Hyunjoo Oh, partner, Lee & Ko
Much of what was discussed in the new administration's capital market policy prospects in early 2022 was carried over from election pledges. That may be why the general market protection policy was widely deployed. Regulatory authority’s intention to regulate unfair trade has been announced several times and is reflected in regulation and supervision in a variety of ways. Robust financial supervisory authorities, a revived joint investigation team for securities crimes at the prosecutor’s office, and special provisions regarding listed companies in the Financial Service and Capital Markets Act of Korea (“FSCMA”) are actively working together. Let's take a look at the impact this regulatory trend will have on listed companies in 2023.
Among the regulatory agendas that have recently been reorganized or are being promoted in the new year, noteworthy items are briefly reviewed as below, focusing on the FSCMA, the regulations thereunder or related guidelines. We will focus on policies announced as shareholder protection measures in situations of M&As and spin-offs, strengthened unfair trade restrictions, and revised delisting systems.
1. Promoting the reinstatement of the obligatory tender offer system in the event of a change in management rights through stock transfer
This is the most noteworthy part of the capital market policy agenda for 2023. As related bills have been proposed multiple times, implementation of this system has not yet been finalized.
The logic behind this mandatory tender offer is that in merger-type M&As, there are protection devices such as a special resolution at a general meeting of shareholders and stock appraisal rights, whereas shareholder protection is weak in stock transaction M&As, and the underlying legal principle is the “shareholder equality principle”. Recalling that the reason for the abolishment of this system in February 1998, which was one year after its introduction, was to promote corporate restructuring during the IMF bailout, some may view that it is surprising that this policy is being promoted instead of being abolished in light of the current economic situation. Supervisory authorities are responding to this concern by stating that they will make certain exceptions, such as ‘in cases where the takeover of control is necessary through laws or government intervention for the purpose of industrial rationalization or business rationalization’. (There is also a one-year grace period as a buffer.) However, criticism can be raised if exceptions are granted only for government-led M&As or their exits.
Even though the directors' duty of loyalty, shareholder representative lawsuits, and class action lawsuits are institutionalized under the Korean law, making tender offers mandatory is a direction that follows the EU and the Japanese model, not the US model that seeks relief through corporate law principles and disputes. While the EU type targets all of the remaining shareholders, the Japanese type is relatively weaker, as it requires a tender offer when acquiring more than 1/3 of the shares, and imposes an obligation to purchase (subscribe) all of the shares held by the remaining shareholders when acquiring more than 2/3 of the shares (1/3 rule + 2/3 rule).
To become the largest shareholder by taking over more than 25% of the shares, a tender offer must be made to the remaining shareholders at the same price as the controlling shareholder (reflecting the management rights premium). The obligatory amount of tender offer is 50% + 1 share minus the shares to be acquired through the M&A transaction. The direction of the policy of 'sharing' the management premium is obviously different from the tax laws that have recognized additional economic value for the controlling shares (Paragraph 3, Article 63 of the Inheritance and Gift Tax Act and many provisions of the Income Tax Act, Corporate Tax Act, and Restriction of Special Taxation Act, to which Paragraph 3, Article 63 of the Inheritance and Gift Tax Act applies mutatis mutandis).
Mandatory tender offers not only increase M&A costs, but also make the cost unpredictable. It is expected that the position of financial providers in transactions will become overwhelmingly high, whereas corporate leadership in M&A will be greatly damaged.
2. Completion of a package of measures to strengthen the protection of general shareholders in vertical split-offs
Amended Enforcement Decree of the FSCMA will be implemented for the purpose of granting stock appraisal rights to opposing shareholders in the event of a vertical split-off of a listed company. The tension between criticisms that providing exit opportunities through the open market is not enough, and opposing opinions questioning whether corporate restructuring or new business challenges should be held back this far is palpable.
Now, as in the case of a merger after division or a spin-off of a listed company in which the business unit is not listed, a significant cost of appraisal rights must be taken into account in split-offs. Large amount of shares acquired in response to the exercise of appraisal rights must be disposed of within five years, which will also be a burden on companies and the stock market at the same time. However, there is no penalty clause linked to this mandatory disposition clause. In fact, there are cases where this deadline is missed out of fear of downward pressure on the stock price or because even the current stock price is not satisfactory. Because treasury shares can be sold off-the-counter as well, such shares can be sold to white knights, for example. (However, with respect to the same, there is a sense of tension as the Financial Services Commission recently announced that it would improve the system for acquiring and disposing of treasury stocks.)
