CONTENTS
- 1. Financial Regulatory Advisory | Overview of the CFD Market Manipulation Case
- - The Lower Court's Determination
- 2. Financial Regulatory Advisory | The Supreme Court's Determination
- - That a CFD Order May Also Constitute Market Manipulation
- - That Liability May Be Recognized Even Without Directly Trading Shares
- - Standards for Determining Market Manipulation
- 3. Financial Regulatory Advisory | Factors Considered by the Supreme Court and the Significance of the Judgment
- - Principal Factors for Determination
- - Significance of the Judgment
- 4. Financial Regulatory Advisory | Legal Risks a Company Should Review
- - Sanctions by the Financial Services Commission and Criminal Punishment
- - Principal Matters for Review
- 5. Financial Regulatory Advisory | Assistance From a Corporate Attorney
- - Assistance From a Corporate Attorney
1. Financial Regulatory Advisory | Overview of the CFD Market Manipulation Case
This case, one of the financial regulatory advisory matters, is a case in which the defendants were indicted on charges of operating an unregistered discretionary investment management organization and using CFD accounts to artificially raise the share price of particular stocks or to prevent their decline.
The prosecution argued that the defendants repeatedly engaged in transactions such as matched trading, high-priced buying, volume absorption, and fictitious buy orders by utilizing numerous CFD accounts for eight stocks, and that they thereby acquired unlawful gains.
A CFD is an over-the-counter derivative under which only the difference arising from changes in the price of the underlying asset is settled, without holding the actual shares.
When an investor places a CFD order, the securities firm manages its risk by trading the relevant stock in the actual market or by entering into a back-to-back contract in order to offset the price-fluctuation risk.
The prosecution took the view that the defendants used precisely this structure to carry out market manipulation in the actual stock market.
The Lower Court's Determination
The lower court focused on the point that a CFD constitutes an "over-the-counter derivative" under the Financial Investment Services and Capital Markets Act.
Article 176 of the former Financial Investment Services and Capital Markets Act defines the object of market manipulation as "listed securities or exchange-traded derivatives," and the lower court held that CFDs are not included therein.
The lower court also determined that, because a CFD order does not always lead to an actual stock market transaction and a securities firm may offset its risk in various ways, it is difficult to treat a CFD order itself as equivalent to a transaction in listed securities.
Accordingly, the lower court denied the establishment of the crime of market manipulation with respect to the portion using CFD accounts.
2. Financial Regulatory Advisory | The Supreme Court's Determination
From a financial regulatory advisory perspective, this judgment is a case confirming that, even for an order using a CFD, which is an over-the-counter derivative, market manipulation under the Financial Investment Services and Capital Markets Act may be established where the order leads to a price-manipulative transaction in actual listed shares.
The Supreme Court reversed the lower court's finding of not guilty as to the CFD transaction portion and remanded the case to the Seoul High Court.
That a CFD Order May Also Constitute Market Manipulation
In reviewing the language of Article 176 of the former Financial Investment Services and Capital Markets Act, the Supreme Court determined that, although the object of market manipulation is clearly listed securities or exchange-traded derivatives, the provision cannot be interpreted as making only orders directly placed for listed securities subject to punishment.
In other words, a transaction is not necessarily excluded from market manipulation merely because its form is that of an over-the-counter derivative.
That Liability May Be Recognized Even Without Directly Trading Shares
Even where an over-the-counter derivatives order, for which trading in listed securities or exchange-traded derivatives is anticipated at a substantial rate, passes through a securities firm and directly leads to a price-manipulative order for listed securities, the crime of violating the Financial Investment Services and Capital Markets Act through market manipulation may be established.
The Supreme Court regarded the purpose of the market manipulation provisions of the Financial Investment Services and Capital Markets Act as the protection of investors and the securing of trust in the securities market.
And it determined that, if a CFD order in substance induces an actual stock market transaction and as a result affects the formation of the share price, there is no essential difference from the case of directly trading shares.
Standards for Determining Market Manipulation
In this judgment, the Supreme Court held that whether market manipulation exists should be determined with a focus on the actual effect on the market and the substance of the transaction, rather than on the transactional form of a CFD itself.
Factor for Determination | Matter Reviewed |
|---|---|
Substance of the Transaction | Whether the CFD order is connected to an actual stock market order |
Market Impact | Whether it affected the formation or maintenance of the share price |
Order Linkage | The connection between the CFD order and the actual stock order |
Purpose of the Transaction | Whether there was a purpose of forming or maintaining the price |
Method of Transaction | Whether market manipulation techniques such as matched trading or fictitious trading were used |
Transaction Structure | Whether leverage was used and multiple accounts were employed |
The Supreme Court found that a substantial portion of the defendants' CFD orders led to actual stock market orders, and that the defendants too were fully aware of this transaction structure.
