[Edaily Marketin, Reporter Ji Young] Allegations have been raised that a transaction in which Jeon Dong-kyu, CEO and largest shareholder of KOSDAQ-listed #Seojin Systems, received a portion of the capital gains from a stock price increase from a securities firm may violate the Capital Markets Act. This assessment is based on the determination that, since a portion of the capital gains from the sale of Seojin Systems shares held by special purpose companies (SPCs) affiliated with Shinhan Investment Securities and Hana Securities went to the individual largest shareholder, the transaction constitutes a form of credit extension to that individual.

Although these securities firms could have profited from the stock sale, they secured only a certain rate of return and transferred the remaining excess profits to the largest shareholder through a side agreement. While the form is a profit-sharing arrangement, critics argue that the economic substance is closer to a structure in which the firm provided the largest shareholder with funds to defend management control in exchange for a fixed return. Credit extensions to individuals by comprehensive financial investment business operators are prohibited under the Capital Markets Act.

Seojin System’s Largest Shareholder’s Profit-Sharing Side Agreement… Potential Violation of the Capital Markets Act

According to an exclusive report by Edaily on the 17th and sources in the investment banking (IB) industry, Shinhan Investment Securities and Hana Securities provided approximately 3500억 won in bridge financing last January to address put options held by Seojin System’s existing financial investors (FIs). The two securities firms each acquired a total of approximately 10 million shares of Seojin Systems through special purpose companies (SPCs). It is understood that the bridge financing agreement signed at the time did not include a clause requiring the SPCs to settle the capital gains—derived from the sale of their holdings—with the former CEO. Related Article ☞ Seojin Systems’ Largest Shareholder Covered Risks and Reaped Stock Price Gains [E-Daily Exclusive]

However, as Seojin System’s stock price subsequently surged, the economic value of the SPCs’ holdings increased. It is reported that the former CEO’s side demanded a settlement of the capital gains from the stock price increase, citing their waiver of call options and the provision of downside protection. Since the structure of the arrangement stipulated that capital gains from the sale of shares acquired through the bridge loan process would, in principle, accrue to the securities firms’ SPCs, the former CEO’s side and the two securities firms reportedly disagreed for some time over whether to distribute the gains.

Ultimately, the former CEO’s side and the two securities firms reached an additional agreement in March by drafting a Memorandum of Understanding (MOU) separate from the existing bridge loan contract. The MOU stipulated that, on the condition that the Seojin Systems shares held by the SPCs of Shinhan and Hana be transferred to a private equity fund (PEF) established by Shinhan, Hana, and SKS, investors would first secure an internal rate of return (IRR) of 12%, and any excess returns would be split between the investors and the largest shareholder in a 3:7 ratio.

The problem is that this additional agreement appears to be a clear circumvention of the regulations on credit extensions to individuals under the Capital Markets Act. Under the Capital Markets Act, credit extensions to individuals by comprehensive financial investment firms are strictly limited. If the securities firm’s SPC bore the risk of stock price fluctuations and held the shares, the capital gains from the sale should, in principle, accrue to the SPC. Nevertheless, through a separate MOU, a structure was effectively created whereby investors are guaranteed a fixed return of approximately 12% IRR as a priority, while a significant portion of the remaining excess returns goes to the largest shareholder personally.

Formally, this was a transaction in which the SPC sold its shares and settled a portion of the profit. However, when considering the economic substance, it could be interpreted as the securities firm providing the funds necessary for the former CEO to defend his management rights, securing only a certain rate of return, and then returning the excess profits resulting from the rise in the stock price to the individual largest shareholder. Given that the former CEO’s control over the company could have been jeopardized had he been unable to secure funds to exercise the put options held by existing financial investors (FIs), the securities firm’s funds were effectively used as a resource for the individual largest shareholder to defend his management control.

