Standard for determining whether an act constitutes a fraudulent act prohibited under Article 178 of the Financial Investment Services and Capital Markets Act / In the case of financial investment instruments with a structure in which the exercise of rights or fulfillment of conditions is decided based on the prices of underlying assets at a certain point or money is settled, whether an act affecting the exercise of rights or fulfillment of conditions by using means, etc. recognized as unfair under social norms constitutes a fraudulent act in violation of Article 178(1)1 of the Financial Investment Services and Capital Markets Act (affirmative), and whether an investor who suffered from a violation may claim damages against an unfair trading person in accordance with Article 179(1) of the Financial Investment Services and Capital Markets Act (affirmative)

Articles 178 and 179(1) of the Securities Exchange and Financial Investment Services and Capital Markets Act

Representative Party 1 and five others (Law Firm Hannuri, Attorneys Kim Sang-won et al., Counsel for the plaintiff-appellant)

Do District Court Decision 200Do4788 decided May 2, 200

Seoul High Court Order 2013Ra1426 dated January 13, 2014

The order of the court below is reversed, and the case is remanded to Seoul High Court.

The grounds of reappeal are examined (to the extent of supplement in case of supplemental appellate briefs not timely filed).

1. The Securities-Related Class Action Act was enacted in order to effectively relieve investors’ damages and to ensure transparency in their management by taking into account the fact that it is difficult to expect that individual victims are relieved of damages due to a relatively small amount of damage on the part of the victim in connection with securities that are issued and distributed in large quantities, and thus, the Act permits securities-related class actions regarding claims for damages under Article 179 of the Financial Investment Services and Capital Markets Act (hereinafter “Capital Markets Act”) under Article 3(1)3.

Meanwhile, Article 179(1) of the Financial Investment Services and Capital Markets Act provides that “any person who violates Article 178(1) of the said Act shall be liable for damages sustained by a person who trades or makes any other transaction in financial investment instruments due to such violation in connection with such trading or transaction.” Article 178(1) provides that “no person shall commit any of the following acts in connection with such trading or other transaction,” provides that “any person shall be prohibited from doing any of the following acts in connection with the trading or other transaction in financial investment instruments.” Article 179(1) provides that “The use of “unfair means, plans or tricks”, false labelling for the purpose of inducing any trade in financial investment instruments, or false taxing for the purpose of inducing any other transaction, and Article 179(2) of the said Act provides that “any person shall not circulation of rumors, deceptive schemes, or assault or threaten any other transaction in financial investment instruments (see, e.g., Supreme Court Decision 201Do14108 Decided, 2010, supra.).

In full view of the legislative purpose, statutory structure, and content of these provisions, whether an act constitutes an illegal act prohibited under Article 178 of the Financial Investment Services and Capital Markets Act in relation to trading of a financial investment instrument ought to be determined by comprehensively taking into account the structure and method of trading the financial investment instrument in question, the developments leading up to the transaction, the characteristics of the market where the financial investment instrument is traded, the rights and obligations of investors arising from the financial investment instrument, the timing of termination thereof, the relationship between investors and the offender, and the situation before and after the act. Therefore, if an act affecting the exercise of rights or fulfillment of conditions in a financial investment instrument based on the price of underlying assets at a certain time or in the structure where money is settled, such an act constitutes an illegal act in relation to trading of the financial investment instrument, and thereby, constitutes a violation of Article 178(1)1 of the Financial Investment Services and Capital Markets Act. If an investor suffers loss due to the change or settlement of the investor’s rights and obligations or the amount arising therefrom, the investor may claim damages against the unfair trading entity.

2. The record reveals the following facts.

A. On August 31, 2007, Korea Investment Securities Co., Ltd. (hereinafter “Korea Investment Securities Co., Ltd.”) issued “289 Korea Investment Securities Co., Ltd. 289 (hereinafter “instant stock-linked securities”)” (hereinafter “instant stock-linked securities”) based on the underlying asset “Korea Investment Securities Co., Ltd.’s common share (hereinafter “KB Financial Co., Ltd.”) and the common share of the National Bank Co., Ltd. (hereinafter “KB Financial Co., Ltd.”)’s common share (hereinafter “KB Financial common share”). The instant stock-linked securities issued a “289 common share (hereinafter “instant stock-linked securities”) at the maturity of 6 months if the assessment value of the two underlying assets at the early redemption base date falls under the standards for early redemption, a certain amount of investment profits and early redemption, and if the aforementioned early redemption base date did not occur, at the maturity of 200,50% of the common share and at least 270% of the redemption base date, and at the maturity of 267.7% of the common share.

B. On August 30, 2007, when the redemption condition of the stock-linked securities of this case is fulfilled, the Korea Investment Securities concluded a sck contract with the other party to trade derivatives of the same structure as the stock-linked securities of this case with the other party in order to avoid the risk that the redemption condition should be met, and transferred the risk caused by the issuance of the stock-linked securities of this case to the other party.

C. Members including the Re-Appellant purchased the instant stock-linked securities from Korea Investment Securities prior to the date of issuance.

D. On August 26, 2009, the maturity date of the instant stock-linked securities, the common share price of KB Finance was set at 54,000 won near the maturity price (54,740 won, which is 75% of the base price). The other party sold the common share of KB finance held around the expiration date in bulk. Ultimately, KB common share price was determined at KRW 54,740,00 below the maturity date of the instant stock-linked securities, and the redemption condition of the instant stock-linked securities was not fulfilled. The investors on the maturity date of the instant stock-linked securities received an amount equivalent to approximately KRW 74.9% of the investment principal with the maturity repayment from the Korea Investment Securities on August 31, 2009.

E. The Re-Appellant filed a lawsuit seeking damages under Article 179(1)1 of the Capital Markets Act against the other party on the ground that the other party’s sale of the underlying asset in large volume, which is an underlying asset, falls under a violation of Article 178(1)1 of the same Act, constitutes a violation of Article 178(1)1 of the same Act, and thus, the Re-Appellant sought permission for securities-related class action.

3. Examining these facts in light of the aforementioned legal principles, since the stock-linked securities of this case are the structure in which the amount to be repaid to investors is determined according to the closing price as of the base date for redemption of underlying assets, the other party’s claim seeking compensation for damages falls under the claim for damages under Article 179(1) of the Capital Markets Act, on the ground that the fulfillment of the redemption conditions for the stock-linked securities of this case was no longer achieved due to artificial decline in the share price, which is an underlying asset, in violation of Article 178(1)1 of the Capital Markets Act, and thereby, the investors holding the stock-linked securities of this case suffered losses due to partial redemption of the investment amount at maturity.

Nevertheless, the lower court determined that the re-appellant could not exercise the right to claim damages pursuant to Article 179 of the Capital Markets Act, and as a result, did not meet the requirements stipulated under Article 3 of the Act, on the grounds that the re-appellant was held passive and passively until maturity after the re-appellant acquired the instant stock-linked securities, and that the other party did not actively trade the instant stock-linked securities, such as selling, exchanging, or offering them as collateral, due to large-scale sale of KB financing common stocks, which are its underlying assets. In so doing, the lower court erred by misapprehending the legal doctrine on the scope of the right to claim damages pursuant to Article 179(1) of the Capital Markets Act.

4. Therefore, the order of the court below is reversed, and the case is remanded to the court below for a new trial and determination. It is so decided as per Disposition by the assent of all participating Justices on the bench.

Justices Lee In-bok (Presiding Justice)