Empowering Shareholders Rights: Derivative and Class-Action Lawsuits

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Empowering Shareholders RightsDerivative and
Class-Action Lawsuits

• OECD Asian Roundtable on Corporate Governance
• November 11-12, 2002
• Mumbai, India
• Hasung Jang
• Korea University

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Why Empowering Shareholders?

• Active shareholder is the most effective agent in
  improving corporate governance
• Shareholders legal action can complement weak
  enforcements of regulations and laws
• In many emerging market countries, weak or lack
  of enforcement is the problem, not the regulation
  itself.
• 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

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How to Empower Shareholders

• Strengthen shareholders rights
• Filing lawsuits
• Inspecting financial record
• Making shareholder proposal
• Seeking injunction against illegal acts
• Action to remove directors and auditors
• Convening special shareholders meeting
• Requesting cumulative voting

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How to Empower Shareholders

• Lower barriers in exercising rights
• Procedural complication
• High cost
• Provide incentives to be active
• Private benefits
• No free-riders
• Enhance accessibility to company information
• More disclosures
• Board activities, compensations etc.

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Derivative Lawsuit

• Shareholders file a suit against directors on
  behalf of the company
• Burden of proof lies with plaintiff
  (shareholders)
• Award paid to the company, not to shareholders
• Legal cost should be paid by the shareholders.
• If shareholders win, the cost can be claimed
  against the company. If shareholders lose,
  shareholders pays
• Management is friendly to director defendant
• No action taken even when plaintiff wins
• Possibility of lawsuit is no credible threat

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Class-Action Lawsuit

• Shareholder files suit against directors to
  recover his/her loss
• Burden of proof is on the defendant (directors)
• Award paid to plaintiff, not to company
• Legal cost paid by plaintiff
• Lawyer's fee is usually contingent on outcome
• Ruling applies to all shareholders subject to the
  same case unless opted out
• Possibility of lawsuit is a credible threat to
  directors

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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
• 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
• Governments enforcements of laws weak

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Possible Problems with Class-Action Lawsuits

• Abusive Litigation
• Professional plaintiff lawyers lawsuit not
  shareholders
• 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

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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

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Number Securities Related Class Action Suit
Filed in US
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Number of Class-Action Lawsuits Filed in US
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Derivative and Class-Action LawsuitsKorean Case

• Derivative Lawsuit
• Allowed by Commercial Code and Security
  Transaction Act
• Three derivative lawsuits filed so far
• No suit filed before the crisis even if it had
  been allowed
• Qualification of plaintiff was too restrictive
  3 of outstanding shares held more than 6 months
• Securities Class-Action Lawsuit
• Government submitted legislation proposal in 2001
• It has not been passed yet

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Derivative Suits Korean Case

• Shareholder or group of shareholders should have
  at least 0.01 of outstanding number of shares
  which 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 do 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

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Derivative LawsuitsKorea 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 courts final decision in March 2002

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Derivative LawsuitsKorea 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.

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Derivative Lawsuit Samsung Electronics

• The second derivative lawsuit filed in Korea
• Court ruled in favor of plaintiff
• 72.4 million awarded out of 283.3 million
  claimed
• Suit filed in October 1998
• District court ruled in December 2001
• Both plaintiff and defendant appealed to higher
  court
• Plaintiff Small number of shareholders (PSPD)
• Defendant Chairman Lee and 10 directors

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Derivative Lawsuit Samsung Electronics

• Illegal political contribution
• Chairman KH Lee 5.6 million
• Related party transaction at transferring price
• 6 directors 46.4 mil
• purchased at 10,000 won/share sold at 2,600
  won/share
• Investment without business judgments
• 8 directors 20.4 mil
• Purchase of equities and provide debt guarantee
  to failed company

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Derivative LawsuitsDaewoo 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

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

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Unlawful Transaction Monitored by Korea Stock
Exchange
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Securities Class-Action LawsuitKorean Case

• Government submitted legislative proposal in 2001
• Parliament has not passed the bill yet
• Resistance and lobby efforts from chaebols is a
  key obstacle in adopting the law.
• Majority party (opposition party) is opposing the
  bill for a reason of possible abusive litigation
• Out of three major presidential candidates,
  opposition party candidate who leads in poll
  opposes it.

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Korean Securities Class-Action LawsuitProposed
Version

• Subjective cases
• Failed audit
• Insider trading
• Price manipulation
• Fraudulent and failed disclosure
• annual/semi-annul/quarterly reports
• prospectus
• Companies with asset size over 1.7 billion

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Korean Securities Class-Action LawsuitProposed
Version

• Features to prevent abusive litigation
• Plaintiff should be more than 50 shareholders
• Court sets pre-hearing and certifies the case
• Courts approval should be obtained on
  settlement, cancellation, give-up of appeal to
  higher court and give-up of collection of award
• Features to prevent professional plaintiff
• Limit lead plaintiff and attorney participation
  to 3 times in 3 years

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What Will Expedite Changes in Emerging Market
Countries

• Peer pressure from international communities
• Neighboring countries
• Regional dialogue. Governmental or private
  network
• International corporate governance rating
• Active international institutional shareholders
• Legal reform assistance from multilateral
  organization
• Impose corporate governance standard
  conditionality on loans, investments and
  assistance from WB, ADB, IMF and OECD

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