Financial Supervisory Service Detects Illegal Management of Bond-type Wraps and Trusts... Third-party Benefit Promotion and Post-benefit Provision Detected

Financial Supervisory Service, Yeouido, Seoul. Photo by Jinhyung Kang aymsdream@

The Financial Supervisory Service (FSS) conducted an investigation into bond-type wrap accounts and specific money trust operations and found serious illegal activities, including the illegal transfer of losses from one customer's account to another through fictitious transactions and the compensation of customers' investment losses using the securities firms' proprietary assets.

On the 17th, the FSS announced that after conducting a focused inspection of bond-type wrap and trust operations at nine securities firms, considering factors such as entrusted assets, fluctuation trends, and market information, it detected acts of promoting third-party benefits and providing post-facto gains.

Last year, due to a liquidity crunch in the money market, many corporate clients requested redemptions of bond-type wrap and trust products they had subscribed to. However, as it became difficult to sell underlying assets such as commercial papers (CP) in the market, redemption suspensions or delays occurred. Additionally, suspicions arose that some securities firms compensated customers' investment losses with the firms' proprietary assets, spreading distrust in the market. In response, the FSS selected and announced a thematic inspection of unhealthy business practices related to wrap and trust products as part of this year's inspection plan.

Bond-type wraps and trusts are representative financial products where securities firms manage assets through one-on-one contracts with customers. Unlike funds that collectively manage multiple customers' assets, these products allow individual management tailored to each customer's investment objectives and cash needs, making them preferred short-term fund management tools for corporate clients.

The main inspection findings revealed practices of transferring losses by purchasing CPs at inflated prices into specific customers' wrap and trust accounts. It is prohibited to promote the interests of oneself or third parties while infringing on the interests of specific investors during wrap and trust management.

However, in some cases, it was found that profits and losses were transferred between customer accounts through illegal fictitious transactions to achieve target returns for accounts reaching maturity. Securities Firm A conducted approximately 6,000 linked and replacement transactions with other securities firms since July 2022, selling CPs from specific customer accounts at inflated prices to other customers' accounts, transferring losses amounting to about 500 billion KRW between customers. The FSS judged that transferring losses to customers through abnormal price transactions constitutes a serious illegal act with potential breach of trust in business and plans to provide key allegations to investigative authorities.

Furthermore, some securities firms, facing difficulties in achieving target returns at wrap and trust maturity due to market fluctuations, provided post-facto benefits by purchasing CPs from customer accounts at inflated prices under decisions made by CEOs and key executives.

Securities Firm B provided benefits totaling approximately 110 billion KRW by purchasing CPs of customer wraps and trusts at inflated prices through specific money trusts subscribed at other securities firms between November and December 2022. Securities Firm C was found to have provided benefits amounting to about 70 billion KRW by purchasing CPs of customer wraps and trusts at inflated prices through funds it established from November 2022 to May this year.

Other illegal activities included violations of contract terms, fictitious transactions between accounts of the same investor, and OEM fund operations. OEM funds refer to funds created by asset management companies under orders, instructions, or requests from fund distributors such as banks or securities firms, which are prohibited under the Capital Markets Act.

The FSS emphasized, "Diligent risk management equivalent to proprietary asset management is necessary even when managing customer assets," and added, "Internal controls over transaction prices must be strengthened, and the principle of investor self-responsibility must be observed during wrap and trust contract conclusion, management, and redemption processes."

It further stated, "Since wraps and trusts are performance-based dividend products, investors should not demand or trust excessive target returns from securities firms. Investors need to regularly check asset details and maturities through management reports and account inquiries to ensure proper management. Demanding compensation for investment losses or guaranteed target returns violates the principle of investor self-responsibility and is not legally permitted."

The FSS plans to promptly address the confirmed illegal activities to establish order in the wrap and trust market. An FSS official explained, "For wrap and trust accounts that incurred losses due to illegal management practices, the Korea Financial Investment Association and the securities industry will cooperate to enable redemptions through objective price assessments and lawful compensation procedures."

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