KOREA-WIDE EVENTS

BUSINESS, FINANCE AND LABOR EVENTS

January 2006

Happy New Year -- Dollar to Won Ratio Drops (Jan-May 2006) The US dollar sank on a five-day losing streak -- starting on New Year's day -- to below the 1000 won barrier creating fears amongst exporters that their goods would become non-competitive with the slide in the rate. Last year, a dollar on average bought W1,024. The sudden drop created fears in the export driven Korean economy. The greenback on 6 Jan, which opened at 995.00 won, traded at 995.1 won at one point, up 7.8 won from 5 Jan's close, the lowest level since November 1997. "Currency authorities and offshore investors are locked in a kind of behind-the-scenes money game, and so far speculative offshore investors seem to have the upper hand," said Lee Jin-woo, an official with National Agricultural Cooperative Federation Futures. "Without special momentum, the dollar will keep losing ground for the time being."


Drop drops (5 Jan 2006)

The South Korean currency authority sent a strong signal of intervention to stem the won's rise, but this did not seem to have had a major impact. The government, through state-run banks, bought dollars worth about $200 million to help contain the won's further rise. But the government was not enough to reverse the direction of the won's rise as offshore investors and exporters dumped their holdings. It soon fell below W990. On 9 Jan the dollar changed hands at 979.2 won. The dollar dropped to 975.00 won on 10 Jan, but rebounded later as the government stepped in to buy the dollar -- with billions of won pumped in the government effort was only partially successful in stabilizing the market. The won continued to slip.

Government officials were wary of letting the won appreciate against the dollar because it made South Korean exports more expensive. The central bank estimated that each percentage-point gain by the local currency against the greenback led to a 0.06-percentage-point fall in economic growth and a 0.1-percentage-point slide in inflation. Each percentage-point rise by the won against the U.S. dollar also resulted in a $520 million cut in the nation's current account surplus.

The Bank of Korea said the situation was only "temporary." In an interview with the Chosun Ilbo on Jan. 12, central bank Governor Park Seung said there were no factors to drive the dollar down further overall this year.


Drop drops (13 Jan 2006)

By 15 Jan 2006, nearly 30 percent of small and medium enterprises in Korea suffered losses from exports due to the won's surge against the U.S. dollar. According to a survey of 113 companies by the Korea Federation of Small and Medium Business, 29.57 percent of the respondents said the won's sharp appreciation had rendered their exports unprofitable. A stronger won made Korean exports more expensive, dealing a blow to exporters. According to the findings, 62 percent of the firms surveyed said they continued to ship their products overseas despite suffering losses. Another 5.2 percent said they had given up overseas shipments out of fear that exchange-rate fluctuations would affect their profits. In order to cope with the exchange-rate swing, 40 percent of the companies surveyed said they would cut costs, while 33 percent said they would raise product prices.

On 16 Jan the won-dollar exchange rate continued its downward trend and fell to as low as 970.3 won per dollar. The current policy of government intervention in shoring up the won was NOT working. The monetary authorities of the Bank of Korea are losing influence over the foreign exchange market because the government has lost the trust of market players. On some occasions, those in the foreign exchange market move along a different course from the course of which the Bank of Korea has planned for the market.

In fact, foreign exchange dealers in Korea are reluctant to trust the Bank of Korea foreign exchange authorities because they have suffered losses due to their confidence in the government. As a result, the government now has to bear higher costs to manage the foreign exchange market, a serious byproduct of mistrust. "If the government enjoys the strong confidence of dealers, it takes only a few words and a purchase of $100 million to raise the won-dollar exchange rate by five won. In reality, the government has to buy $200 million to $300 million to generate the same result," an exchange dealer explained.

On 27 Jan South Korean Finance Minister Han Duck-soo said that the Korean won's ascent against the U.S. dollar has been excessive, and that the currency authorities are closely watching the currency market. "It is difficult to say what the appropriate currency exchange rate is...but it (the won's gains) have been excessive," Han said in an interview on a local radio program.

Local exporters, in particular smaller enterprises, want the authority to take prompt action, saying the won needs to fall against the yen and the greenback to keep their products competitive in overseas markets.

On 2 Feb 2006, the greenback plummeted below W960 during the session but inched up later to close at W961.10, hitting yet another eight-year low.

Unable to control the problem, the Bank of Korea attempted put a positive spin to the problem. The Korea Herald stated on 2 Feb, "local currency yesterday maintained its solid rally against the U.S. dollar for a second consecutive day on clear signs of an improving economy and a steady inflow of foreign capital." Suddenly the "dollar drop" was "a rally of the won against the dollar." It stated that the won's gain had "little immediate impact" on exports as exporters are not as vulnerable as they were in the past, stressing that the Bank of Korea will not intervene in the market as heavily as it has in the past. Critics say market intervention is undesirable because it is too costly and the effect is only short-lived. Meanwhile, global rating agencies have applauded the nation's move to let the currency move more freely against the dollar in recent years. (Source: Korea Herald.)

On 7 Feb 2006, the dollar fell W6.20 to close at W964.60. By 12 Feb, the dollar closed at W976.80. On 20 Feb the dollar ended at 967.20 won down from 972.60 won the previous day, but opened at 969.50 won on 21 Feb.

By 13 Mar the greenback rose to W980. The won continued to hover between 980 and 970, but started to lose ground in the summer falling into the 950s. In Aug it started to inch up slowly. On 25 Aug the dollar opened at 960.00 up from 959.20 won.

Losses in Foreign Currency Reserves The rapid depreciation of the greenback against the Korean won is estimated to have lost the nation some W4 trillion (US$4 billion) this year in the value of its foreign currency reserves, which are mostly in U.S. dollars. That means 3 percent of the budget for the year (W145 trillion) has vanished in just 15 days. Losses were likely to mount as economic think tanks said the dollar would continue to fall. As of late 2005, 65 percent of the nations' currency reserves of US$210.4 billion was estimated to be in dollar assets, meaning loss on evaluation was some W3.98 trillion since Jan.1. Critics said that the ROK's reserves were "way too big."

A recent report by the Korea Chamber of Commerce and Industry sets appropriate reserves given Korea's economic size at $68 billion or three months worth of imports. But as of late 2005, Korea had as much as $142.4 billion in U.S. dollars, the report says. In other words, the country suffered W2.69 trillion in loss on evaluation unnecessarily. The government itself admits that reserves are far too big. Former finance minister Lee Hun-jai, speaking in the National Assembly late in 2004 when reserves stood at $200 billion, said that was appropriate combining reserves of $150 billion plus another $50 billion for reunification. (SITE NOTE: The amount held in reserve for reunification started as $20 billion in 2003, jumped to $40 billion in 2004 and $50 billion in 2005. To analysts though this amount is only a drop in the bucket if North Korea hemorraghed while the South picked up the hospital tab. It has to the potential to bankrupt South Korea.) (Source: Chosun Ilbo.)

The Bank of Korea stated that dollars the government accumulated from selling the local currency are added to foreign-exchange reserves, which rose $4.3 billion to a record $214.7 billion as of Jan. 15, according to the Bank of Korea The increase in reserves, the fourth-largest after Japan, China and Taiwan, signaled that the central bank may have sold the local currency. To insulate the local currency market from speculative trading, Korea began to restrict access to real time currency trading data on 1 Feb.

Bank of Korea Posts Deficit Snowballing bond issues to curb a rapid appreciation of the Korean won were expected to cause a record high deficit to the Bank of Korea. As the Bank of Korea has floated a massive amount of currency stabilization bonds over the past several years, the bank is currently burdened with growing interest payments, which aggravates its bottom line. The BOK announced last September it would post a net loss of 1.4 to 1.5 trillion won ($1.4-$1.5 billion) in 2005, and bank officials and economists also largely agree that the deficit estimates will set a record. The bank said a total of 6.1 trillion won was paid in interest to bondholders last year.

The Finance Ministry announced the aggregate amount of circulating currency bonds exceeded 155 trillion won as of the end of 2005, up 8.7 percent from the same period of 2004. Amid a growing influx of U.S. dollars by surging exports, the central bank has been sporadically buying U.S. dollars to keep up the faltering exchange rate of the Korean won to the greenback. As Korea depends heavily on exports to power its economy, the government and BOK are concerned that a further appreciation could erode their price competitiveness in the global markets.

Nearly 60 trillion won was raised from currency stabilization bonds from 2003 to 2004, most of which were invested to tame the foreign exchange market. "Since the BOK currently holds around 6 trillion won in reserves, we can offset the prospective deficits," a BOK official said. If the reserve is completely dried up, current laws guarantee that the government should compensate for any loss that the bank could incur in the future. Under mounting interests accruing to the bonds, the bank went into the red in 2004 with a 150 billion won net loss after keeping the balance in the black for seven consecutive years since 1997. (Source: Korea Herald.)

