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Contemporary Issues in Business Laws of South and North Korea

Center for Korean Legal Studies

Columbia Law School

|Week 9: Wednesday, March 12, 2008 Session (ESY |Regulation of chaebols: policies, laws, practices and myths |

|session 2) |Statutory framework for financial services sector ownership restriction in Korea |

| |Recent trends and issues |

I. Monopoly Regulation and Fair Trade Act (“Fair Trade Act”)

A. Restrictions on cross shareholding (Article 9)

1. “Business group subject to limitations on cross-holdings”: a business group whose domestic member companies’ combined total assets are 2 trillion Won or more.

2. Certain exceptions to the definition:

• business group solely engaged in financial or insurance business; and

• business group more than ½ of whose members (measured by total assets) are undergoing statutory corporate reorganization or workout, unless the remaining members have total assets of 2 trillion Won or more.

3. The rule: A member company of a business group falling under this definition shall not acquire or hold shares of an affiliate (i.e., another company in the same group) that, in turn, acquires or holds shares of such member company.

4. Certain exceptions to the prohibition:

• in the context of a merger or transfer of an entire business; or

• enforcement of a security interest, or the receipt of an accord and satisfaction;

provided that the shares so acquired are disposed of within 6 months.

B. Restrictions on aggregate amount of equity investments (Article 10)

1. “Business group subject to a ceiling on aggregate equity investments in domestic company”: a business group whose domestic member companies’ combined total assets are 10 trillion Won or more.

2. Certain exceptions to the definition:

• business group that meets the following criteria: (i) (x) the aggregate voting rights percentage of natural person members of the group and their affiliates minus (y) the aggregate ownership percentage of natural person members of the group and their relatives does not exceed 25%; and (ii) the percentage (x) in the preceding clause is at least 3 times the percentage (y); and

• business group that meets the following criteria: (i) there are five or fewer member companies in the group; and (ii) there are no more than two tiers of subsidiaries within the group.

3. The rule: A member company of a business group falling under this definition shall not acquire or hold shares of another domestic company in an amount in excess of 40% of the net asset amount of such member company.

4. Certain exceptions to the prohibition:

• enforcement of a security interest, or the receipt of an accord and satisfaction, provided that the shares so acquired must be disposed of within 6 months;

• acquisition of shares in a foreign-invested company (as designated under the Foreign Investment Promotion Act) in which a single foreign investor holds 10% of more of outstanding shares;

• a company carrying on financial or insurance business;

• a holding company and its first-, second- and third-tier subsidiaries;

• a member company whose total assets amount to less than 2 trillion Won;

• a company that has implemented corporate governance monitoring and controlling systems that are designed to promote transparency in decision-making and management – i.e., a company that has been determined by the Fair Trade Commission to meet at least 3 of the following 4 criteria:

(i) a company that allows its shareholders to exercise their voting rights by proxy, instead of having to attend shareholders’ meetings in person;

(ii) a company that allows cumulative voting;

(iii) a company that has implemented an “affiliate transaction committee” (consisting entirely of outside directors numbering at least 4) to approve affiliate transactions exceeding certain threshold amounts; and

(iv) a company that has implemented policies and procedures to nominate and review outside director candidates.

5. The newly-elected government of President Lee Myung-Bak has declared its desire to abolish these 20-year old restrictions on aggregate amount of equity investments. The government’s stated view in proposing such abolishment is that market forces alone can adequately control the supposedly abusive expansionary impulses of chaebols (which had prompted the enactment of these provisions in the first place). Opponents of this governmental proposal argue that any abolishment or lessening of the restrictions must be accompanied by measures such as enabling of dual derivative actions and reinforcement of inspection powers of the Fair Trade Commission.

C. Restrictions on provision of guarantees (Article 10-2)

1. “Business group subject to limitations on debt guarantees”: same definition and exceptions as those for “business group subject to limitations on cross-holdings”

2. The rule: A member company of a business group falling under this definition shall not guarantee the debt of a domestic affiliate (i.e., another company in the same group).

D. Article 11 of the Fair Trade Act: Disenfranchisement of voting rights with respect to shares held in financial services companies

1. Applicability and the rule: No member company of a “business group subject to limitations on cross-holdings” that is engaged in financial or insurance business may exercise voting rights with respect to shares held by it in its domestic affiliates.

2. Certain exceptions to the prohibition:

• acquisition or holding of shares in order to carry on the financial or insurance business; and

• limited voting rights allowed in the case of votes for (i) appointment or dismissal of officers, (ii) amendment of the Articles of Incorporation or (iii) merger or transfer of business to another company, provided that the entire group’s voting rights will ultimately be limited to 15% (such percentage being gradually reduced, to (A) 25% as of April 1, 2006; (B) 20% as of April 1, 2007; and (C) 15% as of April 1, 2008).

E. Disclosure requirements – applicable to member companies of a “business group subject to limitations on cross-holdings”

1. Substantial affiliate transactions (Article 11-2)

2. Occurrence of material events (Article 11-3)

II. Certain Regulations Directed at the Financial Services Sector

A. Banking Act

Article 2: definitions of “banking business,” “financial institutions” and “non-financial business operator”

• “Financial institution” is a person (other than the central bank) that engages regularly and systematically in the banking business.

• “Banking business” means the business of lending money raised by taking deposits or issuing securities and other instruments of indebtedness.