It also determined that, if the CFD transactions had a structure that affected the formation of actual share prices, market manipulation could be established even if the defendants did not directly trade shares.
3. Financial Regulatory Advisory | Factors Considered by the Supreme Court and the Significance of the Judgment
A company in need of financial regulatory advisory should, through this judgment, confirm that an over-the-counter derivatives transaction may likewise be evaluated as market manipulation under the Financial Investment Services and Capital Markets Act, depending on the substance of the transaction and its market impact.
What the Supreme Court regarded as most important was the linking structure between the CFD orders and the actual stock market orders.
The lower court denied the establishment of the crime of market manipulation on the ground that a CFD is an over-the-counter derivative and that a securities firm does not necessarily trade shares in the same terms.
However, after reviewing the actual transaction structure, the Supreme Court determined that a substantial portion of the defendants' CFD orders led to actual stock market orders.
In particular, according to the judgment, numerous instances were confirmed in which a CFD account order was connected to an identical order in the actual stock market within one to two seconds.
In addition, a relevant securities firm employee also testified that the process by which an investor's CFD order leads to an exchange order takes place within a very short time.
On the basis of these facts, the Supreme Court found that the CFD orders and the actual stock market orders were not independent transactions but, in substance, constituted a connected flow of transactions.
Ultimately, even if an investor used a CFD account, if the order in question induced an actual transaction in listed shares and affected the formation of the share price, it may become subject to a determination of market manipulation under the Financial Investment Services and Capital Markets Act.
Principal Factors for Determination
Factor for Determination | Matter Noted by the Supreme Court |
|---|---|
Linkage Between CFD Orders and Actual Stock Orders | That a substantial portion of the CFD orders led to actual stock market orders |
The Securities Firm's Hedging Structure | That the securities firm directly traded the underlying shares to avoid risk |
The Anonymity of CFDs | That the actual trading party may be displayed as a foreign securities firm or the like |
The Leverage Effect | That the structure allows large-scale transactions with a small amount of funds |
Purpose of Market Manipulation | That multiple accounts were used to affect the price formation of particular stocks |
The Supreme Court found that a substantial portion of the defendants' CFD orders were connected to actual stock market orders, and that the defendants too were fully aware of this transaction structure.
It also determined that, because CFDs can employ high leverage and have the characteristic that the trading party is not clearly disclosed externally, there is a risk of their being used for market manipulation.
Ultimately, the Supreme Court held that whether market manipulation exists should be determined with a focus on the actual effect on the market and the purpose of the transaction, rather than on the transactional form.
Significance of the Judgment
This judgment may be evaluated as a case confirming that the regulation of market manipulation under the Financial Investment Services and Capital Markets Act is not automatically excluded merely because a transaction is an over-the-counter derivatives transaction.
Until now, market manipulation has often been discussed with a focus on direct transactions in listed shares.
However, the Supreme Court determined that, if an order using a CFD led to an actual stock market transaction and affected the formation of the market price, it may be evaluated as market manipulation.
In particular, this judgment is significant in that it gave greater weight to the substance of the transaction and its market influence than to the transactional form.
Going forward, there is a possibility that a similar legal principle will be applied not only to CFDs but also to various financial products linked to actual transactions in underlying assets, such as total return swaps (TRSs) and structured derivatives.
It is also a judgment showing that, from a company's standpoint, the mere fact that it used a legally permitted financial product does not readily mean that the risk under the Financial Investment Services and Capital Markets Act has been eliminated.
Because whether market manipulation or unfair trading exists may be determined according to the transaction structure, the order method, and the effect on the market, the importance of financial regulatory advisory is expected to grow even further.
4. Financial Regulatory Advisory | Legal Risks a Company Should Review
A company in need of financial regulatory advisory should, through this judgment, review the point that an over-the-counter derivatives transaction may likewise be evaluated as market manipulation depending on its actual effect on the market.
The Supreme Court gave greater weight to the transaction structure and market influence than to the transactional form or the name of the financial product, and accordingly a company too needs to examine the relevant legal risks from the transaction design stage.
Sanctions by the Financial Services Commission and Criminal Punishment
(1) A person who falls under any of the following subparagraphs shall be punished by imprisonment for a definite term of at least one year or by a fine equivalent to not less than four times but not more than six times the profit gained or the loss avoided through the violation. Provided, that where there is no profit gained or loss avoided through the violation, or where it is difficult to calculate such amount, or where the amount equivalent to six times the profit gained or the loss avoided through the violation is five hundred million won or less, the upper limit of the fine shall be five hundred million won.
