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Korea regulator probes suspected fraud in small-cap Kosdaq

Cases of ill-intentioned investors targeting struggling companies have risen recently, says top financial watchdog

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The Kosdaq index, where mostly young tech companies are listed, has a market capitalisation of about US$200 billion, and trades at 190 times earnings, compared with 17 times for the big-board Kospi.

Seoul

SOUTH Korean regulators, already moving to protect retail investors from risky hedge-fund investments and complex derivatives, are setting their sights on a fresh target: suspected fraudsters in the nation's small-cap stocks.

In a scheme with parallels to the "pump-and-dump" practice for penny stocks made famous by the film Wolf of Wall Street, ill-intentioned investors are suspected of taking majority shares of small firms. They then release news designed to inflate the share price, or pave the way for selling convertible bonds, by which the actors enrich themselves, according to the Financial Supervisory Service, South Korea's top financial watchdog.

The perpetrators have been termed "company-hunters," and while the practice is not new, it has surged lately, FSS figures show.

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Frenzied appetite

The backdrop: frenzied appetite among retail investors for small-caps, especially those tied to biotechnology. The Kosdaq index, where mostly young tech companies are listed, has a market capitalisation of about US$200 billion, and trades at 190 times earnings, compared with 17 times for the big-board Kospi.

"The company-hunters are becoming more and more sophisticated," Kim Young-chul, director-general at the Capital Market Investigation Department at the FSS, said in a telephone interview.

The FSS revealed last month it had started investigating in early 2019 some 24 listed firms that were suspected targets of company hunters from 2016 to 2018. There were just three such cases back in 2012.

The regulator has declined to name names, either of the target companies or the suspected perpetrators. Adding to the murkiness of the practice, the company-hunters fund their stakes via loans, including from short-term private financiers, according to the FSS. That fact has sometimes been obscured, Mr Kim said.

"They pretended the money they borrowed for M&A was their own money," he said.

Mr Kim said the acquirers typically target struggling companies. After gaining control, they take the firms into new businesses, especially those related to biotechnology. They tend to release "inflated growth figures" to raise more capital, he also said. FSS data showed the 24 firms under investigation raised a total of 1.7 trillion won (S$2 billion) through convertible-bond sales and new share sales from 2016-18.

One case, separate from those being pursued by the FSS, entangled Leed Corp. Prosecutors have launched an investigation into the Kosdaq-listed company, on suspicion of manipulation of its stock after the display-equipment maker was acquired by new owners, local media reported in November.

Leed's stock has been halted for trading since October, after some of its executives were accused of embezzlement and frequent changes in its large shareholders, according to company filings. A spokesman at Leed declined to comment on the prosector's probe. The stock has lost 96 per cent of its value since hitting a record high in mid-2018.

Targets typically have market capitalisations below US$200 million, the FSS says. While in the past, company-hunters would be individuals - such as accountants or financiers - regulators have picked up on a new pattern where a group is organised to help hide identities, according to the FSS.

The watchdog has formed a team of "special investigative police" to detect any unfair trades in financial markets, including stock manipulation, FSS governor Yoon Suk-heun said in his new year's speech. The team, comprising 15 officials, will have access to personal-transaction records and the right to search a trading venue to obtain evidence.

Speculation

With record-low interest rates and a slowing economy, retail investors in Asia's fourth-largest economy have flocked to assets promising big returns. With the government putting a focus on helping small companies and nurturing startups, the small-cap market has proved a rich ground for speculation. Derivatives have been another top play.

The Kosdaq index is little changed since the start of 2020, after a 0.9 per cent drop in 2019 that made it one of the worst-performing markets in Asia. The rally in biotechnology stocks faded, marred by a series of failed clinical studies, a cancelled licence, alleged accounting irregularities and stock-manipulation probes.

"It's hard for local investors to make high returns from the Korean stock market," said Hwang Sei-woon, research fellow at Korea Capital Market Institute. "So more and more people strive for a once-in-a-lifetime opportunity. Hunters are using that sentiment - by creating a significant bubble in something - even if the method is illegal." BLOOMBERG