Future of Won:Dollar Rate (Feb 2006)

The won hovered around the 1000 mark for all of 2005 and was anticipated to do the same in 2006. However, the dollar in early January continued to slide against the won to an eight-month low on 5 Jan, closing at W987.30, down another W11.20 from the previous session. This was the lowest close since Nov. 14, 1997 when a dollar bought W986.30. In a mere four trading sessions this year, the greenback thus lost W24.30. (SITE NOTE: The media has collective amnesia about the low won rates. The lowest rate was in Nov. 14, 1997, when it stood at 986.30 won. But we remember the early 1990s when the rate was 780 won to the dollar and our retirement check was simply not enough to get by on. Those were terrible times for military families or retirees living on the economy.)

The dollar was expected to fall as far as W960 and hover between W970 and W980 in the first quarter of 2006 before sliding a little further, a researcher with the Samsung Economic Research Institute says. The LG Economic Research Institute adjusted its forecast for the dollar exchange rate from W1,005 last October to W990 and discussed whether to make further downward adjustments. Other Korean economic think tanks were also considered readjusting their estimates downward as well. Some stated that the won may fall as low as W930. (SITE NOTE: In Oct 2006, the won broke the W928 barrier, but later stabilized around W930.)

Experts predict the decline will continue since the Fed's rate-hike cycle is expected to draw to a close in the first half of this year and the U.S., which has suffered a massive trade deficit, will pressure East Asian countries with ample surpluses to raise the value of their currencies. Another reason the trend will last is that foreign investors have turned to non-dollar assets in emerging markets, while Korean exports will grow, though not to the record levels seen last year, and keep glutting the market with dollars, a researcher with Samsung Economic Research Institute said. (Source: Chosun Ilbo.)

First Company to Declare Emergency (Mar 2006) SEE HYUNDAI SCANDAL

Korea Export Growth Slowed Due to Holidays (Mar 2006) Korea's export growth slowed sharply in January, hit by the Korean won's strength against the U.S. dollar and fewer working days from the 28-30 Jan Lunar New Year holiday. Exports rose 4.3 percent from a year earlier, to $23.4 billion, compared with 11.2-percent growth in December the Ministry of Commerce said. The growth rate is the lowest since May 2003, when exports rose an annual 3.5 percent. It was also the first time since June that export growth was in single digits. "As a rule, exports are concentrated at the end of the month, but since the Lunar New Year holiday fell on Jan. 28-30 this year, overseas shipments fell noticeably," said Shin Dong-shik, head of the ministry's trade bureau. He added that many manufacturers had given workers five days off, further reducing the number of working days. Some critics stated the real test is whether the trend continued into February as oil prices had reached "danger levels" and small to mid-sized companies were claiming the dollar drop was impacting on their export competitiveness.

Companies Shift Production Overseas (Mar 2006) With the U.S. dollar stuck below W1,000 since the start of the year, Korean exporters were in a race against time to cut costs. Those with overseas factories were expanding production there to even out the effects of a strong won. LG Chem, the LG Group's chemicals arm, decided to procure all materials supplied to its PVC plant in Tianjin, China locally and has started to expand production lines for PVC raw material there. Renault Samsung has asked Japan's Nissan to pay it in won instead of dollars for the SM3 model it exports through Nissan's distribution network.

But there is a danger involved. The Korean government rushed in and developed land in China to sell to Korean companies. But there was a hitch. The Chinese put in a stipulation that if the developed land was not sold within two years it would revert to the Chinese. As such the Korean government has taken a beating and is now selling land at distressed prices to the Chinese. The ROK will be lucky if they get 50 percent of their invested money back from the sales of the land. The great influx did not come to the economic zones that it planned.

In addition, there has been other problems with the increasing wages in the coastal cities of China. The once cheap labor market that caused the Koreans to flock to China, has suddenly been disappearing as the Chinese economy is booming. Many of the companies are pulling up stakes and moving their operations to the interior where cheap labor still can be found.

Won:Dollar Rate hits 945 won:$1 (Apr 2006) The won-dollar exchange rate fell to 940 per dollar on 21 Apr 2006 with the prospect of the end of the current U.S. interest rate hike in the near future. The won-dollar exchange rate on the Seoul Foreign Exchange Market was down from the previous day and closed at 945.6 won. This was the lowest rate in eight years and six months since October 27, 1997 (939.9 won). The won-dollar exchange rate went down by 3.0 percent annually last year, but it already fell by 7.0 percent this year. The dollar declined after it was revealed that the minutes of Federal Open Market Committee (FOMC) this March, released by the Federal Reserve Board (FRB) April 18 (local time), said that “most members think the end of interest rate increase era is pending.

Won:Dollar Rate hits 927 won:$1 (May 2006) South Korea's currency finished at a new eight-year high against the U.S. dollar on 8 May on a bullish run in the local stock market and the global weakness of the greenback. The Korean won ended at 927.9 against the dollar. As of May, the local currency gained more than 7 percent versus the dollar. The dollar continued to float around the 930 mark. Local currency dealers forecast that the won could strengthen further to the 920 won per dollar level.

The only good news was that people going for education in America would make a savings. Some stated that they are waiting for the rate to drop to 800 before they exchange their won for dollars.

Won:Dollar Rate Dollar at 953.60 won:$1 (July 2006) On 25 Jul, the won was up from 952.10 won to 953.6 won. The businesses are suffering and now even North Korea has asked to be paid their tourism fees in Euros. Small and mid-sized export businesses are the ones that are most deeply impacted by the high oil prices coupled with the high exchange rates.

Won:Dollar Rate Dollar at 930 won:$1 (Nov 2006) The won reached W965.6 on 14 Aug then started its decline. It rallied in Oct, but at the end of Oct the won started a decline again bottoming out at W930.3 and then stabilizing at around W930.4.

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Happy New Year! A New 5,000 Won Note (Jan 2006) The main reason for issuing new banknotes is to prevent counterfeiting and forgery. Banknote-designing involves changes in both size and figurative design. It costs a lot to issue coins and banknotes. Banknotes can be said to represent the face of a country. As such, they should be convenient in size and refined in design. The note change came amid increasing numbers of counterfeit 5,000-won banknotes. (NOTE: In 2005, counterfeit 5,000 won notes increased 126 percent to about 950 notes.) The bank decided to issue new banknotes with improved anti-forgery features.



People have traditionally been featured in currency. Ancient rulers were often inscribed on coins to show off their prestige. People, featured in banknotes, are historical figures of a country. Three historical figures current pictured on the W1,000, W5,000, and W10,000 notes are all male, surnamed Yi, from the Joseon Dynasty. They are King Sejong, who created Hangul or Korean alphabet, Confucian scholars Yi Yi and Yi Hwang.

The new 5,000-won notes, 143mm x 68mm, are smaller than the old ones. The overall color is reddish yellow, and the face of Confucian scholar Yi Yi is featured. The Ojukheon, the birthplace of Yi Yi, and bamboo trees are also featured on the front side of the note. Women and scientists from the history were suggested for the design, but it was decided to maintain the existing figure, Yi Yi, because it seems to take too much time to reach a national consensus on a new face.

Immediately after issuing the 5,000 won notes, it was discovered that about 40 notes had slipped out without a hologram. A young boy received a note as a gift and noticed the hologram was missing. The value on the erroneous note was in the millions of won -- but the Bank of Korea stated that it was a hand-check error and it involved only one sheet. Soon afterward the Bank of Korea announced that it was removing the new 5,000 won bills from circulation because there were problems with the hologram whereby they could be counterfeited. However, there was no major panic over the issue and Koreans sluffed it off as nothing.

In the future, new 1,000 and 10,000 won notes will be released. In Feb 2006, the design for the new 1,000 won notes was released. The Korea Minting and Security Printing Corporation has already started delivering the new W1,000 banknotes to the BOK since May 19 and began printing the new W10,000 banknotes from July 7, to be supplied to the central bank soon. (See May 2006 for 10,000 won note)



Won Rate Falls (Nov 2006) The won-dollar exchange rate closed at 934.1 won on 11 Nov, down 2.5 won from the previous day. The rate is the lowest in about half a year since May 12 (932.7 won). The won-dollar exchange rate, which went up to 963.8 won on October 9 immediately after North Korea’s nuclear test, fell by around 30 won in just one month. Falling foreign exchange rates against the dollar and yen are attributable to U.S. economic weakness, a weak dollar, Japan’s move to freeze interest rates, and the North Korean nuclear crisis being subsided.

The Ministry of Commerce, Industry and Energy is concerned that the trade balance for Korea’s biggest export markets, the U.S., China and Japan, will deteriorate due to the strong won. Korea recorded a loss of $14.597 billion in trade with Japan from January to July this year, up by $683 million from last year.

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First Time Use of "Circuit Breaker" as Kosdaq Freefalls (Jan-Feb 2006) Seoul share prices tumbled across the board on a steep fall in U.S. stocks in mid-Jan and raging international oil prices. On 23 Jan the tech-heavy Kosdaq market halted trading of stocks for 20 minutes to contain further falls from panic-driven sell-offs. The trading was suspended for 20 minutes at 2:19 p.m. It was the first time ever that the Kosdaq market has launched the ``circuit breaker'' that suspends share trading in fear of further declines. Under the circuit breaker system, regulators can suspend stock trading if the market falls more than 10 percent for more than one minute. The Kosdaq market introduced the circuit breaker on Oct. 15, 2001. The main Korea Stock Exchange has halted trading three times since April 2000.


