Shareholder initiated Enforcement: Derivative Suit and Class-Action Lawsuits
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Transcript of Shareholder initiated Enforcement: Derivative Suit and Class-Action Lawsuits
Shareholder initiated Shareholder initiated Enforcement:Enforcement:
Derivative Suit and Class-Action Derivative Suit and Class-Action LawsuitsLawsuits
Policy Dialogue on Corporate Governance in ChinaPolicy Dialogue on Corporate Governance in ChinaShanghaiShanghai
February 26, 2004 February 26, 2004
Hasung JangHasung JangProfessor, Korea University Business SchoolProfessor, Korea University Business School
Director, Asian Institute of Corporate GovernanceDirector, Asian Institute of Corporate GovernanceChair, PEC-PSPDChair, PEC-PSPD
Why Why EmpoweringEmpowering Shareholders?Shareholders?
In many emerging market countries, weak or lIn many emerging market countries, weak or lack of enforcement is the problem, not the regack of enforcement is the problem, not the regulation itself. ulation itself.
Shareholder’s legal action can complement weShareholder’s legal action can complement weak enforcements of regulations and laws ak enforcements of regulations and laws
“…“…private rights of action are not only fundamprivate rights of action are not only fundamental to the success of our securities marketental to the success of our securities markets, they are an essential complement to the SEs, they are an essential complement to the SEC's own enforcement program" C's own enforcement program"
Remarks by Arthur Levitt, former chairman of the SECRemarks by Arthur Levitt, former chairman of the SEC
How to Empower How to Empower ShareholdersShareholders
Strengthen shareholder’s rightsStrengthen shareholder’s rights Attending shareholder meetingsAttending shareholder meetings 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 Filing lawsuitsFiling lawsuits
Minority Shareholder RightsMinority Shareholder RightsKorean CaseKorean Case
19971997 2002 2002 Bringing shareholder derivative actionsBringing shareholder derivative actions 1% (0.5%)1% (0.5%) 0.01%0.01% Seeking injunctive action against illegal actsSeeking injunctive action against illegal acts 1% (0.5%)1% (0.5%) 0.05% (0.025%)0.05% (0.025%) Convening a special shareholders’ meetingConvening a special shareholders’ meeting 3% (1.5%)3% (1.5%) 3% (1.5%)3% (1.5%) Making a shareholder proposalMaking a shareholder proposal 1% (0.5%)1% (0.5%) 1% (0.5%)1% (0.5%) Requesting cumulative votingRequesting cumulative voting ---- 3%3% Requesting removal of directors & auditorsRequesting removal of directors & auditors 1% (0.5%)1% (0.5%) 0.5% (0.25%)0.5% (0.25%) Compelling inspection of financial records Compelling inspection of financial records 3% (1.5%)3% (1.5%) 0.1% (0.05%)0.1% (0.05%) Appointing inspector to examine recordsAppointing inspector to examine records 3% (1.5%) 3% (1.5%) 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 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 subject to ownership more than six months
Minority Shareholders’ RightsMinority Shareholders’ RightsKorea and JapanKorea and Japan
Minority SH Minority SH RightRight
Korea Korea public co. (large public co. (large
co.)co.)JapanJapan
Action to removeAction to removedirectors and directors and
auditorsauditors0.5% (0.25%) 0.5% (0.25%) outstanding sharesoutstanding shares 3.0% 3.0% voting rightsvoting rights
Seeking injunction Seeking injunction against illegal actsagainst illegal acts
0.05% (0.025%) 0.05% (0.025%) outstanding sharesoutstanding shares
Auditors may request Auditors may request that director cease that director cease illegal actsillegal acts
Bringing Bringing shareholdershareholder
derivative suitderivative suit0.01% 0.01% outstanding sharesoutstanding shares
Any Any contemporaneous contemporaneous
ShareholderShareholderLimitation on Limitation on
directors directors liabilityliability
Not permissibleNot permissible Permissible under Permissible under Certain conditionsCertain conditions
Compelling Compelling inspection inspection
of financial recordsof financial records0.1% (0.05%) 0.1% (0.05%) outstanding sharesoutstanding shares 3.0% 3.0% voting rightsvoting rights
Minority Shareholders’ RightsMinority Shareholders’ RightsKorea and JapanKorea and Japan
Minority SH RightMinority SH Right Korea Korea public public co. (large co.)co. (large co.) JapanJapan
Convening special Convening special shareholders’ shareholders’
meetingmeeting
3.0% (1/5%) 3.0% (1/5%) outstanding outstanding
sharesshares3.0% 3.0% voting rightsvoting rights
Making a Making a shareholder shareholder
proposalproposal
1.0% (0.5%) 1.0% (0.5%) outstanding outstanding
sharesshares
1.0% 1.0% or 300 voting or 300 voting
sharessharesRequesting Requesting
cumulative cumulative votingvoting
3.0% 3.0% outstanding outstanding
sharesshares
Any shareholder, Any shareholder, unless certificate unless certificate provides otherwiseprovides otherwise
Appointing Appointing inspector to inspector to
examine corporate examine corporate affairs and recordsaffairs and records
3.0% (1.5%) 3.0% (1.5%) outstanding outstanding
sharesshares3.0% 3.0% voting rightsvoting rights
Why Shareholders are not Why Shareholders are not Active?Active?