The Capital Markets Act restricts comprehensive financial investment firms from extending credit to individuals. If the Financial Services Commission or the Financial Supervisory Service prioritizes the economic substance over the name or form of this transaction during their oversight, there is a possibility that this transaction could be viewed not as a stock purchase and sale transaction conducted through an SPC, but rather as a transaction in which funds were provided to the largest shareholder to defend management control in exchange for a fixed return. This is why some observers point out that if the arrangement is deemed to have utilized a roundabout structure to circumvent credit extension restrictions, it could be subject to sanctions.

Shinhan Paid in Full vs. Hana Refused Additional Settlement… Kim & Chang and Kwangjang Also Differ in Their Assessments

The two securities firms differed in their assessments regarding the issue of post-transaction profit settlement. Hana Securities reportedly proceeded with settlement only for a portion of the shares subject to call options and did not accept the former CEO’s request for additional settlement. It determined that the shares already purchased should be treated as investment assets of the SPC, and that capital gains from the sale resulting from stock price fluctuations should, in principle, be attributed to the SPC.

Hana Securities appears to have refused the additional settlement after recognizing the potential for a violation of the Capital Markets Act. It is understood that Hana Securities concluded, following reviews by multiple law firms—including Gwangjang and Sejong—that an additional settlement for the remaining shares would be difficult. This conclusion was based on the assessment that if a securities firm’s SPC were to transfer a significant portion of the excess profits generated from the sale of shares to the largest shareholder personally, it could, in economic substance, be interpreted as a personal credit extension by a comprehensive financial investment business operator—which is restricted under the Capital Markets Act.

In contrast, Shinhan Investment Securities proceeded with the profit settlement. This decision appears to reflect the logic that the former CEO provided his shareholding as collateral to bear the investors’ recovery risk, and that a structure in which a financial institution secures a certain rate of return and then shares the excess profits with the largest shareholder is a common practice in the private lending market.

Kim & Chang, which served as legal counsel to Shinhan, reportedly issued an opinion stating that the payment of the settlement amount did not constitute breach of fiduciary duty or a credit extension. Their reasoning was that even if the SPC paid the settlement amount, it would be difficult to view this as a violation of the duty of care or a breach of fiduciary duty if the SPC could still secure greater profits than under the original MOU; furthermore, since there was no obligation to return the settlement amount after payment, the structure did not expose the SPC to the credit risk of the largest shareholder.

In this regard, Shinhan Securities argued, “Since the former CEO provided downside protection (in the bridge financing deal) and waived the call option, we reached an agreement commensurate with that,” adding, “Profit-sharing is a common practice among credit funds, and we also received legal advice from Kim & Chang stating that this profit settlement does not constitute a credit extension or retroactive preferential treatment for the largest shareholder.”

Hana Securities stated, “We cannot explain the specific terms of a matter subject to confidentiality obligations,” but added, “We settled only the portion related to the call option rights, and we did not comply with requests for additional settlements beyond that scope as they could be illegal. We have no plans for further settlements.”

However, market observers tend to agree that it is difficult to view the issue under the Capital Markets Act as resolved based solely on Kim & Chang’s assessment. Critics point out that if a securities firm, despite having the potential to earn substantial profits from a rise in stock prices, took only a fixed return of around 12% internal rate of return (IRR) and transferred a significant portion of the remaining excess returns to the largest shareholder personally, the economic substance of the transaction could be closer to a provision of funds than to a stock investment.

A private equity fund (PEF) industry official stated, “While it is true that credit funds sometimes structure deals to share upside exceeding a certain rate of return with the largest shareholder, this is generally determined at the initial stage of signing the investment agreement,” adding, “It is unusual to establish a structure for distributing excess returns retroactively after the stock price has surged.”

He pointed out, “Given that the investor could have reaped the variable gains from holding the shares but instead agreed to change the contract terms retroactively—and given that the fund secured only a certain rate of return while transferring a significant portion of the excess returns to the largest shareholder—it is difficult to view this as a mere credit solution practice.”