A stock quote screen shows that the tech-heavy Kosdaq index fell 63.98 points to 601.33, Monday. The exchange activated the first-ever circuit breaker since the establishment of the Kosdaq market to contain further falls. More than 95 percent of the Kosdaq stocks fell. KOSPI also lost 2.06 percent, or 27.35 points, to close at 1,297.43. (23 Jan 06) (Yonhap News)

On 23 Jan 2006 a total of 895 shares dropped on the Kosdaq market, the largest number of falls ever seen on the junior market. It means that more than 95 percent of the 931 stocks listed on the Kosdaq suffered declines. The market's percentage fall is the biggest in four years and four months. Trading resumed at the Kosdaq 20 minutes later, but the market couldn't recover earlier losses. The benchmark KOSPI index also lost 2.06 percent, or 27.35 points, to end at 1,297.43. Dealers said investment and trust firms led institutional selling amid worries that further falls in stock prices may weaken their investment returns. (Source: Korea Times.)

End of a Stellar Run The Korean stock market may be close to the end of a stellar run since exporters' profits are falling, Bloomberg speculated on 12 Feb 2006. The financial news agency cited a stronger won as the cause why "the rally that made Korean stocks last year's best performers in Asia may be over." "The won has risen 4.4 percent against the dollar this year, the third-largest increase among 15 Asia-Pacific currencies," it said. "Every 1 percent gain in the won against the dollar will reduce this year's earning per share by 2 percent at Hyundai Motor, the country's largest automaker, according to a Merrill Lynch & Co estimate." (SEE HYUNDAI MOTORS SCANDAL.)

It quoted Christopher Wood, a global strategist at CLSA, as pointing to problems for Korean exporters from the won's climb against the dollar and yen. Meanwhile, the Korea Composite Stock Price Index closed down 14.44 points or 1.08 percent at 1,320.79 points on 12 Feb, and the tech-heavy Kosdaq slid 2.4 points to 653.21 points. The dollar gained W9 from the previous session to W976.80.

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Insanity Reigns: Xenophobic Business Environment (Feb-July 2006) Overseas investors drastically expanded their presence in the South Korean economy following eased merger and acquisition regulations after the 1997-98 financial crisis. After Sovereign Asset Management's campaign in 2003 to take management control of the SK Corp., the central Bank of Korea raised alarms with "abuses" by foreign funds, primarily speculative funds. South Korea's blue chip "chaebol" conglomerates called for tough measures to defending managerial control from the alleged possibility of hostile foreign takeovers.

There were fears that one out of 10 South Korean companies could become a takeover target for foreign investors as foreign ownership of the country's 10 largest business groups reached 46.9 percent as of the end of Dec 2004, and exceeded 30 percent for the top 20 companies by market capitalization. According to the Korea Chamber of Commerce and Industry, foreigners held more stake than local investors in 53 major Koreans companies at the end of 2004. Foreign investors were also the second-largest shareholders of 138 publicly traded companies as of October 2004, raising concerns that these companies would become a potential takeover target by foreigners. (Source: Washington Times.)

In Apr 2005, the South Korean chaebols braced themselves for possible takeover bids by foreign investors as many offshore funds have explicitly stated their intentions to overhaul the country's family-controlled management. According to financial regulators, a total of 71 cases of foreign investors changed their purpose of investment from "simple investment" to "participation in management." The figure accounted for around 30 percent of the total 240 foreign investors holding more than 5 percent stakes in domestic firms.

The threats against the chaebols by foreign capital gave rise to nationalistic feelings. The names of international investment funds who attempted hostile takeovers and failed are Sovereign Asset Management and Hermes Investment Management. Sovereign Asset Management attempted a hostile takeover of SK Corp., and Hermes Investment Management threatened a hostile takeover of Samsung Corp.

5 percent Rule (Apr 2006) The strict "5 percent Rule" came after Sovereign's aggressive campaign to overhaul the management at SK Corp and the increasing foreign presence on the domestic stock market. Under the government rule, any shareholders, including foreigners, who retains a stake of more than 5 percent in a local company, were required to state the specific purpose of the investment -- greater managerial participation or just investment.

Foreign investors complained the disclosure rule was a "draconian" requirements and contradictory to the country's aim of attracting foreign capital. The Financial Times called the disclosure rule discriminatory against foreign investors, labeling them "economic nationalism" in South Korea which is increasingly hostile to them. Quoting a foreign fund manager as labeling South Korea "schizophrenic" in its relations to foreign funds, the British daily said the regulation was in a stark contrast with South Korea's aim of becoming a financial hub in Northeast Asia.

Seoul's financial regulators defended the stock rule as aimed at enhancing transparency in South Korea's financial community. "The new system is meeting global standards and the system has been designed to closely resemble what is place in the United States and other nations," said an official the Korean Financial Supervisory Services (FSS). Finance and Economy Minister Han Duck-soo said his government would not discriminate against foreign investors nor allow them privileged benefits either. "We will actively attract foreign funds but their illegal activities will be punished under strict rules (just) like domestic investors," he said. (Source: Washington Times.)

BACKGROUND:

NTS Raids Foreign Companies (April 2005) This whole xenophobic fiasco started in Apr 2005 when the National Tax Service supposedly was looking into funds for "unlawful tax evasion" and "wrongful profits." There were allegations from the international press of "paranoia" and "economic nationalism" in Korea -- and this was fueled by the Roh administration trying to condemn the foreign companies who bought companies at rock-bottom prices after the 1997-98 IMF Crisis and then sold them at massive profits when the economy recovered. To the world, this was sound business, but to the Roh administration, this was piracy. One of the primary targets was Lone Star, the largest shareholder in the Korea Exchange Bank. ANY overseas fund that reaped huge marginal profits by selling off shares in banks and real estate they bought cheap in the wake of the 1997 Asian financial crisis. (SEE BUSINESS EVENTS: LONE STAR AFFAIR)

After the raids in Apr 2005, there was rising concern in international opinion over economic nationalism dealing with the 5 percent rule and caps on the number of foreign directors on Korean banks.(Source: Chosun Ilbo.)

The funds complained the Korean government pledged to create an environment where foreign capital could be freely invested in Korea, but conducted raids on offices without prior warning. It was suspicious that the funds targeted by the NTS probe were also the targets of concerted criticism of Korea's "progressive" civic groups with the backing of the Roh administration. Foreign investors believed that the probe was political since it came just ahead of parliamentary by-elections in Apr 2005 -- in which the Uri Party recieved a smashing defeat without winning a single seat.

A few overseas financial firms announced their intentions to pull out of Korea. The American Chamber of Commerce (AMCHAM) protested that the raids on the funds "will greatly hurt Korea's national image, and Korea's foreign investment environment will rapidly freeze over." The unfairness of the situation was echoed that foreign financial firms took the risk and invested in Korea after getting advice from the nation's leading lawyers, and then were labeled criminals just because they made some money. (Source: Chosun Ilbo.)

NTS Levy $214 million Tax Bill (Sep 2005) In Sep 2005, the NTS slapped fines on five U.S funds including Lone Star and the Carlyle Group with a W214.8 billion (about US$214.8 million) tax bill after completing a probe of six firms. It started the investigation in April amid a climate of public resentment of foreign funds, which many say bought up troubled local firms cheap only to sell them for huge profits. The funds are Lone Star, Carlyle, Goldman Sachs, Westbrook and AIG.

The most remarkable aspect is that the NTS for the first time vetoed tax avoidance by companies nominally based in a tax haven. The profits from real estate transactions are taxed by the nation where the property is located, but as for stock sales, they follow the OECD international taxation model in which profits made from stock sales are taxed where the investors reside. However, the OECD does say that local tax authorities can levy taxes after consultation with other Model Tax Convention nations when there are suspicions that speculative capital has set up "paper companies" in an attempt to dodge taxes.

The NTS pursued the case with the premise that the bases in the tax havens were "paper companies" for the specific purpose of evading taxes. According to the NTS, the funds evaded taxes by nominally basing themselves in tax havens, paying higher interest to their overseas affiliates, using illegal expenses or not reporting security transactions in accordance with the law.

Lone Star, the most active overseas fund in Korea, was slapped with a punitive tax of W70 billion (about $70 million) on a profit of W280 billion from selling the Star Tower building in southern Seoul. In Sep 2005, Han Sang-ryul, the head of the NTS investigation bureau, said the tax office planned to report two or three executives of foreign funds to the prosecution for tax evasion and notify the Financial Supervisory Service of the funds' violation of regulations. (Source: Chosun Ilbo.)

ROK Position on Foreign Funds (Oct 2005) The Korean positions is that foreign funds evade tax in Korea by establishing paper companies in tax havens. Thus the U.S.-based fund Lone Star has a subsidiary in Belgium, and the W280 billion profits from real estate it made in Korea were made in the name of that firm, so Lone Star did not pay a penny in tax on account of a dual taxation avoidance treaty between Korea and Belgium. (See Business Events: THE LONE STAR AFFAIR.)

