Corporate governance reforms launched in 1998 have succeeded in bringing Korea's standards of corporate governance up to international standards. Wide-ranging reforms have helped to enhance management accountability and independence, protect minority shareholder interests, promote transparency and disclosures, and strengthen accounting standards as part of overall corporate and financial restructuring. Reform efforts continue today; new changes will soon take effect and yet others are being debated that could, if adopted, bring about higher standards of accountability. At the same time, there is a marked trend – still modest but nevertheless significant – for minority shareholders to rely on litigation to protect their interests.

Historically in Korea, corporate governance reform has been driven by the perceived need to achieve greater transparency and accountability on the part of the Korean chaebol, or conglomerates, that have dominated Korean economic activity for the last half-century. Despite modest shareholding, chaebol founders and their families have continued to wield substantial control over companies through cross shareholdings, with little oversight by regulators. With a lack of regulatory oversight and plentiful credit from banks and financial institutions to fund expansion into new business sectors, many highly leveraged chaebol became insolvent in the late 1990s. Rather than call for greater discipline, creditor banks – which were largely controlled by the government – extended more financing to the chaebol in an effort to stave off bankruptcy. There is a consensus today that the failure of many of these chaebol – starting with Hanbo and Kia and culminating in the collapse of Daewoo in 1999 – and the failure of their bank creditors were instrumental in bringing about the current exchange crisis in 1997/1998 and subsequent domestic financial crisis.

Since 1998, the Korean government has, with the urging of the IMF, pushed through substantial reform of Korean corporate governance and of the Korean financial sector. These reforms go beyond amendments to laws and regulations governing internal controls within a corporation and encompass laws relating to mergers and acquisitions, accounting standards and practices, regulation of the financial sector, and bankruptcy. Specifically, reform was effected through amendments to the Korean Commercial Code, the Securities and Exchange Act, its Enforcement Decree and related regulations (the SEA"), the Act on External Audit of Joint Stock Companies, and the Monopoly Regulation and Fair Trade Act and its implementing regulations (the FTL). Also, new laws such as the Securities-Related Class Action Act were passed.

In recent years, corporate governance has again become a big policy issue both in the aftermath of Enron and Worldcom and because of a number of high-profile cases of alleged accounting fraud at a number of chaebol companies in Korea. Further, the government and business community is increasingly concerned that foreign investors' perceptions about Korean corporate governance being weak has led to a persistent undervaluation of Korean companies, in what is commonly referred to as the Korean discount. Accordingly, there is a growing awareness that weak corporate governance has tangible, quantifiable costs for the Korean economy.

Proposed amendment to the Commercial Code

The Ministry of Justice (MOJ) published this year a proposed amendment to the Korea Commercial Code that would provide, among other things, two potentially big changes to Korea's corporate governance system.

One would be to allow companies to adopt an executive officer system that would entrust officers with managing a company and the board of directors to oversee the officers. This is intended to delineate between the executive duties of the managers of a company and the duty, to be vested in the board of directors, of overseeing the managers to ensure they are carrying out their duties properly. Under Korea's current system, the representative director of a company, who runs the day-to-day operations of a company and represents it externally, is the head director among a company's board of directors. Under the proposed amendment, a chief executive and other executives would be appointed by a board where there would not already exist a representative director, and the board of directors may delegate, to the executive officers, its right to carry out resolutions relating to the execution of a company's businesses other than those that must be determined by the board of directors under statute. However, under the proposed amendment, a chief executive and other executives might also serve as directors on the board of directors. This executive officer system, if approved, would not supplant the current directorship system. Rather, companies would have the option to adopt it if they wish.

The other proposal – the two-tier derivative action – has caused much controversy since the new amendment was published earlier this year. It is intended to make companies belonging to a chaebol subject to greater accountability than previously; if implemented, it would allow shareholders of chaebol companies to bring derivative lawsuits against the directors of the chaebol's closely held subsidiaries on grounds the directors breached their fiduciary duty to their (subsidiary) companies, causing damages to the parent company.

