'Nikkei Option 80 Billion Loss Dispute' KB Securities Responsible... Red Light on Receivables Collection

March 2020 Nikkei Option Product Loss of 80 Billion Won
Legal Battle Continues Between KB Securities and Winners Asset Management
Second Trial Court Rules Margin Call-Free Forced Sale Violates Duty of Care

In March 2020, a loss of approximately 80 billion KRW occurred in an overseas derivative product based on Japan's representative index, the Nikkei 225. Since then, Winners Asset Management, which designed the product, and KB Securities, the seller, have been engaged in legal battles over responsibility. Unlike the first trial court, which ruled in favor of KB Securities, the second trial court ruled that the intraday forced liquidation based on KB Securities' standard terms and conditions was inappropriate. KB Securities now faces a situation where it cannot recover the unpaid funds and must compensate for part of the investors' losses. Following the second trial court's ruling, KB Securities is expected to appeal to the Supreme Court, and their legal dispute is likely to continue.

Lawsuit over Unpaid Funds Triggered by Forced Liquidation

According to the legal community on the 29th, the 18th Civil Division of the Seoul High Court ruled against KB Securities in a damages claim lawsuit filed against Winners Asset Management regarding the forced liquidation of the "Japan Nikkei 225 Index Option Investment Private Fund." The court dismissed KB Securities' claim for unpaid funds from investors and ordered the fund investors to be compensated for 30% of their losses. This overturned the partial plaintiff victory ruling made by the first trial court on January 19 of last year, one year ago.

Previously, Winners Asset Management invested in an option product based on the Nikkei 225 index of the Osaka Securities Exchange in Japan. The Nikkei index fell from 23,523 on February 17, 2020, to 21,143 on February 28 of the same month. Due to the decline in the Nikkei index, the risk level of Winners Asset Management's account increased. The options market continues trading overnight, and the risk level of the option product exceeded 80% around midnight on February 29. KB Securities executed forced liquidation of all Nikkei index put options pursuant to Article 14, Paragraph 2 of the "Overseas Derivative Product Market Trading General Account Setting Terms and Conditions." At that time, the portfolio manager of Winners Asset Management expressed opposition to the forced liquidation, stating that "there is a large bid-ask gap," "there is no liquidity," and "prices are distorted."

KB Securities bore the unpaid funds arising from the forced liquidation process and claimed the unpaid funds and delayed damages from Winners Asset Management. Winners Asset Management countered that KB Securities conducted forced liquidation without issuing a margin call for additional margin deposits in a situation where forced liquidation should not have been executed. They argued that KB Securities arbitrarily finalized losses through forced liquidation and should compensate for the investors' losses.

The first trial court ruled that Winners Asset Management must pay damages and delayed interest to KB Securities. The court stated, "The terms and conditions stipulate an intraday forced liquidation system to manage risks in real time," and "the decision to execute forced liquidation falls under KB Securities' authority."

Second Trial Court: "Forced Liquidation Was Not Justified"

The second trial court focused on the legality of the terms and conditions themselves. Article 14, Paragraph 2 of the terms and conditions states, "If the customer's evaluation margin total falls below 20% of the entrusted margin due to rapid price fluctuations during trading hours, the customer may be subject to forced liquidation of unsettled contracts and disposal of deposited substitute securities without requiring additional margin deposits from the customer."

The court ruled, "For Article 14, Paragraph 2 to be lawful, forced liquidation must fall under the exceptions allowing discretionary trading by investment intermediaries as stipulated in Article 71, Paragraph 6 proviso, and Article 7, Paragraph 4 of the Capital Markets Act." According to the Capital Markets Act, forced liquidation may be conducted under the terms and conditions if ▲ the investor fails to fulfill settlement or additional margin deposit obligations related to financial investment product transactions, or ▲ the investor is notified of additional margin deposit requirements and fails to fulfill them within the deadline.

The court stated, "Even if evaluation losses occurred, it would have been appropriate and reasonable for KB Securities to issue a margin call to Winners Asset Management," and "Since there were nine trading days remaining until the Nikkei put option expiration, and losses were not immediately realized, it was reasonable to allow some time to respond by issuing a margin call."

Options are classified into European and American types based on the exercise period. European options allow the option buyer to exercise rights only on the expiration date, whereas American options allow exercise at any time before or on the expiration date. Nikkei options are European options, so the option seller is not obligated to fulfill the option buyer's exercise rights before the expiration date.

Considering the expected losses, the court judged that conducting forced liquidation without issuing a margin call while time remained until the expiration date when profit or loss realization is determined violated the duties of good faith, due care, and loyalty under the Capital Markets Act.

However, the court limited KB Securities' liability for investor losses to 30%. The court explained, "This considers that forced liquidation was executed based on the terms and conditions, the Nikkei put option price rose sharply in a short period leaving insufficient time for KB Securities to respond, and KB Securities suffered huge losses by paying additional settlement amounts not covered by deposits."

Following the second trial court's ruling, further lawsuits are expected. Attorney Kim Kwangjoong of the law firm Class Hangyeol, representing the investors, said, "It is expected that domestic securities firms will reduce forced liquidation based solely on evaluation losses when brokering overseas derivative products in the future," and "investors who did not participate in this lawsuit may file additional lawsuits."