[Viewpoint] Unjustified Expansion of the Scope of Internal Transaction Regulation

Choi Joon-sun, Honorary Professor at Sungkyunkwan University School of Law

Among the 'Three Corporate Regulation Bills' that the government and ruling party are determined to pass in December, the comprehensive amendment to the Fair Trade Act includes provisions regulating the 'indirect shareholding' of the controlling family. This is said to be aimed at eliminating blind spots in the regulation of private interest exploitation by the controlling family. However, the regulation of indirect shareholding is unacceptable because it targets companies even if the controlling family’s shareholding is 0%, and it blocks the acquisition of technology companies, thereby hindering high productivity and job creation. Nevertheless, the general public finds it difficult to understand, and lawmakers show little interest, so it is likely to pass as originally proposed.

Under the current Fair Trade Act, large business groups with assets exceeding 5 trillion won, where the controlling family holds more than 30% of shares in listed companies (20% for unlisted companies), are classified as subjects to private interest exploitation regulation. If internal transactions exceed 20 billion won or 12% of annual sales, they become targets of the Fair Trade Commission’s regulation for preferential treatment of internal transactions. However, the amendment to the Fair Trade Act proposes ① strengthening the regulation threshold to a 20% controlling family shareholding regardless of whether the company is listed or unlisted, and ② expanding the scope of private interest exploitation regulation to subsidiaries in which the company holds more than 50% of shares.

In case ①, if the controlling family owns 20% of company A’s shares, all transactions between company A and its affiliates are considered subject to private interest exploitation regulation. Case ② is the so-called indirect shareholding regulation. Suppose the controlling family holds 20% of company A’s shares, and company A owns more than 50% of its subsidiary B’s shares. Then, company B also becomes subject to private interest exploitation regulation. This is because it is considered that an indirect shareholding of 0.2 x 0.5 = 10% occurs. Even under the logic of indirect shareholding, a 20% shareholding should be required, but this has no logical basis. It is the same even if the controlling family holds no shares in company B at all. As of September 2020, there are 315 companies subject to private interest exploitation regulation despite the controlling family having no shares in them. The government policy discriminates only against holding companies that have increased their subsidiary shareholding in compliance with the policy. Furthermore, the amendment requires new or converted holding companies to raise their unlisted company shareholding to over 50%. Then, almost all transactions with those unlisted affiliates become subject to internal transaction monitoring. It is like placing someone on a branch and shaking it so they fall and die.

The proposition that internal transactions equate to private interest exploitation is completely unverified. On the other hand, the damage caused by indirect shareholding regulation is surprisingly severe. Suppose the controlling family holds 20% of the shares of company A, a battery manufacturer. Company A acquires more than 51% of company B, a technology-advanced company essential for stable supply of battery production materials, and pursues a post-merger integration (PMI). Even if the controlling family holds 0% of company B’s shares, the indirect shareholding is 0.2 x 0.51 = 10.2%, making it subject to preferential treatment regulation. Before being incorporated into the group, company B freely traded with related companies. Transactions that were never problematic suddenly become subject to preferential treatment monitoring with all group affiliates as soon as shares are acquired. This removes the incentive to actively pursue M&A, and company A must give up efforts to strengthen its competitiveness.

Regulating companies through constantly changing indirect shareholding ratios will only increase confusion. This was the logic the Fair Trade Commission used in the past to reject indirect shareholding regulation. Once a transaction becomes subject to the Fair Trade Commission’s monitoring, it inevitably shrinks significantly. Companies must focus their capabilities on maintaining governance to defend against internal transaction regulations rather than strengthening competitiveness. Even if it is not a new business or an essential sector, companies will inevitably restructure their business by relocating overseas and forming joint ventures to avoid being included as subjects of private interest exploitation regulation. As a result, good jobs and jobs preferred by young people will be lost overseas. The indirect shareholding regulation, the most dangerous toxic clause in this amendment that blocks maximizing corporate efficiency and erodes productivity without any legitimate logic, must be removed.

Choi Joon-sun, Honorary Professor, School of Law, Sungkyunkwan University