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 Jang

Professor, Korea University Business SchoolProfessor, Korea University Business SchoolDirector, Asian Institute of Corporate GovernanceDirector, Asian Institute of Corporate Governance

Chair, 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

auditorsauditors

0.5% (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 suit

0.01% 0.01% outstanding sharesoutstanding shares

Any Any contemporaneous contemporaneous

ShareholderShareholder

Limitation on Limitation on directors directors

liabilityliabilityNot permissibleNot permissible Permissible under Permissible under

Certain conditionsCertain conditions

Compelling Compelling inspection inspection

of financial recordsof financial records

0.1% (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

sharesshares

Requesting 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 Reward paid to the company, not to

shareholdershareholder 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 Illegal transactions such as ‘stock price

manipulation’ is the easiest way to make a big manipulation’ is the easiest way to make a big moneymoney

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

USUS

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 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 suit a suit. If the management does not file a suit in a month, then shareholder has a right to in a month, then shareholder has a right to file it.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 Bank lowered the amount to $3 million due to legal

feefee 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 Supreme court’s final decision in March

20022002

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/share

3.3. 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 Purchase of equities and provide debt

guarantee to failed companyguarantee to 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 Court hearing is in pending due to an

absence of defendantabsence of defendant Plaintiff: Small number of shareholders Plaintiff: Small number of shareholders

(PSPD)(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 July

Price 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 The class as a whole hold 0.01% or more

sharesshares

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 Disclosure and voting of investment trust

companycompany Securities Class Action SuitSecurities Class Action Suit