[VIEWPOINT]Think Twice About Class-Action Suits

Debate over whether to allow class action financial lawsuits has recently intensified.

Such suits allow a selected representative of a group of shareholders to file suit against a firm for financial mismanagement or malfeasance.

In Germany such lawsuits are banned, while Japan and several other countries have suspended them because of perceived problems with the concept. In the United States, the number of states repealing laws allowing such suits is increasing, but the Ministry of Justice and the Ministry of Finance and Economy confirmed in August their plan to introduce such a system here.

The new legislation needs only National Assembly approval to be enacted.

The debate began in December 1990 and draft legislation was written in 1996. It was then forgotten temporarily, but was revived in 1997, during the financial crisis. Several civic groups started a minority shareholder movement to force better corporate management. According to these civic groups, if class action lawsuits are introduced, management will think twice before ignoring minority shareholders' interests. That will make management more transparent, and the transparency will increase the value of the firm and shareholder's stock holdings.

The system does not fit well with our judicial system, though, which is based on informal settlement of personal disputes. It may also violate the constitution. In particular, the decision in a class action lawsuit would apply even to those not joining the suit, limiting their right to bring an individual suit. The Japanese government suspended the use of class action lawsuits because of similar concerns, and is considering modifications to the system.

Although the class action suits are basically civil suits, the government, somewhat irrationally, wants to limit them to only shareholder and stock market-related issues. There is no necessary connection between improvement in a company's management structure, transparency in management and the value of the company on the one hand and avoiding specific discriminatory actions against small shareholders on the other.

While the purpose of class action lawsuits is to protect minority shareholders, companies whose executives acted foolishly or criminally can decline in value, leaving less money to compensate their shareholders. Class action lawsuits in such circumstances can further lower the companies' value, and the firm can then ask the authorities to exclude them as a target of such lawsuits.

There is also a possibility that brokers and lawyers could manipulate the system for self-serving reasons.

Especially because of the distinctive character of the stock exchange, a lawsuit could end up being settled out of court: it is hard to establish a direct, quantifiable link between a company's illegal transactions and the amount of loss suffered by investors.

In the case of the United States, 90 percent of such lawsuits end in an outside settlement. All and all, a class action system could be distorted into a system of insurance for stockholders whose holdings have declined in value, not as a system that would stave off the temptation to commit financial crimes.

Corporations hauled into court could be severely damaged by the amount of time and attention they would be forced to devote to defending themselves against such lawsuits. A company could lose its credibility in the international market at even a hint of a class action lawsuit. According to a U.S. Senate report in 1995, companies that were sued by groups of minority shareholders had to spend about 1,000 hours of employee time on the suits.

Considering the amount of compensation a company could be forced to pay if it were to lose such a lawsuit, a firm and its accountants, which could also be held liable, could easily be forced to file for bankruptcy. Small and medium start-up firms could be bankrupted even more easily by defense costs or out-of-court settlements.

The loss of such a lawsuit could also result in the personal bankruptcy of a company's principal shareholder, so such a firm will look only for short-term gains and quick turnover.

All those problems would put a brake on long-term, aggressive business activities, and would also act as a deterrent against going public. Why should start-up owners take the risk of being bankrupted by disgruntled shareholders, even if the additional capital they could raise in stock markets looks attractive?

Legislation is enacted by mutual consent of the members of society. Every man is equal under the law and disputes are settled under the law. The government must respect the constitution and the existing system before enacting legislation for the purpose of introducing a new system.

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The writer is a professor of law at Dankook University.

by Seok Jong-Hyun