But the NTS now operates on a principle of "real taxation," which says that tax can be levied on the actual investor. As such, it taxed not Lone Star's affiliate in Belgium but its headquarters in the U.S. Although it bars dual taxation, the Korea-U.S. tax agreement provides that profits from transferring real estate can be taxed. (SITE NOTE: This concept can be challenged as it now changes the rules that states the "crimes" of a subsidiary can be laid at the doorstep of the parent company -- even if the parent company is not aware of the acts of the subsidiary. This principle makes it foolish for any company to invest in Korea.)

The real taxation principle, though leaving room for legal conflict, is an international criterion recognized by the OECD. Korea had all but given up taxing foreign funds on account of dual taxation avoidance accords. It has been so engrossed in wooing foreign capital since the financial crisis that it has paid little attention to its dark side, such as the harm speculative funds can do. That is why it matters that the NTS has now invoked the principle. (Source: Chosun Ilbo.)

In Oct 2005, the case stemming from the NTS complaint was referred to the Seoul Central District Prosecutors' Office. The accused include Steven Lee, the former head of Lone Star Korea, three other executives, and 16 Korean affiliates of the fund. They are suspected of evading taxes by deliberately under-reporting transactions and illegally transferring money abroad. A prosecutor said the crux of the investigation was to decide whether Lone Star can be punished under Korean law for tax evasion by nominally basing itself in an overseas tax haven. (Source: Chosun Ilbo.) (SITE NOTE: In Apr 2006, public prosecutors officially sought Lone Star's cooperation in pressuring Steven Lee, a former head of the U.S. investment fund's South Korean office, to return to face charges of embezzlement and tax evasion. The action came after visiting Lone Star Chairman John Grayken said Lee had confessed in an internal audit last year that Lee embezzled millions of dollars from the company. (Source: Yonhap News.) There was not much chance that this would happen.)

Hermes Investment Management Limited ("Hermes") was disappointed to note that the Korean Prosecutor has filed an indictment for summary judgement, in respect of allegations that have been made against a former fund manager of the firm.

Hermes believes that it has complied with Korean laws and regulations in all its activities and has cooperated fully with the Korean authorities in respect of their investigation. Hermes does not accept the Korean Prosecutor's charges and is currently reviewing the position with its legal advisers to determine what further steps it may take.

Richard Bernays, Chairman of Hermes said: "We are disappointed that the Korean Prosecutor has filed charges against the firm. We believe that Hermes has complied with Korean rules and regulations in all of our activities. We will continue to co-operate fully with the Korean authorities. At the same time, we will be reviewing the matter with our Korean legal advisers before determining our next step. " (Source: Hermes Press Release.)

"But is all this a bubble ready to burst? Interest rates are now at very low levels, and a quick rise might make the debt difficult to manage. One big trouble spot: About 60% of credit-card volume in Korea is cash advances, compared with less than 20% in the U.S." This suggests that many cardholders are paying off one card by getting cash from another. Delinquency rates are still low, but that's because some companies are aggressively writing off delinquent accounts. In addition, "low delinquency rates are shielded by the explosive growth of the volume," says Seoul-based Morgan Stanley Dean Witter & Co. analyst Michael Chung. "That will change once interest rates start rising." (NOTE: Korea does not have an revolving installment repayment system (payments based on percentage of outstanding balance owed) as the US credit card companies do. Instead credit cards must be split into monthly repayments or repaid in full.)

The government was slow to react to all the warning signs, though it began efforts to limit card use, lowered card maximum borrowing limits and began measures to share personal credit information. But it was too little, too late. By December 2003, the average South Korean consumer had four credit cards. Total debt on these credit cards totaled a mind-boggling US$97 billion, an alarming 14 percent of GDP in 2003. The worst news was that 15 percent of the card holders had defaulted on their loans. In Dec 2003, Time Magazine called it a "House of Cards" in describing Korea's credit card spree. "Bad accounts have mounted so quickly at card companies that the country's largest issuer, LG Card, recently nearly ran out of money and had to temporarily suspend its ATM cash-advance service. LG was bailed out last week with a $1.69 billion emergency loan package provided by its creditors, mainly banks."

In 2004, the South Korean government was trying to keep LG Card's problems from destabilizing the country's financial system. One-third of South Koreans are LG customers. It is estimated that one of 10 South Koreans above the age of 15 is unable to repay their debt. To state that Warburg Pincus benefitted from "insider information" is rather ridiculous as "analysts" were all warning of the over-extension of credit and potential problems with liquidity. To claim the fund managers needed an "insider" to tell them that LG was going to end up short of funds due to the over-heated borrowing frenzy is ridiculous -- it could be deduced from all the warning signs.

This is simply another example of how the Roh administration is pushing its investment policy that makes it illegal for an foreign company to make a profit in Korea. By charging companies with "illegal insider information" it is trying to shift the blame away from the failed economic policies that caused the credit card crisis in the first place. The insanity is that this may drive investors into other countries where investment is safer -- and NOT retroactively punitive.

In Apr 2006, the impacts of the xenophobic witch hunt dealing with the Lone Star Fund and KEB has led many foreign bidders for LG Card to seek domestic banks to enter into partnership with them to increase their chances of succeeding. By May 2006, there were signs that previously interested foreign bidders were bailing out. The gloom that has descended over the business environment in Korea to keep out foreign ownership has definitely impacted on the strategies of those bidding for LG Card. This is a strange phenomena as the volume of foreign-owned shares is steadily on the rise, as is the number of foreign investors with 5 percent or higher stakes in listed local firms, the Korea Exchange said on 20 Apr. As two more foreign companies pulled out (Nokia-Korea and Sony) their factories, the investment in Korean companies are increasing.

NTS probes Newbridge Capital over sale of Korea First Bank (Apr 2006) According to the industry sources, the National Tax Service (NTS) seized documents at Newbridge's local office on April 10. The agency, however, refused to comment. The move came after the NTS decided that Newbridge Capital was based in Labuan, Malaysia -- a tax haven for the purpose of selling the Korea First Bank in 2005. (SITE NOTE: This is part of the xenophobic drive that somehow foreign companies are ripping off the Koreans. The NTS was conducting checks on foreign-invested companies here to determine whether they benefit from "unfair" tax benefits. Subject to the checks are 4,889 companies in which foreign investors owned more than 10 percent stakes as of the end of 2004.)

The NTS is conducting an investigation into U.S.-based private equity fund Newbridge Capital Ltd. over the sale of its stake in Korea First Bank in 2005. The move came after the country's top tax official hinted earlier this month that Seoul is considering levying taxes on Newbridge's estimated gain of more than 1 trillion won (US$1.06 billion) from the sale of the lender to Standard Chartered PIc in April 2005. Newbridge bought Korea First Bank for 500 billion won in late 1999.

After the sale of the bank, the fund donated 20.4 billion won ($20 million) to the state-run Korea Asset Management Corp. and others, apparently to appease growing public criticism of its nonpayment of capital gains taxes to South Korea. The U.S. fund has maintained that it is not obliged to pay taxes to South Korean authorities under a U.S.-South Korea accord on the avoidance of double taxation. (Source: Yonhap News.)

Seoul City Government Gets into Act on Foreign Company Taxation (May 2006) Seoul City slapped additional taxes on thirteen foreign firms of W36.3 billion (US$33 million) for evading tax or using tax loopholes to reduce their taxes when purchasing large buildings worth trillions of won. The city has asked the Government of Singapore Investment Corporation (GIC) to pay W16.7 billion in additional tax for its purchase of Star Tower from the offshore investment firm Lone Star.

The Seoul Metropolitan Government says it picked out 66 foreign-owned companies suspected of dodging taxes among 126 that conducted large-scale real estate transactions since 1998. Twenty of them have been subjected to an inspection and slapped with additional taxes. The city plans to start investigating the remaining 46 within the first half of this year. (SITE NOTE: Though this is independent of the Newbridge and Lone Star fight with the NTS, it is part of the same package of a xenophobic business environment that is being formed in Korea -- and now in Seoul in particular.)

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Xenophobic Korean Business Environment, Hostile Takeovers and Shareholders' Rights (Feb-July 2006) In Apr 2005 the targets of the NTS audits were identified as foreign companies (mostly US) who allegedly took huge profits avoiding tax payments. The problem is that instead of closing the tax loopholes, the NTS simply changed the rules and retroactively applied the "real taxation" rule. It was obvious to the business community that the actions were politically motivated -- incited by the "progressive" NGO activist groups and backed by the Roh administration. The subsequent rationalizations to explain to the world public how this is rooted in the fear by nationalistic groups of a foreign takeover -- albeit in the form of a business takeover -- is all irrelevant. Business operates on set international principles that as long as it is legal, profits can be made. The companies were advised by Korean legal experts but then the NTS changed the rules and applied it retroactively.

