreme court’s final decision in March 2002Supreme court’s final decision in March 2002

Derivative Lawsuits:Derivative Lawsuits:Korea First BankKorea First Bank

• PlaintiffPlaintiff Small number of minority shareholders with an Small number of minority shareholders with an

assistance from civil activists group, PSPD. assistance from civil activists group, PSPD.

• DefendantsDefendants Two former presidents and two directors Two former presidents and two directors

• CaseCase Illegal loans to failed companyIllegal loans to failed company Taking bribery in return for loansTaking bribery in return for loans

• Successful in enhancing public awareness on Successful in enhancing public awareness on corporate governance, but the bank failed.corporate governance, but the bank failed.

Derivative Lawsuit Derivative Lawsuit Samsung ElectronicsSamsung Electronics

• The second derivative lawsuit filed in KoreaThe second derivative lawsuit filed in Korea• Court ruled in favor of plaintiffCourt ruled in favor of plaintiff

$$72.4 million awarded out of $283.3 million 72.4 million awarded out of $283.3 million claimedclaimed

• Suit filed in October 1998Suit filed in October 1998• District court ruled in December 2001District court ruled in December 2001• Both plaintiff and defendant appealed to higher courtBoth plaintiff and defendant appealed to higher court• Plaintiff: Small number of shareholders (PSPD)Plaintiff: Small number of shareholders (PSPD)• Defendant: Chairman Lee and 10 directorsDefendant: Chairman Lee and 10 directors

Derivative Lawsuit Derivative Lawsuit Samsung ElectronicsSamsung Electronics

1.1. Illegal political contributionIllegal political contribution Chairman KH Lee: $5.6 millionChairman KH Lee: $5.6 million

2.2. Related party transaction at transferring priceRelated party transaction at transferring price 6 directors: $46.4 mil 6 directors: $46.4 mil purchased at 10,000 won/share sold at 2,600 won/sharepurchased at 10,000 won/share sold at 2,600 won/share

3.3. Investment “without business judgments”Investment “without business judgments” 8 directors: $20.4 mil 8 directors: $20.4 mil Purchase of equities and provide debt guarantee to Purchase of equities and provide debt guarantee to

failed companyfailed company

Derivative LawsuitsDerivative LawsuitsDaewoo CorporationDaewoo Corporation

• The third derivative lawsuit filed in KoreaThe third derivative lawsuit filed in Korea• Suit filed in September 1999Suit filed in September 1999• Court hearing is in pending due to an absence of Court hearing is in pending due to an absence of

defendantdefendant• Plaintiff: Small number of shareholders (PSPD)Plaintiff: Small number of shareholders (PSPD)• Defendant: former chairman WJ Kim Defendant: former chairman WJ Kim • $19.7 million claimed$19.7 million claimed• Illegal subsidies from Daewoo corporation to Illegal subsidies from Daewoo corporation to

private companies owned by the familyprivate companies owned by the family

Lessons Learned from Derivative Lessons Learned from Derivative Lawsuits in KoreaLawsuits in Korea

• No private incentive neither to plaintiff No private incentive neither to plaintiff shareholders nor to lawyershareholders nor to lawyer Award paid to company, not the plaintiffAward paid to company, not the plaintiff Plaintiff should pay for legal fee and claim it to Plaintiff should pay for legal fee and claim it to

company when they win the casecompany when they win the case Lawyer has to file another lawsuit to collect legal fee Lawyer has to file another lawsuit to collect legal fee

from the companyfrom the company

• Management is reluctant to collect award even Management is reluctant to collect award even when shareholders won the suit when shareholders won the suit

• It is a suit for public cause, not for private benefitIt is a suit for public cause, not for private benefit

Unlawful Transaction Monitored by Unlawful Transaction Monitored by Korea Stock ExchangeKorea Stock Exchange

1996 1997 1998 1999 2000 July

Price Fixing 37 34 21 77 38Insider Trading 18 35 72 71 33Total 55 69 93 148 71

Securities Class-Action LawsuitSecurities Class-Action LawsuitKorean CaseKorean Case

• Government submitted legislative proposal in 2001Government submitted legislative proposal in 2001• Parliament has not passed the bill yetParliament has not passed the bill yet• Resistance and lobby efforts from chaebols is a key Resistance and lobby efforts from chaebols is a key

obstacle in adopting the law.obstacle in adopting the law.• Majority party (opposition party) is opposing the Majority party (opposition party) is opposing the

bill for a reason of possible abusive litigation bill for a reason of possible abusive litigation • Out of three major presidential candidates, Out of three major presidential candidates,

opposition party candidate who leads in poll opposition party candidate who leads in poll opposes it.opposes it.

Korean Securities Class-Action LawsuitKorean Securities Class-Action LawsuitProposed VersionProposed Version

• Subjective casesSubjective cases Failed auditFailed audit Insider tradingInsider trading Price manipulationPrice manipulation Fraudulent and failed disclosure Fraudulent and failed disclosure

• annual/semi-annul/quarterly reports annual/semi-annul/quarterly reports • prospectus prospectus

• Companies with asset size over $1.7 billionCompanies with asset size over $1.7 billion

Korean Securities Class-Action LawsuitKorean Securities Class-Action LawsuitProposed VersionProposed Version

• Features to prevent abusive litigationFeatures to prevent abusive litigation Plaintiff should be more than 50 shareholdersPlaintiff should be more than 50 shareholders Court sets pre-hearing and certifies the caseCourt sets pre-hearing and certifies the case Court’s approval should be obtained on Court’s approval should be obtained on

settlement, cancellation, give-up of appeal to settlement, cancellation, give-up of appeal to higher court and give-up of collection of awardhigher court and give-up of collection of award

• Features to prevent ‘professional plaintiff’Features to prevent ‘professional plaintiff’ Limit lead plaintiff and attorney participation to Limit lead plaintiff and attorney participation to

3 times in 3 years3 times in 3 years

What Will Expedite Changes in What Will Expedite Changes in Emerging Market CountriesEmerging Market Countries

• Peer pressure from international communitiesPeer pressure from international communities Neighboring countriesNeighboring countries Regional dialogue. Governmental or private networkRegional dialogue. Governmental or private network International corporate governance ratingInternational corporate governance rating

• Active international institutional shareholdersActive international institutional shareholders• Legal reform assistance from multilateral Legal reform assistance from multilateral

organization organization • Impose corporate governance standard Impose corporate governance standard

conditionality on loans, investments and conditionality on loans, investments and assistance from WB, ADB, IMF and OECDassistance from WB, ADB, IMF and OECD