Individual ShareholdersIndividual Shareholders Information access is limitedInformation access is limited High cost and complicated legal proceduresHigh cost and complicated legal procedures Short term investment horizonShort term investment horizon Reward and incentive is limitedReward and incentive is limited
Institutional ShareholdersInstitutional Shareholders Lack of corporate governance risk Lack of corporate governance risk
managementmanagement Lack of internal Chinese wallLack of internal Chinese wall Lack of long-term commitmentsLack of long-term commitments
How to Empower How to Empower ShareholdersShareholders
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
Enhance accessibility to informationEnhance accessibility to information More disclosuresMore disclosures Board activities, compensations etc.Board activities, compensations etc.
Derivative LawsuitDerivative Lawsuit Shareholders file a suit against directors on Shareholders file a suit against directors on
behalf of the companybehalf of the company Burden of proof lies with plaintiff (shareholders)Burden of proof lies with plaintiff (shareholders) Reward paid to the company, not to shareholderReward paid to the company, not to shareholder Ruling applies only to shareholders participated Ruling applies only to shareholders participated
the lawsuitthe lawsuit 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 If shareholders win, the cost can be claimed against the company. If shareholders lose, shareholders paythe company. If shareholders lose, shareholders pay
Management is friendly to director defendantManagement is friendly to director defendant No action taken even when plaintiff winsNo action taken even when plaintiff wins
Class-Action LawsuitClass-Action Lawsuit
Shareholder files suit against directors to Shareholder files suit against directors to recover his/her lossrecover his/her loss
Burden of proof is on the defendant Burden of proof is on the defendant (directors)(directors)
Reward paid to plaintiff, not to companyReward paid to plaintiff, not to company Ruling applies to all shareholders unless Ruling applies to all shareholders unless
opted out opted out Legal cost paid by plaintiffLegal cost paid by plaintiff
Lawyer's fee is usually contingent on outcomeLawyer's fee is usually contingent on outcome Possibility of lawsuit is a credible threat to Possibility of lawsuit is a credible threat to
directorsdirectors
Why Security Class Action Why Security Class Action Suit?Suit?
Private litigations and derivative lawsuits are Private litigations and derivative lawsuits are not effective means for minority shareholders not effective means for minority shareholders in recovering loss from illegal and fraudulent in recovering loss from illegal and fraudulent acts acts Legal cost far exceeds loss for small minority Legal cost far exceeds loss for small minority
shareholders in private litigationsshareholders in private litigations Discovery of facts is difficultDiscovery of facts is difficult Loss for each shareholders is small,but the sum of Loss for each shareholders is small,but the sum of
loss is large.loss 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 is weakGovernment’s enforcements of laws is weak
Potential Problems with Potential Problems with Class Action LawsuitsClass Action Lawsuits
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 Out of court settlement: lawsuit can be used as
“green mail”“green mail” Limited disclosure in a fear of litigationLimited disclosure in a fear of litigation
Passive projections by the management on Passive projections by the management on business perspectives business 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 Sanctions for abusive litigation by levying legal
cost on plaintiffcost on plaintiff Securities Litigation Uniform Standards Act of 1998Securities Litigation Uniform Standards Act of 1998
Covered securities class action suits under Federal Covered securities class action suits under Federal jurisdictionjurisdiction
Number Securities Related Number Securities Related Class Action Suit Filed in Class Action Suit Filed in
USUSFederal Court State Court Total
1991 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 Number of Class-Action Lawsuits Filed in USLawsuits Filed 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 Derivative and Class-Action LawsuitsLawsuits
Korean CaseKorean Case Derivative Lawsuit Derivative Lawsuit
Allowed by Commercial Code and Security Allowed by Commercial Code and Security Transaction ActTransaction Act
No suit filed before the crisis even if it had No suit filed before the crisis even if it had been allowedbeen allowed
Only NGO has filed derivative lawsuits since Only NGO has filed derivative lawsuits since the crisis in 1998the crisis in 1998
Securities Class-Action LawsuitSecurities Class-Action Lawsuit It was adopted in December 2003It was adopted in December 2003 It will go in effect from January 2005It will go in effect from January 2005
Derivative Suits: Korean Derivative Suits: Korean CaseCase
Shareholder or group of shareholders should Shareholder or group of shareholders should have at least 0.01% of outstanding number have at least 0.01% of outstanding number of sharesof shares
Shares should have been held for more than Shares should have been held for more than six months at the time that suit is filed.six months at the time that suit is filed.