The MOJ plans to submit the proposed amendment to the National Assembly for approval soon, after having taken the amendment through the necessary procedural steps. However, given the opposition to the two-tier derivative action on the part of the business community, it is not clear that the proposed amendment in its entirety will be presented to Korea's legislature and, if so, that it will pass. Even if approved, the proposed amendment is not expected to take effect until after 2008, because the presidential decree that needs to be enacted for the amendment to take effect will take time to prepare and be promulgated.

Securities-Related Class Action Act

A key piece of legislation is due to take effect in January 2007, after a delay of two years. Under the Securities-Related Class Action Act that was passed in December 2003, class action lawsuits were to be allowed effective January 1 2005, in respect of companies with W2 trillion �($2 billion) or more in assets for damages caused by window dressing, inadequate audits, false disclosures, stock price manipulation and insider trading. This right was to commence January 1 2007, with respect to smaller companies, except that lawsuits for damages from stock price manipulation and insider trading would be allowed from January 1 2005.

However, due to continued objections by the business community, which expressed concern about the possibility of crippling lawsuits under the new law, the government agreed in 2005 to effectively give companies a two-year grace period to clean up their books and come into compliance with accounting rules. The Financial Supervisory Service (FSS) announced guidelines providing that, if violations of the Korean Gaap included in financial statements as of fiscal years ending on or before December 31 2004 are corrected by December 31 2006 and the corrections are publicly disclosed, such violations might be exempted from FSS audits of companies' financial statements. An addendum to the Securities-Related Class Action Act was added to the same effect in 2005.

Increasing accountability

Corporate governance reforms have also substantially increased the duties of directors and enlarged the scope for potential liability for breach of their fiduciary duty to their companies. Directors are personally liable to the company for breach of fiduciary duty and can be found personally liable to third parties for damages caused by breach of fiduciary duty to the company. Directors can also be found criminally liable for actions or omissions of the company for which the directors are personally responsible.

In recent years, the shareholders and directors of many failed large companies such as Daewoo have been convicted of accounting fraud. Many faced civil liability as well, as shareholders and banks sued them for damages under the External Audit Act and SEA. In cases brought by creditors, it is reported that the government urged creditors to file the lawsuits. Government regulators such as the Korea Deposit Insurance Corporation have been particularly aggressive, as they have the statutory right to require banks that benefited from injection of public funds to sue responsible third parties to seek recovery of the funds.

After many years living abroad, former Daewoo chairman Kim Woo Jung returned to Korea last year, to immediately face charges of accounting fraud and embezzlement in connection with the collapse of Daewoo in 1999. The case was watched closely, the outcome anticipated to be a litmus test for corporate governance reform. Proponents of reform argued that Kim should be convicted and the laws upheld, while others argued Kim should be shown leniency for his contributions to the Korean economy and that it would be unfair to single him out for accounting fraud when the practice was fairly widespread at the time and regulators failed to clamp down on it. Earlier this year, the trial court sentenced Kim to imprisonment of 10 years, imposed a criminal penalty, and ordered him to forfeit W21.4 trillion. The case is now on appeal.

The government has also investigated embezzlement and accounting fraud at chaebols that, unlike Daewoo, have not failed but are strong, going concerns, but the punishments have not been as severe. In one case, the prosecution indicted the four brother shareholders of a large chaebol - as well as 10 directors – in late 2005 on grounds they embezzled tens of billions of won from the company over 10 years. In August 2006, the trial court found them guilty and imposed on each a three-year prison sentence that was suspended for five years and a fine of W8 billion. The court found that the brothers had raised slush funds from the chaebol's accounts, misappropriated the money for the family's living expenses, and ordered accounting fraud. The other 10 executives, who were indicted for aiding and abetting the embezzlement, were given prison sentences of between 8 to 30 months suspended for two to four years. This decision is final as to most of the sentences. These decisions have led analysts to observe that, although prosecutors/judges are much more aggressive today in pursuing shareholders/directors of accounting fraud than in the past, they may still be somewhat hesitant about meting out heavy prison terms to executives of existing chaebols out of concern about the impact on their businesses.

