Shareholder initiated Enforcement: Derivative Suit and Class-Action Lawsuits Policy Dialogue on Corporate Governance in China Shanghai February 26, 2004 Hasung Jang Professor, Korea University Business School Director, Asian Institute of Corporate Governance Chair, PEC-PSPD

Why Empowering Shareholders? In many emerging market countries, weak or lack of enforcement is the problem, not the regulation itself. In many emerging market countries, weak or lack of enforcement is the problem, not the regulation itself. Shareholders legal action can complement weak enforcements of regulations and laws Shareholders legal action can complement weak enforcements of regulations and laws …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" …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

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

Minority Shareholder Rights Korean Case Bringing shareholder derivative actions1% (0.5%)0.01% Bringing shareholder derivative actions1% (0.5%)0.01% Seeking injunctive action against illegal acts1% (0.5%)0.05% (0.025%) Seeking injunctive action against illegal acts1% (0.5%)0.05% (0.025%) Convening a special shareholders meeting3% (1.5%)3% (1.5%) Convening a special shareholders meeting3% (1.5%)3% (1.5%) Making a shareholder proposal1% (0.5%)1% (0.5%) Making a shareholder proposal1% (0.5%)1% (0.5%) Requesting cumulative voting--3% Requesting cumulative voting--3% Requesting removal of directors & auditors1% (0.5%)0.5% (0.25%) Requesting removal of directors & auditors1% (0.5%)0.5% (0.25%) Compelling inspection of financial records 3% (1.5%)0.1% (0.05%) Compelling inspection of financial records 3% (1.5%)0.1% (0.05%) Appointing inspector to examine records3% (1.5%) 3% (1.5%) Appointing inspector to examine records3% (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 subject to ownership more than six months

Minority Shareholders Rights Korea and Japan Minority SH Right Korea Korea public co. (large co.) public co. (large co.)Japan Action to remove directors and auditors 0.5% (0.25%) outstanding shares 3.0% voting rights Seeking injunction against illegal acts 0.05% (0.025%) outstanding shares Auditors may request that director cease illegal acts Bringing shareholder derivative suit 0.01% outstanding shares Any contemporaneous Shareholder Limitation on directors liability Not permissible Permissible under Certain conditions Compelling inspection of financial records 0.1% (0.05%) outstanding shares 3.0% voting rights

Minority Shareholders Rights Korea and Japan Minority SH Right Korea public co. (larg e co.) Korea public co. (larg e co.)Japan Convening special shareholders meeting 3.0% (1/5%) outstanding shares 3.0% voting rights Making a shareholder proposal 1.0% (0.5%) outstanding shares 1.0% or 300 voting shares or 300 voting shares Requesting cumulative voting3.0% outstanding shares Any shareholder, unless certificate provides otherwise Appointing inspector to examine corporate affairs and records 3.0% (1.5%) outstanding shares 3.0% voting rights

Why Shareholders are not Active? Individual Shareholders Individual Shareholders Information access is limited Information access is limited High cost and complicated legal procedures High cost and complicated legal procedures Short term investment horizon Short term investment horizon Reward and incentive is limited Reward and incentive is limited Institutional Shareholders Institutional Shareholders Lack of corporate governance risk management Lack of corporate governance risk management Lack of internal Chinese wall Lack of internal Chinese wall Lack of long-term commitments Lack of long-term commitments

How to Empower Shareholders Lower barriers in exercising rights Lower barriers in exercising rights Procedural complication Procedural complication High cost High cost Provide incentives to be active Provide incentives to be active Private benefits Private benefits Enhance accessibility to information Enhance accessibility to information More disclosures More disclosures Board activities, compensations etc. Board activities, compensations etc.