Shareholder should ask the company to file Shareholder should ask the company to file a suit. If the management does not file a a suit. If the management does not file a suit in a month, then shareholder has a suit in a month, then shareholder has a right to file it.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 Small number of minority shareholders with
an assistance from civil activists group, an assistance from civil activists group, PSPD. 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 Suit filed in October 1998 Suit filed in October 1998 Court ruled in favor of plaintiffCourt ruled in favor of plaintiff
District court: $72.4 mil awarded, Dec. 2001District court: $72.4 mil awarded, Dec. 2001 Higher court: $16 mil awarded, Nov. 2003Higher court: $16 mil awarded, Nov. 2003
Both plaintiff and defendant appealed to Both plaintiff and defendant appealed to supreme courtsupreme court
Plaintiff: Small number of shareholders Plaintiff: Small number of shareholders (PSPD)(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 mil / $5.4milChairman KH Lee: $5.6 mil / $5.4mil
2.2. Related party transaction at transferring Related party transaction at transferring priceprice
6 directors: $46.4 mil / 11.6 mil6 directors: $46.4 mil / 11.6 mil purchased at 10,000 won/share sold at 2,600 purchased at 10,000 won/share sold at 2,600
won/sharewon/share3.3. Investment “without business judgments”Investment “without business judgments”
8 directors: $20.4 mil / rejected8 directors: $20.4 mil / rejected Purchase of equities and provide debt guarantee Purchase of equities and provide debt guarantee
to failed companyto failed 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 Court hearing is in pending due to an absence
of defendantof defendant 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 Lessons Learned from Derivative Lawsuits in Derivative Lawsuits in
KoreaKorea 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 Lawyer has to file another lawsuit to collect legal
fee from the companyfee from the company Management is reluctant to collect award Management is reluctant to collect award
even when shareholders won the suit even when shareholders won the suit Only three suits are filed by NGO due to lack Only three suits are filed by NGO due to lack
of incentives for shareholder and lawyersof incentives for shareholder and lawyers
Unlawful Transaction Unlawful Transaction Monitored by Korea Stock Monitored by Korea Stock
ExchangeExchange
1996 1997 1998 1999 2000 JulyPrice Fixing 37 34 21 77 38Insider Trading 18 35 72 71 33Total 55 69 93 148 71
Securities Class-Action Securities Class-Action LawsuitLawsuit
Korean CaseKorean Case The law was passed in December, 2003The law was passed in December, 2003 Subject casesSubject cases
Accounting manipulation and failed Accounting manipulation and failed auditaudit
Price manipulation, insider tradingPrice manipulation, insider trading Fraudulent and failed disclosure Fraudulent and failed disclosure
annual/semi-annul/quarterly reports annual/semi-annul/quarterly reports prospectus prospectus
Securities Class-Action Securities Class-Action LawsuitLawsuit
Korean CaseKorean Case The law will go in effect from The law will go in effect from
Stock price manipulation: Jan. 2005 Stock price manipulation: Jan. 2005 Other case : Jan. 2005 for large firmsOther case : Jan. 2005 for large firms Jan. 2007 for small and medium Jan. 2007 for small and medium
firmsfirms Companies with asset size over $1.7 billion (2 trillion Companies with asset size over $1.7 billion (2 trillion
KRW)KRW) EligibilityEligibility
Fifty or more shareholdersFifty or more shareholders The class as a whole hold 0.01% or more sharesThe class as a whole hold 0.01% or more shares
Securities Class-Action Securities Class-Action LawsuitLawsuit
Korean CaseKorean Case Features to prevent abusive litigationFeatures to prevent abusive litigation
Court sets pre-hearing and approve on Court sets pre-hearing and approve on commencementcommencement
Court’s approval should be obtained on Court’s approval should be obtained on SettlementSettlement Cancellation of SuitCancellation of Suit Give-up of appeal to higher courtGive-up of appeal to higher court Give-up of collection of awardGive-up of collection of award
Features to prevent ‘professional plaintiff’Features to prevent ‘professional plaintiff’ Limit lead plaintiff and attorney participation to 3 Limit lead plaintiff and attorney participation to 3
times in 3 yearstimes in 3 years
Minority Shareholder Activism Minority Shareholder Activism in Korea: PSPDin Korea: PSPD
People’s Solidarity for Participatory DemocracyPeople’s Solidarity for Participatory Democracy Independent civil rights advocacy NGOIndependent civil rights advocacy NGO Watchdog on government, legislator, judiciary, Watchdog on government, legislator, judiciary,
businessbusiness ActivitiesActivities
Anti-Corruption Anti-Corruption Advocacy of civil rightsAdvocacy of civil rights Reform legislationReform legislation
Participatory Economy Committee (PEC)Participatory Economy Committee (PEC) Minority shareholder activism under PSPDMinority shareholder activism under PSPD Since January 1997Since January 1997
Minority Shareholder Activism Minority Shareholder Activism in Korea: PSPDin Korea: PSPD
Who are PSPD-PEC activists?Who are PSPD-PEC activists? 2 full time staff2 full time staff 25 professional volunteers: professors, lawyers, 25 professional volunteers: professors, lawyers,
CPAsCPAs How is it funded?How is it funded?