Shareholder activism

Another marked trend is the increase in shareholder activism, to file lawsuits against controlling shareholders and directors. The milestone case in this context remains the lawsuit against Samsung Electronics executives. In December 2001, the trial court imposed an unprecedented W97.7 billion damages award on the company's chairman and nine other directors – they were held jointly and severally liable – for having breached their duty to the company. The appellate court confirmed the lower court decision on some issues and struck down on others but reduced the damages to W19 billion in recognition of the directors' contribution to the growth of the company. In October 2005, the Supreme Court upheld the appellate court ruling.

In recent months, trial court decisions have been obtained in other lawsuits against the directors of large chaebols. In one case, eight directors were found jointly and severally liable to the tune of W40 billion for breach of fiduciary duty to their company (belonging to a chaebol) in deciding to sell shares of the company's subsidiary to the controlling shareholder of the chaebol at a low price. However, the liability of inside directors who were not the controlling shareholders themselves was reduced to W6 billion, and outside directors' liability was reduced to W3 billion.

These cases were initiated and developed by civic organizations that held a small number of shares in the chaebol and were supported by activist plaintiff's counsel. With judges more willing to award substantial damages, greater media interest and coverage in such cases, greater awareness of corporate governance overall, and new laws coming into effect, it is likely that the numbers of lawsuits brought against directors will increase in the coming years.

Over the past two years, there have been a number of high-profile cases of foreign investors trying to exercise their minority shareholding rights, but results have been mixed at best.

Sovereign Asset Management, a Dubai-based investment fund, sold off its 14.9% stake in SK Corp, Korea's largest oil refining company, in 2005 after failing to bring about corporate governance reforms in the company. In March 2005, Sovereign sought to urge other shareholders to vote against a resolution to re-elect the chairman and nephew of the company founder, Chey Tae Won, to another three-year term on the board – Chey had been convicted of accounting fraud at SK Corp. Sovereign did not succeed in having any of the board's 10 directors – of whom seven are outside directors – to vote to remove Chey. But Sovereign's activism does appear to have contributed to important changes in corporate governance; for example, in addition to seven of the 10 directors being outside directors, the outside directors have direct oversight of the company's audit committee.

In January this year, investors Carl Icahn and Warren Lichtenstein, holders of 7.8% equity in KT&G Corporation (Korea Tobacco & Ginseng), pressured the company to sell off certain assets – real estate and other equity securities held by KT&G, list the shares of its subsidiary engaging in the ginseng business, and pay out higher dividends to shareholders. After months of inaction, KT&G announced in August that it would return up to $3 billion to shareholders through share buy-backs and higher dividends. However, no decisions were announced with respect to the sale of real estate or the listing of the company's ginseng subsidiary.

More reform, and more activism

Corporate governance reform continues today. Although much of the legal reform necessary to achieve world-class corporate governance standards has been effected, a new amendment is being considered that could hold directors of companies to greater accountability in the chaebols. Also, in recent years there has been a modest but marked trend towards greater shareholder activism, which is likely to increase.

Biographies

Kyung Taek Jung Kim & Chang Law Offices Kyung Taek Jung is a senior partner of Kim & Chang Law Offices. After more than 20 years in corporate practice with the firm, he has extensive experience in the areas of corporate structure and governance, mergers and acquisitions, joint ventures, antitrust, and commercial contracts. He is the head of the firm's corporate department and chairs the firm's fair-trade practice group, and pharmaceutical and food practice group. He is a standing adviser to the Korean government on fair trade and antitrust issues. Jung received his BA in law from Seoul National University and his LLM from Harvard Law School. He is a member of the Korean Bar and the Bar of the state of New York. Apart from his career at Kim & Chang, Jung was a visiting associate at Skadden Arps Slate Meagher & Flom in New York City from 1986 to 1987. He speaks Korean and English.   Hwa Soo Chung Kim & Chang Law Offices Hwa Soo Chung is a foreign legal consultant at Kim & Chang Law Offices, which she joined in 1992. She has a broad-based corporate and commercial law practice, which includes commercial contracts, joint ventures, mergers and acquisitions, and corporate structure and governance, and has extensive experience representing multinational clients in the pharmaceutical, food, and cosmetic sectors. Chung received her BA from Harvard College, a Masters in Public Affairs from the Woodrow Wilson School, Princeton University, and a JD from the University of California, Hastings College of Law. She is a member of the California Bar. Chung speaks English and Korean and is a proficient in French.