Derivative Lawsuit Shareholders file a suit against directors on behalf of the company Shareholders file a suit against directors on behalf of the company Burden of proof lies with plaintiff (shareholders) Burden of proof lies with plaintiff (shareholders) Reward paid to the company, not to shareholder Reward paid to the company, not to shareholder Ruling applies only to shareholders participated the lawsuit Ruling applies only to shareholders participated the 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 the company. If shareholders lose, shareholders pay If shareholders win, the cost can be claimed against the company. If shareholders lose, shareholders pay Management is friendly to director defendant Management is friendly to director defendant No action taken even when plaintiff wins No action taken even when plaintiff wins

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

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 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 Legal cost far exceeds loss for small minority shareholders in private litigations Discovery of facts is difficult Discovery of facts is difficult Loss for each shareholders is small,but the sum of loss is large. 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 Illegal transactions such as stock price manipulation is the easiest way to make a big money Governments enforcements of laws is weak Governments enforcements of laws is weak

Potential Problems with Class Action Lawsuits Abusive Litigation Abusive Litigation Professional plaintiff: lawyers lawsuit, not shareholders Professional plaintiff: lawyers lawsuit, not shareholders Out of court settlement: lawsuit can be used as green mail Out of court settlement: lawsuit can be used as green mail Limited disclosure in a fear of litigation Limited disclosure in a fear of litigation Passive projections by the management on business perspectives Passive projections by the management on business perspectives

US Class-Action Lawsuit Federal Rules of Civil Procedure of 1938 Federal 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 projections if meaningful cautionary warning is stated Liability exemptions on forward looking statement or projections if meaningful cautionary warning is stated Restriction on professional plaintiff Restriction on professional plaintiff Most representative lead plaintiff. Most representative lead plaintiff. Limit lead plaintiff to 5 times in 3 years Limit lead plaintiff to 5 times in 3 years Sanctions for abusive litigation by levying legal cost on plaintiff Sanctions for abusive litigation by levying legal cost on plaintiff Securities Litigation Uniform Standards Act of 1998 Securities Litigation Uniform Standards Act of 1998 Covered securities class action suits under Federal jurisdiction Covered securities class action suits under Federal jurisdiction

Number Securities Related Class Action Suit Filed in US

Number of Class-Action Lawsuits Filed in US

Derivative and Class-Action Lawsuits Korean Case Derivative Lawsuit Derivative Lawsuit Allowed by Commercial Code and Security Transaction Act Allowed by Commercial Code and Security Transaction Act No suit filed before the crisis even if it had been allowed No suit filed before the crisis even if it had been allowed Only NGO has filed derivative lawsuits since the crisis in 1998 Only NGO has filed derivative lawsuits since the crisis in 1998 Securities Class-Action Lawsuit Securities Class-Action Lawsuit It was adopted in December 2003 It was adopted in December 2003 It will go in effect from January 2005 It will go in effect from January 2005

Derivative Suits: Korean Case Shareholder or group of shareholders should have at least 0.01% of outstanding number of shares Shareholder or group of shareholders should have at least 0.01% of outstanding number of shares Shares should have been held for more than six months at the time that suit is filed. Shares should 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 does not file a suit in a month, then shareholder has a right to file it. Shareholder should ask the company to file a suit. If the management does 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 Suit stands as long as there is at least one shareholder remains Three derivatives lawsuits filed since 1997 Three derivatives lawsuits filed since 1997

Derivative Lawsuits: Korea First Bank The first derivative lawsuit filed in Korea The first derivative lawsuit filed in Korea Court ruled in favor of defendant Court ruled in favor of defendant $33.3 million awarded $33.3 million awarded Bank lowered the amount to $3 million due to legal fee Bank 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 1998 District court ruling in July 1998 Higher court ruling in January 2000 Higher court ruling in January 2000 Supreme courts final decision in March 2002 Supreme courts final decision in March 2002

Derivative Lawsuits: Korea First Bank Plaintiff Plaintiff Small number of minority shareholders with an assistance from civil activists group, PSPD. Small number of minority shareholders with an assistance from civil activists group, PSPD. Defendants Defendants Two former presidents and two directors Two former presidents and two directors Case Case Illegal loans to failed company Illegal loans to failed company Taking bribery in return for loans Taking bribery in return for loans Successful in enhancing public awareness on corporate governance, but the bank failed. Successful in enhancing public awareness on corporate governance, but the bank failed.