The test case for this xenophobic business environment was the battle for "shareholders rights" between the SK Corp and Sovereign Asset Management, a majority shareholder of SK Corp. In 2002, the SK Global Co. scandal shook the confidence of foreign investors by doctoring its books. The chairman of SK Global was convicted of involvement in a US$1.2 billion fraud at affiliate SK Networks Co., formerly SK Global Co. Chey's appeal on 30 March 2003, upheld his conviction. Chey, the son-in-law of former South Korean president Roh Tae-woo and nephew of the founder of the SK group, was one of 10 directors convicted in June of wide ranging malpractice within SK Group. The most serious fraud involved SK networks, the trading company previously known as SK Global, which had its accounts manipulated to hide $5.6bn of losses. Sovereign tried to force Chey into resigning, but failed while Chey remained free on bail pending his appeal in Mar 2003. The conviction was upheld in Jun 2003 and Chey entered prison in July 2003. Despite his conviction, Mr Chey kept his position as chairman of SK Corp. However, after only three months he was released from jail on bail pending his appeal -- and after a short hospital rest, he reentered management in his old position.

The world investment circles monitored the developments of this scandal as a signal of Korea's willingness to reform its chaebols -- and whether accusations of the xenophobic nature of the Korean business environment were true. (See Roh Promised Reforms of Chaebols all Smoke and Mirrors for details of the Sovereign Asset Management versus SK Global test case.)

In 2002 Sovereign questioned the right of the SK Group to urge the oil refiner to participate in the bailout plan as the SK Group was NOT a shareholder of SK Corp. and it was NOT even a legal entity. Sovereign tried to block the move. It failed. The battle over whether majority shareholders had a financial right to control the destiny of a chaebol-controlled company was lost by Sovereign when the domestic and foreign shareholders of SK Group approved the bailout plan -- and the decision was backed by the Korean courts. After other bailout actions of other SK Group subsidiaries by SK Global, Sovereign started a hostile takeover battle.

By 2005, Sovereign found that the Roh administration was NOT willing to reform the chaebols -- and the "old-boy" network was simply too strong. The lack of transparency in the affiliations between chaebols, banks and other power blocks simply could not be broken -- and it was apparent that there was ACTIVE support from the Roh administration to prevent any form of foreign influence. Under the Roh administration, the world learned that for all the talk of reform, the government was unwilling to tackle the powerful chaebols.

In March 2005 the Joongang Ilbo reported, Sovereign Asset Management tried to turn the annual meeting into a referendum on SK Corp. Chairman Chey Tae-won. The reappointment of Chey Tae-won as a board member supposedly came from 60.63 percent of the shareholders.

In Jun 2005 the Seoul Court of Appeals granted probation on Chairman Chey Tae-Won's three-year sentence on his appeal of his June 2003 lower court conviction. Though it reaffirmed the stock manipulation conviction of Chey, the reason for probation given was: "The court recognized that the events that led to the charges against Mr Chey occurred in the process of trying to resolve problems from the past that he inherited when he became chairman. The court believes that Mr. Chey did nothing motivated by self interest." (Source: SK Newsletter.)) The Korea Times stated on 6 Dec 2005, "Chey Tae-won, who received a very kind and timely get-out-of-jail-free-card just last week from an appeals court. Despite upholding Chey's original conviction of accounting fraud in the order of 1.5 trillion won, the court decided he will never have to serve any more jail time as long as he keeps his nose clean. He did three months of a three-year sentence before being freed on bail and, according to the court, has since made sufficient ``efforts toward a more transparent management'' of his company as to warrant this second chance."

However, others viewed the court reasoning for granting probation as absurd. Chey traded off his shares in the Sheraton-Hilton at inflated prices to garner a $60 million dollar profit and traded equity shares to consolidate his control of the SK Group -- the key point in his conviction. If that is not "self-interest" than nothing is. As to the problems being "inherited" by Chey, he was chairman for seven years when most of the fraud took place.

In Jul 2005, Sovereign Asset Management sold off its entire 14.8-percent stake in SK Corp., ending a two-year attempt to change the company's management. "Having exhausted all of the legal rights currently available to shareholders under Korean law, Sovereign is now exercising the only meaningful right remaining open to us - withdrawal from our investment in SK Corp.," Mark Stoleson, head of Group Investments at Sovereign, said in a statement. Of course, Sovereign made a massive profit on the transaction, which the press immediately pounced on to show how foreign investors were simply in Korea to make a quick profit. Sovereign is estimated to have earned an 800 billion won profit from the sale. It reportedly sold 19 million shares to mostly foreign investors for about 49,000 won a share. (Source: Money, Jul 2005.) The private equity firm reportedly made a 4x return on the investment but would have held it longer if not for the local push against its reform. It just goes to show that pushing your companies to do the right thing in Asia, especially when it's in public and not in private, often makes enemies, not friends. (Source: Mansell Group.)

This test case has now appeared in every financial newsletter throughout the world. It is used as a textbook example of how shareholders -- the real owners of the company -- are cut out of the decision making processes by the Korean board of directors and their "old boy" network which has the monies to purchase stocks to give the boards a voting majority. It also illustrates how the Korean court system "forgives" the chaebol leaders for business malfeasance and how the Presidential pardons of convicted chaebol leaders "cleans the slate." The lesson learned in Korea is that even if you defraud a company of millions of dollars for your own personal gain, you can still evade punishment and remain on the board of directors. The failure of the ROK government's frequent claims to ensuring corporate transparency are shown to be cosmetic and lacking in substance. In addition, it has shown that there are two standards of justice under the Roh administration egalitarian reform policies -- the rich like Chey Tae-won and poor are NOT equal in the eyes of Korean law.

However, the move by Sovereign that appears as cutting one's losses in disgust is still viewed by Koreans as a ploy to increase its profits. Analysts recalled "a Dubai-based investment fund Sovereign Asset Management that reaped huge gains after selling its stake in SK Corp. last year. Sovereign demanded SK improve its corporate governance, hinting at possible takeover of the nation's largest oil refiner. But its purpose of investment in SK Corp proved to maximize its investment returns." (Source: Korea Times, 7 Feb 2006.)

The next test case was started with the Icahn insistence for management say-so in the operations of KT&G by shareholders.

Icahn Hostile Takeover Attempt of KT&G In Jan 2006, the New York billionaire Carl Icahn, who has a reputation for snapping up companies in distress, increased his holdings in Korea's KT&G to become the third largest shareholder with a hand in managing the $8 billion cigarette and ginseng maker. KT&G, a state-run monopoly until the late 1980s, accounts for about 80 percent of the tobacco market with more than 30 cigarette brands. Icahn's name strikes fear into the hearts of many who recall his hostile takeovers of large companies like the moribund U.S. carrier TWA and steelmaker USX. More recently, he pressured the world's biggest media conglomerate Time Warner to buy back its stocks.

Icahn reportedly told KT&G at the end of last year to sell off its ginseng subsidiary to boost the stock price, raising fears of another management conflict with an overseas fund here after what Korean's call the "SK Crisis," the sorry tale of Sovereign Asset Management's bid to seize management control of SK Corporation last year.

In Jan Icahn sent representatives to Seoul to urge the former state-run Korean company to list its rapidly-growing ginseng unit on the stock market and sell its real estate properties in order to boost its share price. According to KT&G executives, Mr. Icahn's representatives said the company's share price, despite rising about 50 percent over the past year, was undervalued compared with firms in other nations. They asked the executives to take radical steps to correct the problem. Such steps, the executives said, included selling land in Daegu, Cheongju, Jeonju and Suwon, where KT&G's plants, now closed were located. Another suggestion was listing the firm's ginseng subsidiary on the stock market. They also recommended that KT&G sell off its non-core assets such as Buy the Way, its convenience store chain, to increase share value. (SITE NOTE: Actually the Buy the Way chain idea was to combat the influx of foreign tobacco makers by providing an outlet for KT&G domestic brands. Domestic brands were under attack as foreign tobacco companies were actually "dumping" their products in Korea to increase their market share. After the shareholder's meeting on 24 Mar, it was announced that KT&G C said that it was in talks to sell its convenience store business, Buytheway Co., to local snack maker Orion Corp. In a regulatory filing, the company said it was also considering the sale of its stake in YTN, an all-news cable network.)


KT&G (Korea Tomorrow & Global) Privatized in 2002

But executives of KT&G, which controlled three-quarters of the domestic tobacco market in a country where one in four people smoke, rejected the proposal, said the company did not intend to sell the land, nor to list shares in its ginseng subsidiary. KT&G felt it was better to improve the undeveloped land to increase its worth and then sell. KT&G planned to re-develop its eight idle factory sites worth 57 billion won ($59 million) at book price in a bid to boost their value. He also said the re-development will be made in the interest of shareholders and over a long period of time, at least three to four years per site.

KT&G said in late Jan 2006 that it would buy back three million shares, equivalent to a 1.8 percent stake in the company, and pay a dividend of 1,700 won ($1.80) per share, up 100 won from a year earlier. KT&G will bring in a homegrown fund in the face of U.S. corporate raider Carl Icahn's attempt to gain a say in the management of Korea's tobacco company, the company's top executive said. He didn't rule out the possibility of a management buyout (MBO) to take the company private.

The billionaire's Icahn Partners Master Fund, registered in the tax haven of the Cayman Islands, said on 3 Feb 2006, it bought 10.7 million shares of KT&G, acquiring 6.59 percent of the company for the purpose of taking part in managing the company. The fund, virtually owned by Icahn, became the third biggest shareholder after Industrial Bank of Korea, which held 15.84 percent including treasury stock, and Franklin Mutual Advisers, which owns 7.14 percent. The fund was to exercise its right to vote in a general meeting of shareholders, it said in its report to the Financial Supervisory Service. Anyone acquiring a stake of more than 5 percent is required to declare the purpose to the Korean financial authorities.

