"LIN persuaded the court to invalidate derivatives standard agreement that allowed domestic brokerage firms to sell off its client’s position without margin calls"

The Seoul High Court dismissed a lawsuit seeking damages filed by KB Securities against Winners Asset Management ("Winners"), while partially upholding a counterclaim filed by Winners and investors against KB Securities for damages resulting from unlawful counter trading by KB. The is the first case where the court ruled that counter trading implemented by securities firms without margin calls, in accordance with the general terms agreement utilized by most of all Korean securities firms for their clients, is unlawful under the Korean finance law. This ruling is expected to have a significant impact.

Korean investors engaged in trading Nikkei 225 index options via accounts established with KB Securities. On February 29, 2020, amidst significant downturn in the global stock market prompted by the coronavirus pandemic, volatility peaked, leading to adverse valuation impacts on the positions held by Korean investors during the overnight session at the Osaka Exchange in Japan. As the valuation of the investors’ positions reached a predefined threshold, KB Securities implemented counter trades to initiate the forced liquidation of all investors' positions, in accordance with the standard agreement utilized by KB for its clientele. The standard agreement included a provision crafted by the Korea Financial Investment Association, stipulating that counter trades may be executed without the necessity of margin calls if the cumulative valuation of the client’s position falls below 20% of the custody margin due to sharp fluctuations in intraday market prices.

The investors adversely affected by counter trades comprised four private funds under the management of Winners Management along individual and corporate investors who executed discretionary investment contracts with Winners. As a result of KB Securities' counter trades, all the option contracts held by the investors were liquidated overnight, resulting in the complete loss of their investments and incurring of additional liabilities totaling KRW 80 billion.

The investors filed a lawsuit asserting that KB Securities' implementation of counter trading was unlawful.  Simultaneously, KB Securities filed lawsuits contending that the investors are liable to compensate for the losses incurred due to the liquidation of their positions and unlawful operation of Winners.  

One of the primary issues addressed at the trial court was the validity of the standard agreement under under the Terms and Conditions Regulation Act, among other issues. The trial court ruled against the investors.  Upon appeal, Law Firm LIN entered the case to advocate for the investors and introduced a novel argument grounded in financial law. LIN contended before the appellate court that the counter trading constituted discretionary trading, a practice typically prohibited under the Capital Markets Act with some exceptions, and that the specific countertrading in question did not qualify for any exceptions under the Act.

Our team, comprising litigation and finance lawyers with diverse experiences and profound expertise in financial products from law firms, multinational financial institutions, and court settings, contended that the counter trading conducted without margin calls  under the standard terms agreement violateed the Capital Market Act. LIN argued that the securities firm essentially functions as a broker in option transactions and that investment judgment should rightfully remain within the domain of investors, rather than brokers. We also argued that such practices failed to align with the underlying policies behind the finance laws designed to safeguard investors. Furthermore, the LIN team substantiated the argument regarding the impermissibility of such counter trading in other developed capital markets by presenting compelling evidence and expert witness testimony.

In this case, the appellate court adopted a unique approach to witness testimony. The court facilitated simultaneous testimony by two expert witnesses, with each witness appointed by each party. These witnesses were asked the same questions concurrently, allowing for a comparative and dynamic assessment of their responses. The appellate court The appellate meticulously considered the significance and ramifications of the outcome of this case on the capital market. Through deliberate and thorough deliberation the court ensured a comprehensive evaluation of the matter at issue.

After nearly a year of proceedings, the appellate court ruled in favor of the investors. The court decided that the Capital Markets Act prohibites trading by investment intermediaries except in exceptional circumstances. Considering the legislative history and policies behind the relevant provisions of the Capital Markets Act, which aim to protect investors and promote a sound trading order, the provision in question under the standard terms agreement was deemed to violate the Capital Markets Act and therefore cannot be recognized as effective.

The appellate decision is expected to have significant implications for the financial and legal communities. Some large securities firms are reportedly responding to the ruling by conducting an internal review of their terms and conditions and system improvements.

The lawyers at LIN, equipped with extensive knowledge and experience across a diverse range of financial markets, are committed to safeguarding and advancing the best interests of our clients. Our efforts are directed towards promoting fairness and fostering the development of capital markets.
 
If you have any inquiries, please do not hesitate to reach out to lawyers at LIN. They will be more than happy to assist you.