Simplifying Corporate Governance of Large Enterprises... Prohibition of Joint Investment in Grandchild Subsidiaries

Last September, Party-Government Fair Economy Creation Plan
Amendment to Fair Trade Act Enforcement Decree Passed at Cabinet Meeting
Strengthening Disclosure Obligations for Internal Transactions of Holding Companies
Fair Trade Commission: "55.4% of Internal Transactions Are Between Parent, Grandchild, and Great-Grandchild Companies in Holding Company Conversions"

The person on the right is Joseph Cho, Chairman of the Korea Fair Trade Commission, and the person on the left is Kim Tae-nyeon, Floor Leader of the Democratic Party of Korea. Photo by Dongju Yoon doso7@

[Asia Economy Reporter Moon Chaeseok] The government is banning 'joint grandson companies' that complicate the governance structure of large business groups and strengthening disclosure obligations for internal transactions of holding companies. The Fair Trade Commission (FTC) imposed a fine of 4.4 billion KRW and corrective orders on Mirae Asset Group last month regarding internal transactions. Hanwha Group, which the FTC plans to review at a plenary meeting, is under suspicion of preferential treatment in business dealings, and with internal transactions accounting for 67%, it cannot be exempt from this issue.

On the 9th, the Fair Trade Commission announced that the amendment to the Enforcement Decree of the Fair Trade Act containing these details has passed the Cabinet meeting.

This amendment to the Enforcement Decree is part of the 'Early Achievement Plan for Fair Economy' discussed last September by the Democratic Party and the government (including the Ministry of Economy and Finance and eight other ministries).

First, joint investment in grandson companies is prohibited. Here, a grandson company refers to an affiliate of a subsidiary, where the shares owned by the subsidiary are equal to or greater than those owned by the largest shareholder among special related parties.

The amendment excludes cases where 'the shares owned by the subsidiary are the same as those of the holding company' and 'the shares owned by the subsidiary are the same as those of another subsidiary' from the cases where joint investment is allowed.

Currently, under regulations, two or more companies can be the largest shareholders investing the same shares in a single grandson company. This is to allow joint ventures between subsidiaries and other companies (such as affiliates outside the holding company system).

There is a loophole that holding companies and subsidiaries or multiple subsidiaries can also jointly invest in grandson companies.

Because there is no provision excluding affiliates within the holding company system from the scope of special related parties, the FTC judged that the advantage of a simple and transparent governance structure, which is a strength of the holding company system, could be damaged.

The disclosure obligation for internal transactions will also be strengthened. The amendment removes 'subsidiaries, grandson companies, and great-grandson companies of the holding company' from the list of transaction counterparts exempted from board resolution and disclosure obligations in internal transactions of goods and services.

However, companies belonging to a corporate group where the same person is not a natural person are still exempt because it is difficult to establish support acts for the controlling family.

Transactions conducted until September 30 will apply the existing Enforcement Decree (exemption from board resolution and disclosure obligations) to give companies time to adapt.

Until now, among the obligations imposed when trading with companies where the controlling family holds 20% or more shares, board resolution and disclosure obligations have been exempted when trading with subsidiaries, grandson companies, and great-grandson companies.

However, the number of groups that have converted to the holding company system doubled from 10 in September 2009 to 23 in September last year over ten years, and the proportion of internal transactions that holding companies conduct with subsidiaries, grandson companies, and great-grandson companies has become too large.

According to the FTC, as of July 2018, the proportion of internal transactions targeting subsidiaries, grandson companies, and great-grandson companies of converted holding companies was 55.4%, much larger than the 14.1% for companies subject to private interest regulation.

The FTC expects internal transactions of large business groups to decrease thanks to the amendment.

The fine level for false disclosure of large-scale internal transactions will be lowered to the same level as for omitted disclosures. Like omitted disclosures, fines for false disclosures will be reduced if supplemented afterward.

Currently, false disclosures incur a fine of 70 million KRW, and omitted disclosures incur 20 million KRW.

The asset total standard for holding companies will be raised to clarify the status of companies whose holding company status is ambiguous.

The current Enforcement Decree, revised on July 1, 2017, raised the asset total standard for holding companies from 100 billion KRW to 500 billion KRW and allowed 'existing holding companies' with assets under 500 billion KRW at the time of enforcement to be regarded as holding companies until June 30, 2027.

During the grace period, companies were required to meet the asset total standard. Therefore, even if the asset total fell below the previous standard of 100 billion KRW during the grace period, they were recognized as holding companies because they met the previous standard at the enforcement date.

However, the current Fair Trade Act does not consider a company a holding company from the day its asset total falls below the standard amount of 500 billion KRW. The FTC viewed this as inconsistent.

The amendment stipulates that if a company's asset total under the grace period does not reach the previous standard of 100 billion KRW, it will be excluded from holding company status from that day.

The parts of the amended Enforcement Decree related to board resolution and disclosure of large-scale internal transactions will take effect from the 1st of next month. Other amendments will take effect immediately upon promulgation.

An FTC official said, "This amendment to the Enforcement Decree will help supplement deficiencies found in the operation of the holding company system and the imposition of fines for violations of disclosure obligations," adding, "The FTC plans to revise related notifications reflecting the amended Enforcement Decree."

This content was produced with the assistance of AI translation services.