The special section for listed companies in the FSCMA has again been expanded in this direction. However, it is unlikely that the plan to grant parent company shareholders preferential rights to new shares in subsidiaries will be adopted. As a result, shareholder protection measures in the situation of split-offs have reached an end, following the strengthening of the reporting duty and the strengthening of the listing eligibility review last year.
3. New restrictions on refixing and call options for (redeemable) convertible preferred stocks
「Regulations on Issuance and Public Disclosure of Securities」 will be amended to introduce restrictions on redeemable convertible preferred stocks and convertible preferred stocks issued by listed companies that are equivalent to restrictions on convertible bonds.
With the purpose of enhancing the transparency of the convertible bond market and regulating cases where issuance of such securities is used as a means of increasing the equity interest of largest shareholders, ① the 『Regulations on Issuance and Public Disclosure of Securities』 was amended mainly to reflect mandatory upward adjustment of the conversion price of convertible bonds issued by listed companies when stock prices rise, limitation of the scope of the exercise of call options by largest shareholders and related parties and strengthening of relevant disclosure obligations, and ② the 「Guidelines for Supervisory Treatment of Call Option Accounting for Convertible Bonds」 was announced to classify call options as a separate derivative asset and treated as such for accounting purposes when issuing convertible bonds with call options designated to a third party, and to disclose the issuance conditions in the footnotes. The amendment mentioned in the above paragraph is in furtherance of the foregoing measures.
Around the time of the adoption of the previous measures, it is known that financial investment companies have already significantly strengthened their internal investment screening process for convertible bonds and convertible preferred stocks. It will be disappointing for companies that want to take advantage of the relatively low interest rates of equity-linked securities even while accepting share dilution concerns.
The remaining issues regarding convertible bonds or convertible preferred stocks that the financial authorities have not yet acted on include the refixing cycle and the conversion FX rate. However, since the market has already contracted at a significant level, the driving force for further strengthening of regulations can be seen to have been lost.
4. Introducing the system for prior disclosure of insider transaction
An amendment to the FSCMA is underway to require insiders (executives and major shareholders) of listed companies to disclose the purpose, price, quantity, and expected trading period at least 30 days prior to trading stocks issued by such company. The FSCMA amendment is also expected to include the imposition of criminal penalties for non-fulfillment of this duty. The scope of disclosure obligations and the scope of stocks, etc. are already familiar issues, so it is worthwhile to know the standard for the amount of stocks subject to reporting. If the size of stocks, etc. is 1% or more or the transaction amount is 5 billion won or more, the transaction amount during one year prior to the scheduled trading date must be accumulated. Trading must be diversified within a band narrower than the general upper and lower limit standards, trading must be completed within 10 business days from the scheduled trading date, and, in principle, the submitted trading plan cannot be changed or withdrawn. It remains to be seen how much exceptions will be acknowledged and utilized.
This is an additional measure related to insider transaction in furtherance to the six-month mandatory custody after the listing of stocks acquired through the exercise of stock options. Because supervisory authorities expect to mitigate market volatility through such measures, the speed of implementation is expected to be fast. Thus, it is necessary to promptly educate insiders to prevent such violations.
5. Assistance in utilizing Insider Trading Alarm Service (K-ITAS)
This is a measure to make up for the limitation that it is difficult for companies to check if their executives and employees omit reporting of stock trading. Through the Korea Exchange's Insider Trading Alarm Service (KRX-Insider Trading Alarm Service), the trading details of executives and employees are notified to the company. As the 「Standard Disclosure Information Management Regulations」 and the 「Standard Internal Information Management Regulations」 are to be amended so that executives and employees' duty to report trading details would be deemed to be fulfilled through such notification service, each listed company is recommended to reflect the amendments to the above regulations in their internal regulations.
6. Promoting restrictions on capital market transactions and appointment of executives in listed companies for unfair traders
An amendment to the FSCMA is in the process of consultation with relevant institutions, which will restrict unfair traders under the FSCMA regarding the restrictions on: ① trading financial investment products and opening accounts and ② being appointed as executives of listed companies and financial companies. No particular impediments to the proposed amendment are expected.
This measure is noted to be very broad in scope and strong in the context that (i) it will be applied to all types of unfair trading practices under the FSCMA, including not only the so-called three major unfair trading practices (use of insider information, market manipulation, and fraudulent trading) but also market order disruption and naked short selling, (ii) restriction period is to be up to 10 years, which is longer than that of major foreign countries, and (iii) administrative sanctions will be levied in addition to existing criminal penalties. Listed companies need to take measures to be sufficiently vigilant against the risks of unfair trade by internally educating their officers and employees on the scope of the application of the amendment and exceptions.
