South Korea: Securities companies’ liabilities

Soonghee Lee

In May 2011, an employee at a defendant's branches introduced a discretionary investment agreement operated by a certain investment advisory company to individual investors (the plaintiffs). The investment product was mainly invested in KOSPI 200 options listed on the Korea Exchange using contract monies received by the investment advisory company from investors under discretionary investment agreements. In introducing the investment product, the employee presented and introduced a discretionary investment proposal prepared by the investment advisory company. Later, the employee visited the plaintiffs and prepared an application for the opening of an account, which proposed the plaintiffs' subscription to the investment product, with the defendant as the securities company for transactions. In August 2011, the KOSPI 200 stock price index declined sharply, and the plaintiffs incurred considerable losses. The plaintiffs then filed a suit for damages against the defendant, claiming the defendant had made an investment recommendation and thus had violated the suitability principle and its duty to explain, which should have been observed when the investment recommendation was made, under the Financial Investment Services and Capital Markets Act (FISCMA).

In the course of litigation, the defendant argued that no investment recommendation had been made, since the investment product was not sold by the defendant itself, and investment recommendations must be construed as limited in scope to cases where the relevant financial investment business recommends an agreement which it directly handles. The defendant's argument was that it had merely introduced the investment product and, for the plaintiffs' convenience, had assisted in the execution of the contracts. Therefore, the defendant had not made an investment recommendation subject to the suitability principle and the duty to explain. In support of such argument, the defendant stated it did not receive any sales commission or operating income, and did not directly handle the investment product. The court of first instance held that the defendant, as a financial investment business, was in the position of a person recommending the investment product to the plaintiffs. The court held that the employee first presented and explained the discretionary investment proposal to the plaintiffs while introducing the investment product; the plaintiffs only intended to invest after listening to such explanation, and their investment decision seems to have been based on the employee's explanation. As the employee even prepared a confirmation statement on the results of investment tendency screening and a discretionary investment agreement for each of the plaintiffs, in their name, the plaintiffs could reasonably believe that the defendant was performing the role of an intermediary for the discretionary investment agreements, and although the defendant did not obtain any sales commission or operating income, the defendant did earn a transaction fee.

The appellate court added the following points: FISCMA has never limited the discretionary investment agreements for which investment recommendations may be made to those directly handled by the relevant financial investment business, the duty of the business recommending a discretionary investment agreement which is suitable for the investment tendency of a particular investor and to explain the fundamental risks of the agreement, and the duty of the business handling the agreement to once again ascertain the investor's investment tendency and whether the agreement is appropriate, and to explain the specific terms, earning structure and risks of such agreement, are not necessarily the same, and the business recommending a discretionary investment agreement and the one executing it bears independent duties. Moreover, the courts both held that the defendant had violated the suitability principle and the duty to explain that should have been observed at the time of making its recommendation.

Until now, we have not found any cases where a securities company that had introduced a product was held liable as a person making an investment recommendation. Some view this court decision as expressly holding that the suitability principle and the duty to explain must be observed when there are circumstances to indicate that the securities company actively recommended a product, since investors may be injured due to a gap in the law if securities companies profit by having investors use their accounts while introducing products that they do not formally handle. Securities companies are critical of this court decision as one that is far removed from the realities of the industry, since the details of investment by the discretionary investment business cannot be known.

Soonghee Lee

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