The intervention of foreign investors in KT&G boosted the firm's stock value in early Feb. KT&G share prices soared on speculation that major shareholders will compete to raise their stakes in the company. It closed up 9.88 percent at 56,700 won on 3 Feb. (Source: Chosun Ilbo.)

Icahn and his investors made it clear that their stake investment in KT&G was intended to have a say in management. They emerged as the second largest shareholder of KT&G, followed by Franklin Mutual Advisers with a 7.15 percent stake. Among other major shareholders are the Industrial Bank of Korea with 5.85 percent and KT&G's employee shareholder group with 5.78 percent. However, KT&G looks to have the upper hand as it had backing in 20 percent of shareholdings made up of treasury stocks (5.75 percent), Industrial Bank of Korea's 5.85 percent stake and other domestic institutional investors, compared to Icahn's 6.59 percent.

However, KT&G's management owns only a small stake, with 61.78 percent of the company owned by foreign investors. Its biggest shareholder Industrial Bank of Korea can exercise voting rights for just 5.9 percent of the stock. One analyst pointed out that KT&G shares are not cheap, and predicted Icahn would attempt to throw in its lot with other foreign investors rather than try to control the company by itself. KT&G, which takes 75 percent of the Korean tobacco market, has been attractive to foreign investors. The full-year profit of the company whose market capitalization reaches 7.7 trillion won rose 9.2 percent year-on-year to 515.9 billion won in 2005.

On 6 Feb, Icahn and a group of foreign funds proposed three candidates to contest seats on the board of KT&G, signaling that they wanted to have an active role in managing the nation's largest tobacco group. The move came just days after Icahn raised his stake in KT&G to 6.59 percent stake from less than 5 percent by teaming up with Steel Partners II, LP and other foreign investment funds. In the upcoming shareholders meeting, the three-year terms of six of the manufacturer's nine outside directors will expire. Shareholders will have to decide on how many outside directors to elect from nominees, including Icahn's three nominees. To become an outside board member, they need to get approved at an annual shareholders general meeting scheduled for March.

Icahn's nominees for the KT&G's 12-member board are Warren Lichtenstein, legendary 39 year-old head of Steel Partners II, LP; Steven Wolosky, a New York-based attorney; and Howard Lorber, CEO of Vector Group, a U.S. tobacco maker. They are up against KT&G's candidates Aekyung CEO Ahn Yong-chan (47) and Daehan Investment and Securities adviser Kim Byeong-gyun (60). (Source: Chosun Ilbo.)

From the start it was expected that the Icahn group would have the representation on the board, but the question was how many. (Source: Korea Times.)

On 10 Feb KT&G said it had selected Goldman Sachs as its counselor in its efforts to better combat corporate raider Carl Icahn's bid to "take a bite out of it." At that time, it was thought that the Icahn and his supporters were unlikely to attempt to take over management control of KT&G, but would sell their stake in the end after raising share prices of the company with calls for management improvement, according to the Korea Center for International Finance -- as it had done in the past in other takeover bids. (Source: Korea Times.) The stock of KT&G rose 16 percent to 59,000 won from 51,600 won on 13 Feb. The value of shareholdings held by Icahn and his friendly forces reached 631.8 billion won as of 10 Feb with the return on investment estimated at 35.7 percent. (Source: Korea Times.)

However, the wishful thinking of Icahn selling out did not materialize. Instead, it became apparent that there was a possibility of a a hostile take-over bid. It was estimated the shareholdings of KT&G and its friendly forces were at 39.9 percent, while Icahn and his allies were expected to raise their stake to 16 percent. Friendly shareholder groups of KT&G include Industrial Bank of Korea with 5.85 percent, employee shareholders with 5.75 percent and domestic institutional investors with 16.64.

Then KT&G announced the five candidates, including the three executives recommended by Steel Partners, for two board vacancies, meaning that at least one of the foreigners has no chance of being elected to the 12-member board. Steel Partners "demanded" that KT&G make an extra board seat available so all three of its foreign director-nominees can be put to a fair vote. Steel Partners protested with an accusation that the company's nomination procedure is an "antitakeover device." Ichan and his partners claimed that KT&G violated the local law by "limit(ing) the number of directorships that may be filled by the Committee at just two, while the company is guaranteed the election of four of its director nominees."

KT&G responded that the company had effectively limited the open seats for two possible nominees rather than six - saying that Icahn and his partners failed to follow the procedures for nominating its candidates to four other seats on the board for audit directors, in addition to two seats for nonexecutive directors. A company official responded that it is unfortunate that the adherence to "established local market practice and securities laws" should be interpreted as a takeover defense. (Source: Korea Herald.) The dispute was likely will end up in the courts.

On 17 Feb, KT&G said that it planned to collect proxies from shareholders to fend off a foreign investors' bid to seat their nominees on the company's board up to the March 17th shareholders meeting. On 24 Feb, the Icahn faction went one step further than simply trying to achieve management representation -- that was actively being thwarted by the KT&G management. U.S. investors Carl Icahn and Warren Lichtenstein made a tender offer Friday to buy KT&G Corp., South Korea's largest tobacco company. The U.S. investors offered 60,000 won (US$61.91) a share, 17 percent more than KT&G's closing price on 23 Feb in South Korea. Stock prices shot up to 57,000 won a share. As expected, KT&G rejected the acquisition offer after an emergency board meeting on 27 Feb stating, "The acquisition offer is no help to boost shareholder value."

"A series of recent steps KT&G has taken including refusal to sell its idle real estate assets show that the company is completely neglecting shareholders' rights," Icahn and partners claim, prompting them to take over the firm. While Icahn and partners say they proposed a friendly takeover to control the company, stock experts argue the bid was effectively hostile from the start, adding it was unlikely company management will accept the offer. "If Icahn and partners actually start to buy KT&G shares, it would be the first-ever case where foreign investors attempt a hostile takeover by buying shares in a domestic listed company," an official with the Financial Supervisory Service said. There were conflicting views whether Icahn would succeed.

On 1 Mar Steel Partners' CEO LP Warren Lichtenstein struck back at the board by making a formal request for detailed financial information to include payments given to the board of directors, fees paid to Goldman Sachs Inc. and Lehman Brothers Holdings Inc., and donations made to the company's social welfare foundation. It stated that in 2004, KT&G raised the compensations made to the board of directors from the previous 500 million won to 1.5 billion won, and raised it further last year to 3 billion won; such pay raise seems to have been excessive even considering the sales growth the company achieved. KT&G replied that it was set aside for the boards of the nation's leading corporations. (NOTE: KT&G is NOT one of these leading corporations.) Lichtenstein also questioned whether it was in a "legitimate, appropriate manner" to donate 17 billion won ($17 million) to the company's welfare foundation since it was founded in 2003, including 12 billion won given to the foundation from July 2005 to January this year.

Rumors circulated that industry insiders got calls from representatives asking if the shareholder would hand over the KT&G shares for 80,000 won per individual share. The allies of Icahn allegedly contacted the National Pension Service - one of the major domestic shareholders of KT&G - asking if the agency would sell its stake for 80,000 each. Facing increasing pressure from the U.S. investors, KT&G reaffirmed its commitment to the shareholders' interest by raising the dividend per share from 1,600 won to 1,700. (Source: Korea Herald.)

On 6 Mar it was announced the Icahn faction was taking the KT&G to court. On Feb. 24, foreign investors led by Icahn filed the complaint with the court in Daejeon, where KT&G is based, to halt the election process. The court was expected to issue its decision on the request by the Icahn-led team to block any important decisions regarding the election of directors at the shareholders meeting scheduled two days after that date. The Icahn faction requested that the court invalidate decisions made at the March 17 shareholders meeting. They asked KT&G to adopt cumulative voting so as to give all three of its candidates a chance to be elected to the board at the same time, but KT&G rejected the request.

On 7 Mar KT&G announced that an "outside director" may be elected to the board. KT&G’s original plan was to fill both outside directorships with its own candidates. It apparently changed its mind after failing to muster sufficient support from foreign investors, who own around 60 percent of the company. ”KT&G has obtained around 40 percent friendly investors and Steel Partners and associates around 35 percent, according to our estimates”, KT&G president Kwak Young-kyoon said. “But even if Steel Partners and associates succeed in putting one of their candidates on the board, it won’t be enough to change the big picture in terms of company management.”

As the shareholders meeting approached, the proxy votes was cut-off one day early prompting the Icahn faction to protest that it adversely affected the voting rights of the foreign shareholders. The Icahn faction cried "foul" but the FSS stated that everything was above board and off-shore votes could be cast up to the cut-off date.

On 14 Mar the Daejeon District Court rejected a request sought by the Icahn-led investors to stop voting to elect new board members at the company's annual shareholder meeting on 17 Mar. When Icahn and the other investors failed to obtain an injunction to stop the election at the meeting, attention was focused on the outcome of a proxy battle at the meeting. The court ruling meant that KT&G would gain an early advantage to beat the Icahn side. The Icahn side would have to settle for one elected director. Meanwhile, some FSS officials urged the Ministry of Finance and Economy to come up with countermeasures to better protect Korean firms from hostile acquisitions in the market but the ministry has made clear it has no plans to do so.