100% individual donations100% individual donations No government, no invitational fundNo government, no invitational fund
How does it maintain independenceHow does it maintain independence Does not represent any interested partyDoes not represent any interested party Members do not hold outside directorship or Members do not hold outside directorship or
government related positionsgovernment related positions
PSPD: Target CompaniesPSPD: Target Companies Conglomerates: ChaebolsConglomerates: Chaebols
• Samsung ElectronicsSamsung Electronics Samsung GroupSamsung Group• SK TelecomSK Telecom SK GroupSK Group• Hyundai Heavy IndustryHyundai Heavy Industry Hyundai GroupHyundai Group• DacomDacom LG GroupLG Group• Daewoo Corp. Daewoo Corp. Daewoo GroupDaewoo Group ( (dissolved)dissolved)
Financial InstitutionsFinancial Institutions• Korea First BankKorea First Bank• Hyundai Investment Trust CoHyundai Investment Trust Co• Hyundai Securities Co.Hyundai Securities Co.
PSPD ActivitiesPSPD Activities Monitoring and reporting corporate activitiesMonitoring and reporting corporate activities Constructive talks with managementConstructive talks with management Attending shareholder meetingsAttending shareholder meetings Exercise shareholder rightsExercise shareholder rights Legal actionsLegal actions
LawsuitLawsuit Filing criminal investigationFiling criminal investigation
Legislative proposalsLegislative proposals Corporate governance information serviceCorporate governance information service
PSPD: Legal ActionsPSPD: Legal Actions LawsuitsLawsuits
Derivative LawsuitsDerivative Lawsuits Nullify agenda un-lawfully adopted at Nullify agenda un-lawfully adopted at
shareholder meetingsshareholder meetings Cancellation of CB & BW issued to controlling Cancellation of CB & BW issued to controlling
familyfamily Injunction to stop debt guarantee to affiliated Injunction to stop debt guarantee to affiliated
companycompany Injunction to prohibit listing of new equity Injunction to prohibit listing of new equity
issued to controlling familyissued to controlling family Lawsuit against auditing accounting firm for Lawsuit against auditing accounting firm for
manipulationmanipulation
PSPD: Legal ActionsPSPD: Legal Actions
Filing Criminal InvestigationFiling Criminal Investigation Stock price manipulationStock price manipulation Fund embezzlementFund embezzlement Off-shore paper company operation Off-shore paper company operation Off-shore off balance sheet debt Off-shore off balance sheet debt Asset stripping using convertible bond, bond Asset stripping using convertible bond, bond
with warrantwith warrant Unfair related party transactionsUnfair related party transactions Falsified minutes of boardFalsified minutes of board Illegal political contributionIllegal political contribution
PSPD: Legal ActionsPSPD: Legal Actions
Requesting Investigation on Accounting FirmRequesting Investigation on Accounting Firm FSC: Financial Supervisory CommissionFSC: Financial Supervisory Commission Accounting manipulation, False disclosureAccounting manipulation, False disclosure Failed audit by accounting firmsFailed audit by accounting firms
No report on off-shore option contactNo report on off-shore option contact Delayed disclosure on correction of Net Delayed disclosure on correction of Net
IncomeIncome Inspection of financial recordsInspection of financial records
Record of in-house asset transactions: Hyundai ITCRecord of in-house asset transactions: Hyundai ITC
PSPD: Proposal of LegislationPSPD: Proposal of Legislation Strengthen minority shareholder rightsStrengthen minority shareholder rights
Amendment of Commercial Code & Security Amendment of Commercial Code & Security Exchange LawExchange Law
Lowering legal requirements on shareholder rightsLowering legal requirements on shareholder rights Mandatory cumulative voting (not succeeded)Mandatory cumulative voting (not succeeded)
Regulation on related party transactionRegulation on related party transaction Amendment of Fair Trade ActAmendment of Fair Trade Act Corporate governance guidelineCorporate governance guideline
Governance on financial institutionsGovernance on financial institutions Regulation on bank ownershipRegulation on bank ownership Disclosure and voting of investment trust companyDisclosure and voting of investment trust company
Securities Class Action SuitSecurities Class Action Suit