Derivative Lawsuit Samsung Electronics The second derivative lawsuit filed in Korea The second derivative lawsuit filed in Korea Suit filed in October 1998 Suit filed in October 1998 Court ruled in favor of plaintiff Court ruled in favor of plaintiff District court: $72.4 mil awarded, Dec District court: $72.4 mil awarded, Dec Higher court: $16 mil awarded, Nov Higher court: $16 mil awarded, Nov Both plaintiff and defendant appealed to supreme court Both plaintiff and defendant appealed to supreme court Plaintiff: Small number of shareholders (PSPD) Plaintiff: Small number of shareholders (PSPD) Defendant: Chairman Lee and 10 directors Defendant: Chairman Lee and 10 directors

Derivative Lawsuit Samsung Electronics 1. Illegal political contribution Chairman KH Lee: $5.6 mil / $5.4mil Chairman KH Lee: $5.6 mil / $5.4mil 2. Related party transaction at transferring price 6 directors: $46.4 mil / 11.6 mil 6 directors: $46.4 mil / 11.6 mil purchased at 10,000 won/share sold at 2,600 won/share purchased at 10,000 won/share sold at 2,600 won/share 3. Investment without business judgments 8 directors: $20.4 mil / rejected 8 directors: $20.4 mil / rejected Purchase of equities and provide debt guarantee to failed company Purchase of equities and provide debt guarantee to failed company

Derivative Lawsuits Daewoo Corporation The third derivative lawsuit filed in Korea The third derivative lawsuit filed in Korea Suit filed in September 1999 Suit filed in September 1999 Court hearing is in pending due to an absence of defendant Court hearing is in pending due to an absence of 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 private companies owned by the family Illegal subsidies from Daewoo corporation to private companies owned by the family

Lessons Learned from Derivative Lawsuits in Korea No private incentive neither to plaintiff shareholders nor to lawyer No private incentive neither to plaintiff shareholders nor to lawyer Award paid to company, not the plaintiff Award paid to company, not the plaintiff Plaintiff should pay for legal fee and claim it to company when they win the case 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 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 Management is reluctant to collect award even when shareholders won the suit Only three suits are filed by NGO due to lack of incentives for shareholder and lawyers Only three suits are filed by NGO due to lack of incentives for shareholder and lawyers

Unlawful Transaction Monitored by Korea Stock Exchange

Securities Class-Action Lawsuit Korean Case The law was passed in December, 2003 The law was passed in December, 2003 Subject cases Subject cases Accounting manipulation and failed audit Accounting manipulation and failed audit Price manipulation, insider trading Price 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 Lawsuit Korean Case The law will go in effect from The law will go in effect from Stock price manipulation: Jan Stock price manipulation: Jan Other case : Jan for large firms Other case : Jan for large firms Jan for small and medium firms Jan for small and medium firms Companies with asset size over $1.7 billion (2 trillion KRW) Companies with asset size over $1.7 billion (2 trillion KRW) Eligibility Eligibility Fifty or more shareholders Fifty or more shareholders The class as a whole hold 0.01% or more shares The class as a whole hold 0.01% or more shares

Securities Class-Action Lawsuit Korean Case Features to prevent abusive litigation Features to prevent abusive litigation Court sets pre-hearing and approve on commencement Court sets pre-hearing and approve on commencement Courts approval should be obtained on Courts approval should be obtained on Settlement Settlement Cancellation of Suit Cancellation of Suit Give-up of appeal to higher court Give-up of appeal to higher court Give-up of collection of award Give-up of collection of award Features to prevent professional plaintiff Features to prevent professional plaintiff Limit lead plaintiff and attorney participation to 3 times in 3 years Limit lead plaintiff and attorney participation to 3 times in 3 years

Minority Shareholder Activism in Korea: PSPD Peoples Solidarity for Participatory Democracy Peoples Solidarity for Participatory Democracy Independent civil rights advocacy NGO Independent civil rights advocacy NGO Watchdog on government, legislator, judiciary, business Watchdog on government, legislator, judiciary, business Activities Activities Anti-Corruption Anti-Corruption Advocacy of civil rights Advocacy of civil rights Reform legislation Reform legislation Participatory Economy Committee (PEC) Participatory Economy Committee (PEC) Minority shareholder activism under PSPD Minority shareholder activism under PSPD Since January 1997 Since January 1997