On 14 Mar, KT&G said it had decided to accept a due diligence request from its domestic allies, a move expected to build more shareholder support for the current management in the near future. The National Pension Service, South Korea's biggest institutional investor with a 3.11 percent stake in KT&G, said it would support KT&G at the annual shareholders' meeting -- rejecting the Icahn offer to purchase its shares.

The due diligence request from the Industrial Bank of Korea and Woori Bank was accepted by KT&G. The Industrial Bank of Korea, KT&G's third-largest shareholder with a 5.96 percent stake, and Woori Bank were considering buying a 9.75 percent stake owned by the tobacco company's employees to help KT&G defend itself from Icahn's hostile takeover bid -- including the possible purchase of treasury shares, after due diligence. Commenting on the two banks’ move, the U.S. financier said, ``Woori and IBK are not industry participants. There is no strategic element to this proposed sale. Any sale of shares should certainly be conducted through a competitive bid process or a public offering to ensure maximum return by KT&G.’’ On 15 Mar the KT&G Corp. said its board had made no decision about a plan to sell treasury shares to its domestic allies, one day after activist shareholders led by U.S. billionaire Carl Icahn threatened to sue the Korean company to obstruct the move. "Contrary to the misrepresentations of the dissident shareholders...the board has yet to make any decision regarding the possible sale of its treasury shares." The tobacco firm countered when it said in a prepared statement that it ``will provide all of the same information to any other shareholder who expresses interest in reviewing this material.''

On 17 Mar the Icahn faction succeeded in placing Warren Lichtenstein on the board of KT&G. The Chosun Ilbo stated, "A cat among the pigeons, the new outside director is expected to work for his and Icahn’s bid for control of the company in a boardroom full of KT&G-appointed directors." Lichtenstein won 39.6 percent of the vote for one of two outside directorships up for grabs. The other is Ahn Yong-chan, the CEO of Aekyung, with 34.9 percent. The result was as expected. The only thing that was uncertain was the exact percentage of shareholder votes either side would be able to command. The result was 52 percent overall for KT&G and 48 percent for the offshore funds. (Source: Chosun Ilbo.)

After the shareholder's meeting on 24 Mar, it was announced that KT&G C said that it was in talks to sell its convenience store business, Buytheway Co., to local snack maker Orion Corp. In a regulatory filing, the company said it was also considering the sale of its stake in YTN, an all-news cable network.

On 6 Dec it was reported that Carl Icahn sold most of his shares in KT&G taking about 145 billion won in estimated returns, ending a one-year battle with the tobacco maker's management over how the company should be run. The three funds led by Icahn sold a 4.75 percent stake, or 7 million shares, in KT&G for 425 billion won, or 60,700 won apiece, according to Citiglobal Market Securities, the lead manager of the share sale. It was a discount of 3.8 percent to the previous day's closing of 63,100 won. Unspecified foreign institutional investors bought the majority of KT&G shares from the Icahn-led funds, it said.

The share sale cut Carl Icahn's stake in KT&G to less than 1 percent from 4.87 percent, or 7.76 million shares. Analysts said that Icahn might have sold all of his shares already. ``Carl Icahn's move was expected after the U.S. investor-led funds severed its alliance with Steel Partners, led by Warren Lichtenstein, last August,'' Baik Woon-mok, an analyst of Deawoo Securities said. ``But the move came somewhat earlier than expected as it sold shares before receiving dividends for this year.''

Market watchers said Icahn seems to have sold most of his shares as his funds achieved their profit targets. His sudden departure is likely to trigger a fresh debate over foreign corporate raiders as Icahn sold his stake in KT&G after indicating that he will carry out a campaign to improve KT&G's corporate value. In August, the shareholdings of Icahn-led funds stood at 4.87 stake, while Steel Partners held 2.87 stake. Icahn-friendly shareholdings reached 6.6 percent last February when Icahn jointly bought KT&G shares with Steel Partners. ``Considering KT&G shares rose 33 percent to 60,000 won from 45,000 won last February, Icahn's pure investment gains are around 105 billion won ($130 million) from the stock sale,'' Kim Tae-hoon of KT&G said. If dividends for 2005 were combined, Icahn's gains are estimated at about 145 billion won. Despite a steep fall of KT&G yesterday, analysts said the effect of Icahn's departure will be short-lived and positive for KT&G in the long-term.

``The foreign selling will not affect the fundamentals of KT&G,'' Baik said. He has set a 12-month stock price target of 70,000 won for the company. Cha Se-hyun of Dongbu Securities also said the recent stock buyback and high dividends plan of KT&G will bring investors back soon. ``From now on, prospects for the company's earnings will decide the direction of the stock price,'' Cha said. (Source: Korea Times.)

Hostile Takeover of Hyundai Development in the Wind Samsung Electronics, which has the biggest market capitalization, is 53.5 percent foreign-owned. For POSCO, the figure is 68.4 percent, for LG Philips LCD 53.7 percent, for Hyundai Motor and SK Telecom 49 percent each, for Kookmin Bank 85 percent and for Hana Financial Group 81.2 percent. If the Icahns of this world set their sights on them and rally overseas shareholders in support, things could be even worse than at KT&G.

In Nov 2005, it was said that Hyundai Development, Korea's biggest apartment builder, may be taken over by foreign investors. Analysts said it was quite possible that foreign shareholders would try and take management control. Some analysts say that foreign funds could pull out their investments after reaping huge gains by spreading rumors of hostile takeover plans. Foreign investors are focusing on the management rights of the apartment construction company after the death of Chung Se-yung, a former Hyundai Group chairman who is Chung Mong-gyu's father and a younger brother of late Hyundai founder Chung Ju-yung.

Franklin Templeton Investments (22.87 percent stake in Hyundai Development via its two subsidiaries in Singapore and Luxembourg -- Templeton Asset Management (16.4 percent) and FTIF Templeton Asia Growth Fund (6.47 percent) -- was the majority shareholder and announced that it is willing to participate in the management of the Korea's construction company. It changed its investment purpose to the Financial Supervisory Service (FSS) and Korea Exchange (KRX), from "normal investment" to ``management participation.''

The Hyundai Development incumbent chairman Chung Mong-gyu is the second-largest shareholder (13.34 percent). Even if the shares of Chung's friendly powers were included, the shares of the second-largest shareholder would only reach 16.89 percent.

London-based Hermes Pensions Management, is the third largest (7.03-percent) has also changed its investment purpose and now wishes to take part in management. The British fund's move attracted keen attention as its subsidiary, Hermes Investment Management, has been criminally accused of alleged manipulation of Samsung Corp. stock prices.

Los Angeles-based Alliance Capital Management, an arm of the Capital Group, holds a 6.03 percent stake and Capital Income Builder of the U.S. with 3.3 percent. In Nov 2005, Toscafund Limited, a British hedge fund, purchased a 5.57 percent stake in the company, raising the ratio of foreign shareholding in Hyundai Development to over 70-percent. (Source: Korea Times.)


Foreign Funds (Chosun Ilbo)

POSCO Vulnerable to Hostile Takeover POSCO Co., the world's fifth-largest steelmaker, will probably increase its purchase of its own outstanding stock to discourage a hostile takeover bid. Samsung Securities analyst Kim Kyung-joong said in a research report that the South Korean steelmaker may boost its stock buybacks to raise its friendly shareholdings from the current 20-percent level. In recent months, analysts have been warning that POSCO's position makes it lucrative as a target for a hostile foreign takeover.

Calls for Protection against Hostile Takeovers On 8 Feb, the government dismissed calls for stronger protection for local companies against hostile mergers and acquisitions following moves by foreign investors to influence management at the nation's tobacco monopoly. "We promote an open economy, and based on this principle, we are discouraged from discriminating against foreign investors operating here," said Deputy Finance Minister Kim Seok-dong in a briefing yesterday. "Also, companies exposed to foreign investors are expected to gain in terms of corporate governance." He went on to stress that existing laws would be sufficient to protect local companies against hostile M&A attempts. (Source: Korea Herald.)

At the same time, Yoon Jeung-hyun, chairman of the Financial Supervisory Service, on 8 Feb 2006 remarked that Korea needs to review its long-held policy that prevents cross-investment between commerce and finance as economic policymakers are striving to find a way to counter the growing influence of global players on the local financial sector. Korea has made little progress in nurturing major homegrown players, prompting some people to call for more proactive approaches to cope with the predominance of foreign capital. Whether conglomerates should be allowed into the financial industry has been a long-standing controversy in Korea.

The nation's conglomerates - Samsung, LG, and Hyundai - have dominated the nonbanking financial sectors, taking up 72.5 percent of the insurance market and 35.7 percent of the brokerage market. At present, the business groups largely refrain from acquiring stakes in local banks.

In 1997, the government introduced a law requiring the financial units of conglomerates to obtain the financial regulator's approval before acquiring a stake of more than 5 percent in a non-financial affiliate. The government wants to revise the law to ban conglomerates' financial arms from exercising voting rights on their share holdings in excess of 5 percent. (Source: Korea Herald and Korea Times.)