7. Disclosure of Violators of Unfair Trade Regulations
Persons subject to sanctions for regulatory violations, such as short selling and market disruption, which are finally decided by the financial authorities (imposition of penalty surcharges and negligence fines) will be disclosed on the FSC website. In the past, while sanctions were posted, persons subject to such sanctions were anonymized, but now the name of the corporation and the individual are disclosed. Meanwhile, sanctions on domestic financial investment companies were identifiable by the sanctions status section in their business reports. Now, the legal names of foreign professional investors can be identified through this measure. Foreign media reports that this is Korea's name and shame policy. However, this disclosure does not disclose sanctions imposed on foreign financial institutions or large foreign investors abroad, so domestic investors cannot be informed of such violations in advance before such institutions or investors commit illegal acts in Korea. (Although there are foreign news media coverages, disclosure is not mandatory and also it is difficult to verify the truth of such news reports,)
Further, this system raises questions of fundamental equity, because while persons subject to penalty surcharges, etc. are disclosed, in case of persons subject to criminal prosecution or notification to an investigative agency, the subject of action and the name of the event continue to be kept private, taking into account the impact on investigation and trial even when both administrative penalty and criminal accusation are imposed simultaneously. Although authorities may have been conscious of the crime of publicizing the facts of suspected crimes under the Criminal Act of Korea, criminal punishments are not subject to disclosure by the financial authorities even after it is finalized.
8. Promotion of gradual mandatory English disclosure for listed companies
According to the mandatory English disclosure plan announced by the Financial Services Commission, KOSPI-listed companies with assets of 10 trillion won or more (93 companies as of 2021) will be subject to English disclosure from 2024, and KOSPI-listed companies with assets of 2 trillion won or more (234 companies as of 2021) from 2026. Since this plan is mandatory, 2023 should be used as a preparation period. The mandatory English disclosure means more IR tasks and shareholder communications in addition to the mandatory ESG disclosure that will be applied to KOSPI-listed companies from 2025.
9. Improvement of delisting system
Most finance-related reasons for delisting were converted to ‘substantive reviews’, giving companies the opportunity to file objections. Even in the case of non-submission of regular reports and insufficient trading volume, companies will be provided with the opportunity to file objections and resolve the reasons for delisting. Some matters that were subject to substantive review were instead designated to call for ‘precaution’. (I believe the constant audit requested by some is unrealistic and unreasonable). Will the expansion of substantive review show a discernment, or will it just provide everyone with a year of mere prolongation?
10. Dividend system reform
In order to increase the predictability of investment for dividend, authorities have announced to first inform the market of the size of the dividends and then to set a record date to determine shareholders entitled to receive such dividends. This issue also requires legislative reform, but it is at an early stage compared to other agenda items.
11. Allow door-to-door sales of financial investment products
With the recent amendment to the 「Act on Door-to-Door Sales, etc.」 (“Door-to-Door Sales Act”), financial investment products can be sold through door-to-door sales without being subject to the Door-to-Door Sales Act. In line therewith, the Korea Financial Investment Association distributed the 「Best Practice Guideline for Door-to-Door Sales」 (“Best Practice Guideline”), which stipulates the standards and procedures to be followed by financial product sellers during door-to-door sales.
The purpose of this guideline is to fill the gap that exists regarding consumer protection with Best Practice Guideline, since the implementation of the supplementary amendment to the 「Financial Consumer Protection Act」, which was scheduled to be implemented along with the amendment to the Door-to-Door Sales Act, is being delayed. In the insurance industry, which is an industry closely related to the financial investment industry, exempting financial investment products from the application of the Door-to-Door Sales Act is viewed as unpleasant, as only insurance products were originally excluded from the application of the Door-to-Door Sales Act before this amendment to the Door-to-Door Sales Act.
Executives and employees of listed companies who have experienced corporate sales of financial investment companies may ask whether door-to-door sales are finally possible. If there are guidances and explanations that have not been provided before, please think about this context. Even if the Best Practice Guideline is violated, it is unlikely that the judicial effect of the transaction will be denied as a result (see Supreme Court 2011 Da 53683, 53690 En Banc Decision on September 26, 2013). However, if the case is not a dispute over the invalidity of the transaction, but rather a dispute over whether or not the financial investment company was negligent (refer to Supreme Court decision 2014Du36259 on February 18, 2016), the direction of the dispute may be affected.
[1] This is a translation of the article included in Auditor Journal of Korea published in January 2023 (vol. 277) by the Association of Listed Companies Auditors of Korea). This paper is the personal opinion of the author and does not represent the official opinion or position of the firm. In addition, any progress made on the regulatory atmosphere after the date of this paper was not reflected in this paper.