Minority Shareholder Activism in Korea: PSPD Who are PSPD-PEC activists? Who are PSPD-PEC activists? 2 full time staff 2 full time staff 25 professional volunteers: professors, lawyers, CPAs 25 professional volunteers: professors, lawyers, CPAs How is it funded? How is it funded? 100% individual donations 100% individual donations No government, no invitational fund No government, no invitational fund How does it maintain independence How does it maintain independence Does not represent any interested party Does not represent any interested party Members do not hold outside directorship or government related positions Members do not hold outside directorship or government related positions

PSPD: Target Companies Conglomerates: Chaebols Conglomerates: Chaebols Samsung Electronics Samsung Group Samsung Electronics Samsung Group SK TelecomSK Group SK TelecomSK Group Hyundai Heavy IndustryHyundai Group Hyundai Heavy IndustryHyundai Group DacomLG Group DacomLG Group Daewoo Corp. Daewoo Group ( dissolved) Daewoo Corp. Daewoo Group ( dissolved) Financial Institutions Financial Institutions Korea First Bank Korea First Bank Hyundai Investment Trust Co Hyundai Investment Trust Co Hyundai Securities Co. Hyundai Securities Co.

PSPD Activities Monitoring and reporting corporate activities Monitoring and reporting corporate activities Constructive talks with management Constructive talks with management Attending shareholder meetings Attending shareholder meetings Exercise shareholder rights Exercise shareholder rights Legal actions Legal actions Lawsuit Lawsuit Filing criminal investigation Filing criminal investigation Legislative proposals Legislative proposals Corporate governance information service Corporate governance information service

PSPD: Legal Actions Lawsuits Lawsuits Derivative Lawsuits Derivative Lawsuits Nullify agenda un-lawfully adopted at shareholder meetings Nullify agenda un-lawfully adopted at shareholder meetings Cancellation of CB & BW issued to controlling family Cancellation of CB & BW issued to controlling family Injunction to stop debt guarantee to affiliated company Injunction to stop debt guarantee to affiliated company Injunction to prohibit listing of new equity issued to controlling family Injunction to prohibit listing of new equity issued to controlling family Lawsuit against auditing accounting firm for manipulation Lawsuit against auditing accounting firm for manipulation

PSPD: Legal Actions Filing Criminal Investigation Filing Criminal Investigation Stock price manipulation Stock price manipulation Fund embezzlement Fund 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 with warrant Asset stripping using convertible bond, bond with warrant Unfair related party transactions Unfair related party transactions Falsified minutes of board Falsified minutes of board Illegal political contribution Illegal political contribution

PSPD: Legal Actions Requesting Investigation on Accounting Firm Requesting Investigation on Accounting Firm FSC: Financial Supervisory Commission FSC: Financial Supervisory Commission Accounting manipulation, False disclosure Accounting manipulation, False disclosure Failed audit by accounting firms Failed audit by accounting firms No report on off-shore option contact No report on off-shore option contact Delayed disclosure on correction of Net Income Delayed disclosure on correction of Net Income Inspection of financial records Inspection of financial records Record of in-house asset transactions: Hyundai ITC Record of in-house asset transactions: Hyundai ITC

PSPD: Proposal of Legislation Strengthen minority shareholder rights Strengthen minority shareholder rights Amendment of Commercial Code & Security Exchange Law Amendment of Commercial Code & Security Exchange Law Lowering legal requirements on shareholder rights Lowering legal requirements on shareholder rights Mandatory cumulative voting (not succeeded) Mandatory cumulative voting (not succeeded) Regulation on related party transaction Regulation on related party transaction Amendment of Fair Trade Act Amendment of Fair Trade Act Corporate governance guideline Corporate governance guideline Governance on financial institutions Governance on financial institutions Regulation on bank ownership Regulation on bank ownership Disclosure and voting of investment trust company Disclosure and voting of investment trust company Securities Class Action Suit Securities Class Action Suit