[Inside Chodong] Burning Down the House to Prevent Another "Padu" Incident

Shifting All Losses to Underwriters
Concerns Over Neutralizing the Technical Special Listing System

The shock of the Padu incident was significant. The IPO underwriter estimated that Padu's annual sales this year would reach 120.3 billion KRW. However, the sales announced immediately after the listing were only 59 million KRW in the second quarter and 321 million KRW in the third quarter. There was even a sarcastic joke that small business owners like pub owners and motel owners were shouting, "We also have sales exceeding 100 million KRW, so please list us too." The stock price plummeted below the offering price, and investor losses expanded. Law firms are gathering affected investors and preparing lawsuits against the underwriters.

The Padu incident primarily places great responsibility on the listing underwriters. Whether intentional or accidental, it revealed significant flaws in the underwriters' due diligence obligations. Accurate verification of sales is a core task of due diligence. The Korea Exchange, which serves as the gatekeeper for listings, also bears considerable responsibility. It failed to filter out the credibility of the estimated sales during the listing review process. The financial authorities, who accepted the securities registration statement containing so-called 'inflated sales,' cannot escape responsibility either. Claims that the cancellation of major sales contracts was 'unforeseeable' or 'could not have been anticipated' sound like mere excuses.

Strong penalties against underwriters and institutional improvements to prevent recurrence are inevitable. In this regard, we agree with the content of the financial authorities' and Korea Exchange's proposed improvements to the technical special listing system. The authorities require prospective listed companies to disclose sales and operating profit and loss (including provisional figures) up to the month before submitting the securities registration statement for the IPO. Companies in a state of capital erosion must also include detailed plans to resolve the capital deficit. The due diligence period for underwriters has been extended. Most of the proposed improvements focus on enhancing transparency through detailed information disclosure and strengthening the listing review process.

However, some recurrence prevention measures are difficult to readily accept. One proposal grants general investors the right (put-back option) to request the underwriter to repurchase shares if the technical special listing company becomes insolvent within two years after listing. In other words, it intends to make the underwriter bear all economic responsibility for investor losses resulting from listing a failing company. This is essentially a put-back option covering all responsibility for the Padu incident.

This measure is not much different from neutralizing the technical special listing system. Would any securities firm take on underwriting duties that might require them to bear investor losses ranging from hundreds of millions to billions of KRW just to earn underwriting and acquisition fees of about 1%? Perhaps only a securities firm CEO about to retire might make such a choice. If large securities firms with IPO underwriting capabilities refuse, relatively less capable small and medium-sized securities firms may take on underwriting, potentially exacerbating side effects. This could cause 'adverse selection' in the technical special underwriting market, where deterioration drives out improvement.

The technical special listing system offers investors a proactive investment opportunity in companies with promising technology, but for companies, it is also a crucial means to raise funds necessary to translate technology into business. If technical special listings become difficult, venture capital (VC) investments in innovative companies will inevitably shrink. It is unreasonable to expect active investment when exit routes to recover invested funds are blocked. The put-back option against underwriters could cause side effects that disrupt the virtuous cycle of funding for innovative companies. We hope not to commit the folly of burning down the thatched cottage while trying to catch a flea.

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