4. A person who, in violation of Article 176 (1), commits any act falling under any subparagraph of the same paragraph for the purpose of making others mistakenly believe that trading in listed securities or exchange-traded derivatives is flourishing, or otherwise for the purpose of causing others to make erroneous judgments
5. A person who, in violation of Article 176 (2), commits any act falling under any subparagraph of the same paragraph for the purpose of inducing trading in listed securities or exchange-traded derivatives
6. A person who, in violation of Article 176 (3), conducts a series of trades, or commissions or accepts the commission thereof, with respect to such securities or exchange-traded derivatives for the purpose of fixing or stabilizing the price of listed securities or exchange-traded derivatives
7. A person who, in connection with trading, etc. of securities or derivatives, commits any act falling under any subparagraph of Article 176 (4)
The current Financial Investment Services and Capital Markets Act provides for criminal punishment of market manipulation.
Where there is a profit gained or a loss avoided through the violation, aggravated punishment is possible depending on its scale, and where the amount of unlawful gains is five billion won or more, life imprisonment or imprisonment for at least five years may be imposed.
In addition, confiscation of or collection of the equivalent value for the profit gained or the loss avoided through the violation may become an issue, and in the course of an investigation by the Financial Services Commission and the Financial Supervisory Service, account relationships, transaction records, fund flows, and communication records may be reviewed together.
Principal Matters for Review
Item for Review | Principal Content |
|---|---|
CFD and Over-the-Counter Derivatives Transactions | Reviewing whether they are linked to actual transactions in listed shares |
Discretionary Investment Structure | Reviewing whether it is subject to discretionary investment management registration |
Method of Account Operation | Reviewing the regulatory risk from the use of multiple accounts |
Internal Control System | Whether an abnormal-transaction detection and reporting system is operated |
Management of Transaction Purpose | Management of the transaction decision-making process and internal records |
Response to Financial Authorities | Establishing a process for responding to investigations and examinations |
In particular, in the case of financial products linked to actual transactions in underlying assets, such as CFDs, total return swaps (TRSs), and structured derivatives, a prior review of the transaction purpose and market impact may be crucial.
In addition, because discretionary investment management regulation may become an issue depending on the solicitation of investors, the provision of investment judgments, and the method of account operation, a review of the overall business structure is necessary.
5. Financial Regulatory Advisory | Assistance From a Corporate Attorney
A company in need of financial regulatory advisory should comprehensively review not only the lawfulness of the transaction structure but also the unfair-trading regulation under the Financial Investment Services and Capital Markets Act, the supervisory framework of the financial authorities, and the possibility of criminal liability arising.
In particular, because for transactions utilizing over-the-counter derivatives such as CFDs and TRSs the actual effect on the market may be evaluated as more important than the transactional form, the process of examining the legal risks at each stage of the transaction is crucial.
A corporate attorney can collaborate with legal professionals such as financial attorneys, accountants, and administrative attorneys to comprehensively review the structure of the financial product, whether regulation under the Financial Investment Services and Capital Markets Act applies, the response to investigations by the financial authorities, and the possibility of criminal proceedings, and can devise a response plan suited to the company's circumstances.
Assistance From a Corporate Attorney
▶ Response to Financial Authority Investigations : In Financial Supervisory Service investigations, Securities and Futures Commission deliberations, and Financial Services Commission sanction procedures, organizing transaction records, account relationships, fund flows, and internal decision-making processes and developing a logic for responding to the investigation
▶ Review of Discretionary Investment Management Regulation : Analyzing the method of soliciting investors, whether investment judgments are provided, and the account operation structure to identify the need for registration as a discretionary investment management or investment advisory business and the risk factors in the business structure
▶ Establishment of an Internal Control System : Organizing an abnormal-transaction monitoring system, regulations governing financial transactions by officers and employees, compliance procedures, and an internal reporting system in order to establish a framework for managing the risk of violating the Financial Investment Services and Capital Markets Act
▶ Response to Criminal and Civil Disputes : Where market manipulation, unfair trading, the recovery of unlawful gains, or claims for damages by investors become an issue, analyzing the facts and the transaction structure to establish a response strategy
If you need financial regulatory advisory in connection with over-the-counter derivatives transactions such as CFDs, you are welcome to comprehensively review the transaction structure and the legal risk factors through a 🔗corporate attorney legal consultation reservation.
