[Invest&Law] "Overseas Derivatives Forced Liquidation Illegal"

A ruling has been made that the forced sale executed by KB Securities related to an 80 billion won overseas derivatives investment loss that occurred in early 2020 during the COVID-19 pandemic-induced stock market crash was illegal. The court also judged that the ‘Standard Terms and Conditions for Overseas Derivatives Accounts’ (Overseas Derivatives Terms) by the Korea Financial Investment Association, which was the basis for the forced sale, violated the Capital Markets Act.

◆Court dismisses KB Securities' claim for unpaid funds in appeal= The Civil Division 18 of the Seoul High Court (Presiding Judge Jung Jun-young, Judges Min Dal-gi and Kim Yong-min) on the 26th of last month dismissed KB Securities' claim in the appeal trial of the damages lawsuit against Winners Asset Management (Winners) related to the forced sale of the ‘Japan Nikkei 225 Index Option Investment Private Fund’ and ruled that "Winners must compensate 30% of the loss amount incurred by the investor," resulting in a ruling against the plaintiff (2023Na2008554). This overturned the partial victory for the plaintiff in the first trial in January last year.

On February 29, 2020, as option prices fell due to the stock market plunge, KB Securities executed a forced sale of all Nikkei 225 stock index put options managed by Winners on the Osaka Securities Exchange in Japan. When an unrealized loss occurred in the securities account, all unsettled contracts were liquidated without a ‘margin call’ (request for additional margin). Article 14, Paragraph 2 of the Overseas Derivatives Terms stipulates that if the total evaluation margin of the customer falls below 20% of the margin due to a sudden intraday price fluctuation, the customer may not be required to deposit additional margin, and the unsettled contracts may be forcibly sold in the necessary quantity.

KB Securities bore the unpaid funds generated during the forced sale process and later filed a damages lawsuit claiming the unpaid funds and delayed damages from Winners. However, Winners counterclaimed against KB Securities, arguing that "KB Securities executed the forced sale arbitrarily without a margin call in a situation where forced sale should not have been done, causing losses, so the investor should be compensated for the loss amount."

The private fund managed by Winners and individual investors suffered losses of about 80 billion won, including the entire investment principal and unpaid debt, as all option contracts were liquidated due to KB Securities' forced sale.

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◆"Provision allowing forced sale without margin call in Overseas Derivatives Terms is invalid"= The first trial court ruled in favor of KB Securities, stating that "KB Securities' forced sale was lawful as it met Article 14, Paragraph 2 of the Overseas Derivatives Terms by the Korea Financial Investment Association, so Winners and others are responsible for paying the unpaid funds, and KB Securities has no liability for damages." The first trial also stated that "the decision to execute the forced sale is within KB Securities' authority."

However, the second trial court had a different judgment. The court pointed out problems with the Korea Financial Investment Association’s standard terms and ruled that the forced sale by KB Securities based on these terms was unlawful.

The court judged that for Article 14, Paragraph 2 of the terms to be lawful, it must correspond to the exceptions under Article 71, Paragraph 6 of the Capital Markets Act, which stipulates that forced sale can be conducted under the terms only when △ the investor fails to fulfill settlement or additional margin deposit obligations arising from trading financial investment products, or △ the investor fails to fulfill the additional margin deposit obligation within the deadline after being notified of the request for additional margin deposit of entrusted margin or settlement payment.

Furthermore, the court ruled, "Even if an evaluation loss occurs, it would have been appropriate and reasonable for KB Securities to issue a margin call to Winners."

The court also found that Article 14, Paragraph 2 of the Overseas Derivatives Terms cannot be applied to the ‘European-style option’ Nikkei option, so the forced sale was unlawful. The court stated, "This forced sale was executed without lawful legal grounds, or the plaintiff executed the forced sale without meeting the requirements of Article 14, Paragraph 2 of the terms, thereby violating the duties of good faith, fiduciary duty, and diligence under the Capital Markets Act."

As the court ruled that forced sales based on the Korea Financial Investment Association’s standard terms are illegal, revision of the terms is expected to be inevitable.

Changes are also expected in securities companies’ overseas derivatives brokerage operations, which have applied the same terms uniformly to various types of derivatives with different profit structures and risk profiles.

Kim Kwang-jung, a lawyer at Class Han-gyeol Law Firm (age 47, Judicial Research and Training Institute class 36), who represented Winners in this case, said, "Unlike previous rulings, by recognizing the illegality of the Korea Financial Investment Association’s standard terms and the forced sale based on them, this will greatly contribute to correcting the improper business practices of domestic securities companies and preventing similar damages in the future."

Lee Dong-jae, a lawyer at Lin Law Firm (age 51, class 31), who represented Winners’ managed funds in the second trial, explained, "This ruling will serve as a warning for financial investment businesses to conduct more meticulous legal reviews of the terms they prepare themselves and that investors sign."

Reporter Hong Yoon-ji, Legal Times

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