"Financial Institutions' Internal Controls Should Encourage Incentives Over Punishments"

Banking Law Association, Seminar on "Improvement Directions for Internal Control Systems of Domestic Financial Companies"

[Asia Economy Reporter Kim Jin-ho] Financial authorities have been urged to encourage financial companies to establish internal controls through incentives rather than punishments. It is a policy suggestion that voluntary compliance is more effective in ensuring the effectiveness of internal control systems. It was also stated that when administrative sanctions are imposed based on internal control violations, clear legal grounds and sanction standards must be established.

Professor Lim Jeong-ha of the Graduate School of Law at the University of Seoul made these remarks during a keynote presentation at the special policy seminar titled "Improvement Directions for Internal Control Systems of Domestic Financial Companies," held on the 18th at the Bankers' Hall in Myeong-dong, Seoul.

Professor Lim first examined that internal control under the current governance law is a form of self-regulation, then proposed four measures to ensure the effectiveness of this self-regulated internal control.

First, he stated that internal control structures and operational plans tailored to the individual characteristics of financial companies must be established. Next, he emphasized that the supervisory authorities should focus more on suggesting directions for improving internal controls rather than imposing sanctions. In particular, when imposing administrative sanctions due to internal control violations, such violations should be equivalent to legal violations or administrative obligations arising from dispositions, and clear legal grounds and sanction standards must be prepared.

Furthermore, to ensure the effectiveness of internal controls, incentives (such as benefits related to inspections and sanctions) should be provided for building internal control systems. Professor Lim said, "Financial companies that establish and effectively operate reasonable information and reporting systems and internal control systems should be granted incentives."

Professor Yoon Seung-young of Hankuk University of Foreign Studies Graduate School of Law emphasized "the duties and responsibilities of directors regarding internal control under corporate law." Referring to U.S. case law, Professor Yoon proposed ten specific criteria (guidelines) to judge directors' monitoring duties.

Specifically, he categorized cases of directors' monitoring duty violations into four types: ▲ tacit approval or involvement in serious illegal acts ▲ failure of supervisory reporting systems for important company operations, among others. He also classified non-violation cases into three types: ▲ managerial risks ▲ failure to recognize illegal acts despite implementation of internal control systems, etc. Then, he presented ten items, including whether preventive standard procedures are established and whether monitoring bodies are designated, as criteria to judge directors' monitoring duties who must maintain internal controls.

The final presenter, Attorney Kim Si-mok of Yulchon LLC, pointed out problems with the current governance law and recent sanctions in his presentation titled "Review of the Financial Company Governance Act Amendment."

Attorney Kim said, "Financial authorities have recently sanctioned financial companies for 'not establishing effective internal control standards' in cases where violations of internal control standards were an issue. This not only contradicts the purpose of the governance law but also goes against the interpretation of the current governance law," sharply criticizing the situation.

Meanwhile, Kim Kwang-soo, chairman of the Korea Federation of Banks, attended the special policy seminar in person and listened to the presentations. Chairman Kim said, "The recent problems arising in the banking sector's internal control systems occurred in a situation where legal standards were unclear and there were no similar precedents. Considering the principles of clarity and predictability, it is desirable to approach this from the perspective of system improvement rather than disciplinary measures."

He added, "We will try to prepare improvement plans for internal control systems jointly with other financial sectors in the second half of the year and propose them to the financial authorities."