The shareholding limit, when introduced in 1987, was designed to rein in family-owned business groups bulking up by creating subsidiaries or acquiring other companies. Advocates sought to discourage the chaebol from borrowing beyond their means for expansion and, at the same time, prevent economic power from being concentrated in the hands of a select few.

It was scrapped during the 1997-98 financial crisis because it was feared it would expose domestic companies to a greater risk of being taken over by foreign corporate raiders. But it was reinstated in 2001 to police families controlling chaebol, who were denounced for exercising more power than warranted by the amount of stock they held.

This argument in favor of the regulation may still hold true. Even so, it is overshadowed by the need to protect domestic corporations from hostile takeover bids by foreign hedge funds. If it was needed to remove the shareholding cap in 1998 when takeover threats lay dormant, it is all the more necessary to do so now because they have become realities. (Source: Korea Herald.)

(SITE NOTE: It seems that Korea has amnesia. We have a different view of the events over this law. The law was not abolished in the 1997-1998 "IMF Crisis" -- or simply "IMF" to Koreans -- it was rewritten by demands from the International Monetary Fund (IMF) to force the chaebols to divest themselves of the bank interests because of the lack of transparency in the financial sector. (Though the IMF had nothing to do with the root causes, the financial crisis was popularly named after it.) The root cause of the IMF Crisis was that the chaebols had misused their control of financial institutions to issue cross-assurances to prop up failing chaebol subsidiaries. When the house of cards started to unravel because of external factors in the Asian economy, it moved swiftly in Korea and many major companies were facing bankruptcy or receivership. This action dropped Korea to its knees and required the assistance of the International Monetary Fund to bail the country out of its massive debt. The lack of transparency and other problems dealing with accountability by the chaebols were conditions demanded by the IMF before it acquiesced to the bailout. Korea was pushed by the IMF and other international loan-guarantors as part of the packages to force the chaebols to divest their interests in the banks. However, once the IMF loan was repaid -- well in-advance of schedule -- the chaebols slowly went back to their old ways -- kicking and screaming under Kim Dae-jung calling for delays in legislated reforms -- while using their monetary power to influence politics -- and under the Roh administration seeking to reverse the trend back to the "good ol' days." Using the guise of nationalism, the chaebols are again seeking to regain control of those areas of power that were stripped away from it after the IMF crisis. The chaebols family heads have refused to release control of their empires -- and simply passed management on to their heirs.)

How the Double-Standard Works On 5 Feb 2006, it was announced that Viacom Inc.'s Paramount Pictures bought a 5 percent stake of a DreamWorks SKG unit from Korea's CJ Corp. for about $37 million. Lee Entertainment, a unit of CJ, sold all of its 2.3 million shares in DreamWorks Studio to Paramount on Jan. 31, CJ said in a regulatory filing in Seoul, where the company is based. CJ will book a $36 million gain from the transaction, it said.

In December Paramount Pictures agreed to buy DreamWorks SKG for about $774 million, wresting the movie studio away from NBC Universal and securing the talents of director Steven Spielberg. CJ's subsidiary still holds 4.9 million shares, or 5 percent of DreamWorks Animation, the Korean parent company said in its statement. (Source: Korea Herald.)

Not a word was said in the Korean Press of how a $37 million sale netted CJ a $36 million gain.

Foreign Investment Down Before 1995, foreign direct investment into Korea was less than $2 billion. In 1999 and 2000 it soared to $15 billion per year as foreign investors purchased numerous insolvent companies in the wake of the "IMF financial crisis" -- a misnomer for a crisis caused by chaebol cross-assurances on bad loans. Foreign investment has declined slightly since 2000 but remains well above the pre-IMF Crisis level. Before 1998, foreign investors accounted for only 20 percent of Korea's stock market capitalization, but by the end of 2004, their share had more than doubled to 42 percent.


Direct Foreign Investment Down in 2005 (Sep 2005) (Korea Times)

Before 1998, foreign investors accounted for only 20 percent of Korea's stock market capitalization, but by the end of 2004, their share had more than doubled to 42 percent. According to the Korea Center for International Finance, this is higher than the corresponding shares of stock markets in advanced countries like the United States, Japan, and France, and Asian countries like Taiwan.

The following is an excerpt from an article by Choe Heung-sik, president of Korea Institute of Finance, in the Korea Times on 22 Sep 2005.

As foreign investors raise their investment in the Korean stock market, their shares of stocks of Korea's major companies have risen. In fact, they hold more than 50 percent of the outstanding shares of Samsung Electronics, POSCO, and SK Corp. In addition, after the financial crisis, foreign investment in the Korean banking industry increased sharply as well.

Except for Woori Financial Group and Jeonbuk Bank, foreign investors now hold more than 50 percent of the outstanding shares of all commercial banks in Korea. Korea Exchange Bank, Citibank Korea, and Standard Chartered First Bank all became foreign banks because they are directly managed by foreign capital. We cannot deny the positive economic benefits of the increased penetration of foreign capital into Korea, though there has been some criticism of it. First of all, foreign capital has accelerated Korea's financial restructuring through the acquisitions of insolvent companies and financial institutions.

The inflows of foreign capital into Korea's stock market expanded the demand base of it. Foreign capital also increased the degree of transparency in business management. In the financial sector, it has helped raise confidence in Korea and improve expertise in financial supervision and financial laws and systems. Since foreign banks have introduced advanced financial techniques, the financial supervisory authority has been forced to develop new techniques of financial supervision. Despite all these tremendous benefits, there is still widespread criticism of the penetration of foreign capital into Korea.

As foreign investors have recently become major shareholders in important domestic companies and now even own some banks which are thought to be significant players in the economy, serious concern about the negative effects of foreign capital has been raised.

It has been suggested that, due to the excessive demand for dividends by foreign capital, the fruits of Korea's economic growth have gone to foreigners and the growth potential of the Korean economy has been reduced. In addition, due to the absence of proper instruments for the protection of management rights, the management rights of domestic major companies are in danger of falling into foreign hands, which in turn has led to decreased investment by domestic companies because they have diverted funds to purchase their own stock specifically to protect management rights.

The criticism that foreign capital demands excessive dividends is a mistaken generalization, though it cannot be denied that there are several cases where foreign investors did indeed take excessive dividends by unreasonable methods.

Some empirical studies show that foreign investors' shares of stocks in domestic firms have not significantly affected the dividend allowance. The dividend yield ratio of Korean firms was 1.9 percent in 2004. Of 11 major Asian countries, only Japan and India showed lower ratios, so there seems no reason to worry about excessive dividends going to foreign investors. We need only ensure that the Financial Supervisory Authority thoroughly intervenes in special cases in which foreign investors take excessive dividends by unreasonable or unlawful means.

The assertion that the threat of hostile takeovers by foreign capital has caused domestic investment to shrink may also be off base. The recent slump in investment may not be due to a shortage of funds.

Firms have actually had difficulty in finding good investments. The debt-to-equity ratio of Korean manufacturers fell to 104.2 percent by the end of 2004 from 396.3 percent at the end of 1997. Some of the largest companies in Korea are reported to be flush with cash. If they can find good investments, they will indeed be able to raise the funds for them.

Because some hostile takeovers have been attempted by foreign capital, it is asserted that additional instruments for the protection of management rights should be introduced. However, most foreign capital in the Korean stock market is in portfolio funds, which are interested in capital gains instead of management rights. Since foreign stockholders are not a single entity, they would have to band together in order to pursue hostile takeovers, and this is necessarily very difficult.

It is also true that we already have various instruments for the protection of management rights, like the '5 percent rule,' under which any investor who holds 5 percent or more of the outstanding shares of stock of a company must report the fact to financial supervisory authorities. It can indeed be said that hostile takeovers of major Korean companies by foreign capital are rare events.

Moreover, hostile takeovers do not have only a dark side. They can increase the value of a firm by improving the transparency of management and corporate governance through the supervision of corporate managers. A better means of addressing the threat of hostile takeovers by foreign capital may not actually be the introduction of new instruments for the protection of management rights, but continued market reform.

It would almost certainly become much more difficult for foreign capital to conduct hostile takeovers if corporate value increases due to improvement in the transparency of corporate governance as a result of on-going market reform.

It may also be better for Korean companies not to try to evade foreign capital but to make good use of it after making efforts to increase corporate value. That is, contrary to what we might expect, the threat of hostile takeovers by foreign capital may be helpful in raising the corporate value of Korea.

Though we previously attracted foreign investment to raise international confidence in Korea and to rebound from the financial crisis, we now need to devise a strategy for foreign investment at the government level. We especially need to bring foreign investment into the sector, which has many related industries, but is relatively uncompetitive. Foreign investment is also necessary for the establishment of a cluster of industries and the development of human capital.

We don't have to keep away from foreign capital with unfounded allegations about excessive dividends, falling investment, and hostile takeovers. Foreign capital is not evil. It is only a profit-seeking economic agent. Now is time to wisely make use of foreign capital for the benefit of the Korean economy. (Source: Korea Times.)