Supreme Court: Company Must Prove That Normal Stock Price Excludes False Disclosure Support Portion

Supreme Court Remands Case on Shareholders' Damage Claims Against Daehan Electric Wire Company

Supreme Court, Seocho-dong, Seoul.

[Asia Economy Reporter Choi Seok-jin, Legal Affairs Specialist] The Supreme Court has ruled that when calculating the damages for shareholders who acquired stocks after false disclosures due to accounting fraud, the stock price formed immediately after the normal disclosure can only be considered the normal stock price if the company proves that the portion inflated by the false disclosure has been removed.

The Supreme Court's Second Division (Presiding Justice Cheon Dae-yeop) overturned the lower court's ruling, which partially dismissed the plaintiffs' claims, in the damages lawsuit filed by shareholders and former shareholders of Daehan Cable against the company, former representatives, and accounting firms, and remanded the case to the Seoul High Court on the 11th.

The court stated, "Since the defendant company's 59th fiscal year's third quarter report was disclosed without false statements on important matters, the stock acquisition acts after that can mainly be seen as based on the financial statements recorded therein. Therefore, unless there are special circumstances such as the contents of the financial statements not containing information necessary for proper market value formation or the transactions being made solely based on past financial statements with false statements on important matters, it cannot be concluded that the causal relationship for transactions under the Capital Markets Act is recognized for stock transactions after the disclosure date."

It continued, "However, even in such cases, under circumstances where the accounting fraud of the defendant company has not yet been publicly announced through measures such as the Financial Services Commission and Korea Exchange's announcement of the detection of accounting fraud and suspension of stock trading, it cannot be said that the market's evaluation of the overall reliability of the defendant company was fully reflected in the stock price immediately after the company disclosed the provision for bad debts and the resulting deterioration of financial condition. Nor can it be considered that the presumption of damages under Articles 162(3) and 170(2) of the Capital Markets Act is broken."

The court further explained, "From November 14, 2013, when the defendant company's 59th fiscal year's third quarter report was disclosed, until November 20, 2013, when the lower court judged the normal stock price was formed, the closing price of the stock in question showed no significant change and even rose by about 340 won per share. However, considering the stock price trend, such as the suspension of trading on December 4, 2014, due to underestimation of the provision for bad debts on the relevant bonds, and the stock price near the low price immediately after the suspension was lifted on December 8, 2015, it cannot be said that the closing price on November 20, 2013, fully reflected the underestimation of the provision for bad debts or that the closing price was a normal stock price with all inflated parts due to accounting fraud removed."

The court added, "Therefore, the lower court should have carefully examined whether the closing price on November 20, 2013, properly evaluated and reflected the underestimation of the provision for bad debts on the relevant bonds and whether it was a normal stock price with all inflated parts due to accounting fraud removed, considering related circumstances such as stock price fluctuations around that date, to the extent that it would break the presumption of damages under the Capital Markets Act. However, the lower court focused only on the fact that there were no false statements on important matters in the defendant company's 59th fiscal year's third quarter report disclosure and made the judgment as previously stated. This constitutes a legal error affecting the judgment by misunderstanding the legal principles regarding causation of damages and formation of normal stock price under the Capital Markets Act," thus explaining the reason for reversal and remand.

According to the court, Daehan Cable made false disclosures by not setting some or all of the provision for bad debts or not reflecting inventory valuation losses in business reports and audit reports from March 16, 2012, to August 14, 2013, and corrected the false disclosures with normal disclosures starting November 14, 2013.

The Financial Services Commission's Securities and Futures Commission detected Daehan Cable's accounting fraud in December 2014 and imposed fines, and the Korea Exchange suspended trading of Daehan Cable's stocks for about a year from December 4, 2014, to December 8, 2015.

In response, Daehan Cable investors filed lawsuits seeking damages primarily based on liability under the Capital Markets Act and alternatively on tort liability under the Civil Act against the company, former company representatives, executives, and accounting firms.

Both the first and second trials partially ruled in favor of the plaintiffs, but there were differences in the standards and amounts of damages awarded.

The key issue in the trial was at which point in time the stock price should be considered the normal stock price when calculating damages. This is because stock price fluctuations after normalization are not recognized as causally related to the false disclosures and thus cannot be included in the damages.

Daehan Cable's stock price hovered around 2,000 won from 2012 to 2014 but dropped to 1,200 won before the Financial Services Commission's announcement of accounting fraud and was suspended. After trading resumed, the price plunged to the 400 won range.

The first trial considered the stock price before the capital reduction on December 10, 2015, after the accounting fraud announcement, as the normal price.

In contrast, the second trial recognized the closing price of 2,485 won on November 20, 2013, when Daehan Cable made normal disclosures, as the normal stock price and calculated investors' damages accordingly.

The Supreme Court found problems with the second trial's judgment.

A Supreme Court official explained, "This ruling explicitly states for the first time that when determining the recognition of damages liability for shareholders who acquired stocks after false disclosures due to accounting fraud or calculating damages, the stock price formed immediately after the company’s normal disclosure should not be considered the normal stock price merely because it is unclear whether the portion inflated by false disclosures remains or has been fully removed. To consider the stock price formed immediately after normal disclosure as the normal stock price, the defendant must prove that the inflated portion due to false disclosures has been removed." The official added, "This ruling is expected to serve as a precedent guiding lower courts when handling similar types of damages cases."

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