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Lesson Learned – How to (un)live with securities-related financial crimes

2021.04.05

In a deluge of articles covering countless issues, one topic stands out in particular. As one might have guessed from the title, that one particular topic relates to securities-related financial crimes – one of the most topical issues in modern-day capitalist society. With more and more people, such as, asset management company representatives, company owners, managers and governmental officials becoming involved, we witness a new drama almost on a daily basis. However, the situation is not a new or recent phenomena; the issue has been around in some form or another for decades. Deja-vu, one might say. 
 
A soundly sourced deal that is thoroughly diligence, successfully closed and which yields satisfactory profit-sharing for the interested parties – what more could we ask for? But in reality, achieving this virtuous cycle is easier said than done. 
 
At any stage the basic human instincts of greed and trickery may come into play and a weak link is inevitably going to be easy to break. Too often, insiders divert investment funds, the fraudsters lurking around jump at every opportunity to snatch off crumbs and investors end up losing a fortune. The very phrase ‘written as an investment but read as a fraud’ is no exaggeration. 
 
 
Beyond Your Imagination 
 
The types of securities-related financial crimes are already diverse and are gradually becoming more technical and modernized. Securities transactions are usually comprised of numerous complex phases, involving a variety of roles and players. It is a structure that is prone to various crimes at each stage and phase of a transaction. 
 
Unfair trading practices, such as the use of material nonpublic information, market price manipulation and deceptive schemes, which are regulated by the Financial Investment Services and Capital Markets Act (the “Act”) are typical securities-related financial crimes. Material nonpublic information can be easily accessed by interested parties such as executives, employees, counterparties, lenders and arrangers and it would be difficult to resist the temptation to use such information to buy or sell shares as one sees fit. Market price manipulation involving matched orders, wash trades, pump and dump, spoofing, marking the open and marking the close by interested parties is also common in the market. 
 
The Act also regulates deceptive schemes to capture not only unfair trading practices as discussed above but also rapidly changing securities-related financial crimes. A deceptive scheme essentially use illegal means, plans or skills to offer and sell financial instruments in the market. Recent court rulings have seen (i) a participation in a third party allotment by a company owner under an alias, (ii) false favorable articles published by online publisher, and (iii) false disclosures and dissemination of false articles on an acquisition of a blue chip company (which was completed as a leveraged buyout (LBO) transaction) being classified as deceptive schemes. 
 
 
Caution on ‘DCF’ Model 
 
With respect to false disclosures, a number of issues arise from the use of ‘Discounted Cash Flow (DCF)’ models. DCF is a valuation method which estimates what a company is worth today by using projected cash flows and applying certain discount rates (rather than basing its estimation on the company’s then current assets and operating profit). Caution is to be exercised with these models as they often use unverified, exaggerated, or even false, business plans and projected cash flows to overvalue a company and to subsequently lure innocent investors. 
 
We also see corporate raiders push ahead with company acquisitions through LBO transactions only to cause the acquired company to go bankrupt and cause significant losses to its shareholders. LBOs involve the acquisition of a target company through significant levels of financing which are backed up by assets of said target company as collateral. The Supreme Court of Korea in its decision in 20121) ruled that any arbitrary pledging of the assets of a target company as collateral without due and proper consideration would constitute a breach of trust and misappropriation of assets. Corporate raiders are known to hinder financial activities by misusing the target company’s assets, causing share prices to increase through false disclosures based on false business plans and, eventually, realizing profit therefrom. 
 
 
Pledging of Assets as Collateral without Proper Consideration 
 
The so-called ‘Ponzi Scheme’ (a pyramid scheme) related crimes are also continuously occurring. In the 1920s, Charles Ponzi committed a long-term investment fraud by recruiting new investors through false business plans and paying existing investors with funds collected from these new investors. These financial pyramid schemes that rely on a ‘robbing Peter to pay Rob’ approach is like the Tower of Babel bound to cave in someday. 
 
In the case of South Korea, the Act on the Regulation of Conducting Fund-Raising Business without Permission (the “Regulation Act”) prohibits the raising of funds without a license and thus pyramid schemes are treated as a violation of the Regulation Act as well as fraudulent under the Criminal Act. 
 
Although various institutions such as the Financial Supervisory Service, the Korea Exchange and the Korea Financial Intelligence Unit work collaboratively to prevent securities-related financial crimes, it is virtually impossible to prevent every single incident due to limited resources. Moreover, the Seoul Southern District Prosecutors’ Office’s securities crime investigation team, which was in charge of investigating these crimes, was abolished in January 2020. 
 
 
Launch of Special Judicial Police under the Financial Supervisory Service 
 
However, with investigations being actively carried out by the special judicial police since its launch under the Financial Supervisory Service in July 2019, expectations are high for the special judicial police to develop into a specialized body that rapidly responds to securities-related financial crimes. 
 
In terms of preventing losses in advance, an economist has opined that, in a capitalist society, ultimate responsibility for an investment rests with investors and that these investors ought to conduct a thorough review of the target company, including the target company’s financial statements and documents made available on the Financial Supervisory Service’s Data Analysis, Retrieval and Transfer System in order to avoid possible losses. However, it would be unfair to hold investors fully accountable for losses when a specialized supervisory body is struggling to prevent these losses itself. Ultimately, we need a more systematic system from the supervisory body that thoroughly supervises, manages and inspects investment targets and opportunities in advance. That way, we may finally put an end to this rather chaotic situation and establish an order in financial transactions that is based on justice and trust.

<img alt="" border="0" src="http://www.jipyong.com/newsletter/en/15_202101_2/img/line.png" /> 
1)  Supreme Court Decision 2012Do1283, June 14, 2012

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