• “Non-financial business operator” is a group of persons (i.e., a person and its specially-related persons) that meets one of the following criteria: (i) the aggregate capital amount of non-financial companies (i.e., companies that are not engaged in “financial business” as designated in Article 1-5 of the Presidential Decree) within the group account for 25% or more of the aggregate capital amount of all the group companies; or (ii) the aggregate capital amount of non-financial companies within the group is 2 trillion Won or more.

Article 15. (1) No person, acting alone or together with its specially-related persons, may hold shares of a financial institution in excess of 10% of its outstanding voting shares (or 15% in the case of a regional financial institution).

(2) Requirement to notify the Financial Supervisory Commission when (i) a person, together with its specially-related persons, acquires more than 4% of outstanding voting shares of a financial institution; (ii) a person holding more than 4% of voting shares of a financial institution becomes its largest shareholder; or (iii) there is a change of more than a 1% change in shareholding by a person holding more than 4% of voting shares.

Article 16-2. A non-financial business operator may not hold more than 4% of outstanding voting shares of a financial institution (or 15% in the case of a regional financial institution). Various exceptions apply.

B. Financial Holding Company Act

Article 2: definitions of “financial holding company” and “bank holding company”

• “Financial holding company” is a company that (i) has as its primary business the control of a financial institution (i.e., a company engaged in the financial business) or a company related closely to the operation of the financial business and (ii) controls one or more financial institutions.

• “Bank holding company” is a financial holding company that controls a bank.

Article 8. (1) No person (other than a financial holding company), acting alone or together with its specially-related persons, may hold shares of a bank holding company in excess of 10% of its outstanding voting shares (or 15% in the case of a regional bank holding company).

(2) Requirement to notify the Financial Supervisory Commission when (i) a person (other than a financial holding company), together with its specially-related persons, acquires more than 4% of outstanding voting shares of a bank holding company; (ii) a person (other than a financial holding company) holding more than 4% of voting shares of a bank holding company becomes its largest shareholder; or (iii) there is a change of more than a 1% change in shareholding by a person (other than a financial holding company) holding more than 4% of voting shares.

Article 8-2. A non-financial business operator may not hold more than 4% of outstanding voting shares of a bank holding company (or 15% in the case of a regional bank holding company). Various exceptions apply.

C. Act on Structural Improvement of Financial Services Industry

1. No financial institution, acting alone or together with other financial institutions that are members of the same business group, may make the following types of acquisitions without prior approval of the Financial Supervisory Commission (“FSC”):

(i) an acquisition following the consummation of which such financial institution, together with its financial institution affiliates, would collectively hold 20% or more of the outstanding voting shares of the issuer; or

(ii) an acquisition following the consummation of which such financial institution, together with its financial institution affiliates, would collectively hold 5% or more of the outstanding voting shares of the issuer and where the business group of which such financial institution is a member is deemed to control the issuer.

2. The following additional restrictions became effective on April 27, 2007:

• With respect to the restriction described in clause (i) above, prior approval of the FSC is required for any incremental acquisition that would cross a 25% or 33% aggregate holding thresholds.

• No financial institution that is holding voting shares of an issuer in excess of the limits described in clause (i) or (ii) above may exercise voting rights with respect to such excess shares without prior approval of the FSC.

• Any financial institution that acquired voting shares of an issuer after March 1, 1997 above the limits described in clause (i) or (ii) may not, as of the effective date (i.e., April 27, 2007), exercise voting rights with respect to such excess shares and, furthermore, must divest such excess shares within 5 years of the effective date.

• Any financial institution that acquired voting shares of an issuer before March 1, 1997 above the limits described in clause (i) or (ii) may not, as of the second anniversary of the effective date (i.e., April 27, 2009), exercise voting rights with respect to such excess shares except in accordance with Article 11 of the Fair Trade Act.

D. Recent Trends and Issues

1. The Lee Myung-Bak Administratino proposes to loosen the 25-old year regime separating banking from commerce and, in fact, has announced that such relaxation is one of its top policy priorities.

2. The Financial Investment Services and Capital Market Act (the “Capital Market Consolidation Act”) for the financial services sector was enacted in July 2007 and is scheduled to become effective in February 2009. Key provisions of the Capital Market Consolidation Act include the following:

• Introduction of negative system (rather than the current enumerated system) with respect to the definition of terms “securities”[1] and “derivatives”;

• Introduction of a functional regulation system for capital markets participants;

• Expansion of the business scope of financial services, so that a single “financial investment company” may engage in the business of dealing, underwriting, brokerage, collective investment, investment advisory and trust under one roof;[2] and

• Implementation of a regulatory system to promote protection of investors, such as the introduction of a mandatory product guidance rule, know-your-customer rule and suitability requirements and restriction of unsolicited calls.

Statutes, Regulations and Other Reading Materials

Various laws regulating chaebols

Selected Provisions of the Banking Act, the Financial Holding Company Act and the Act on Structural Improvement of Financial Industry

MOFE informational document regarding the Capital Market Consolidation Act

Accompanying press release

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[1] The new definition of “securities” would adopt the Howey test, which has the following four elements: (1) investment of money, (2) in a common enterprise, (3) with an expectation of profits (4) solely for the efforts of others.

[2] Capital Market Act may provide product-expansion opportunities (particularly, in the payments and settlement business) to securities companies and create a threat to the private banking and trust departments of commercial banks due to the abolishment of a licensing restriction on asset management business. This could give rise to consolidation plays within the Korean financial services sector. Commercial banking and insurance businesses will still require a separate banking and insurance licenses, respectively.

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