[NEWS ANALYSIS] Complex scheme rattling Korean markets

Finance

Published: 08 May. 2023, 18:46 Updated: 08 May. 2023, 20:11

[NEWS ANALYSIS] Complex scheme rattling Korean markets

Financial authorities on April 27 load confiscated items after raiding an office in Gangnam, southern Seoul, used by alleged stock manipulators. [NEWS1]

An unprecedented, elaborate stock manipulation scheme is rattling Korea’s financial markets.

Unlike the short-term, pump-and-dump stock manipulation cases in the past, the recent scam involved stealth ramping of carefully selected stocks for as long as three years. Some of these stocks became “10-baggers” over the period, under the radar of the regulators.

The scheme was revealed when the Paris-based Societe Generale Securities began unloading a huge number of shares on April 24. With the sell-off, eight stocks hit the daily price limit of minus 30 percent at the open, and some continued to crash in that way for four full trading days.

The liquidation of contracts for differences (CFD) — a leveraged derivative that dumps shares at the opening price if deposits fall below a certain percentage — may have accelerated the plunge and caused a snowballing of damage. More than a thousand investors, including high net-worth individuals such as doctors, celebrities, athletes and businessmen, have reportedly suffered losses nearing 2 trillion won ($1.5 billion) in total.

These disgruntled punters are preparing to file a group lawsuit against Ra Deok-yeon, head of an investment firm and a key suspect in the manipulation case. Ra claims to be a “victim” himself and has been touring local media outlets for interviews arguing that he did not manipulate the shares, though he did design the entire investment plan to “buy good stocks.”

Ra on April 28 blamed Kiwoom Group Chairman Kim Ik-rae for triggering the crash. Kim was found to have sold 1.4 million shares of Daou Data two trading days before plunging 30 percent for three days from April 24. Kim filed a defamation lawsuit against Ra on May 2 and held a press briefing on May 4 to announce his resignation.

With interest parties — retail investors, Ra, Kim and public figures like singer Im Chang-jung — all playing the blame game, a joint investigation team comprised of prosecution and financial authorities was established on April 28 and is tasked with identifying the victims and the perpetrators.

Kiwoom Securities' headquarter building in Yeouido, western Seoul [NEWS1]

Which stocks crashed?

Eight stocks — Kospi’s Seoul City Gas, Daesung Holdings, Samchully, Sebang and Daol Investment & Securities and Kosdaq’s Sun Kwang, Daou Data and Harim Holdings — hit the daily limit of minus 30 percent on April 24.

Seoul City Gas, Daesung Holdings and Sun Kwang hit the floor for four consecutive days. These three lost 80 percent of their market cap in a span of four days. Sun Kwang traded at 167,700 won on April 21 but closed at 17,200 won on April 27.

Samchully dropped 30 percent for three days and lost 27 percent on the fourth.

Sebang and Daou Data hit the bottom for two days. Sebang slipped another 26 percent and Daou another 19 percent on the third day.

Daol Investment & Securities and Harim Holdings fell another 10 percent on April 25 after skidding 30 percent on the previous day.

All eight remained relatively flat following their drops.

But these stocks may not complete the list. A handful of other shares lost ground by over 10 percent on April 24, including CJ Corp., which lost 28.2 percent but recovered during the session to close at minus 12.7 percent.

About 8.2 trillion won of market cap is estimated to have dissolved that week.

What is the suspected scenario?

Based on testimonies of people who claim to have been involved in the scheme and Ra Deok-yeon himself, the alleged manipulators began pumping up stock prices as early as 2019.

The group led by Ra set up an investment firm in March 2019 and engaged in matched orders to haul up prices.

Ra reportedly said that he discovered “the secret” of the stock market during an investment seminar hosted by his newly-established firm. He added trading through matched orders, given enough money, is a must-win scenario.

Ra Deok-yeon, head of a unregistered investment firm and a key suspect in the stock manipulation case, talks to a local news outlet on May 1. [YONHAP]

A matched order involves a broker selling stocks at a pre-determined time and price to another broker to make it seem like a normal trade, which in turn injects apparent volatility into the stock.

To increase their funding by gathering “investors,” the manipulators reached out to high-income individuals, such as celebrities, athletes and doctors, and convinced them to join their plot.

Then they sent a blank smartphone to a convinced investor and had it opened under that person’s name. The working smartphone was then returned to the investment team along with the investor’s personal information required to open a trading account, which the manipulators used to begin trading through the mobile trading system.

Most trades were dealt as CFDs through Societe Generale Securities. The derivative allowed them to multiply excess profit, and all trades were logged as foreign investment, because CFDs allow traders to essentially “borrow” a security firm’s name and money to make leveraged investments.

The group took their time to gradually lift stock prices through matched orders and to evade monitoring. Stocks that were purportedly targeted from the early stages — Daesung Holdings, Seoul City Gas and Sun Kwang — have risen in a near perfect linear trend since 2020.

Daesung stocks traded at around 10,000 won in May 2020, and by April this year, it was trading at 130,000 won.

Trades were also made in different locations under different IP addresses to further deceive the financial regulators.

Ra’s team reportedly received 50 percent of the earnings as commission for their trades. They made cash-back transactions using a credit card opened under the investor’s name at affiliated business sites — a Chinese restaurant, a gym, a horse riding course and an indoor golf training center, to name a few.

Depending on the amount of the commission, the bogus purchases included: imported alcohol; golf lessons; and memberships at the gym and horse riding course.

A golf academy in Gangnam, southern Seoul, where the alleged stock manipulators collected commissions by making cash-back transactions [YONHAP]

As the trading volume and profit grew, the Ponzi scheme was attracting more high-value “investors” who entrusted their money to the group as well as retail investors who wished to jump on the stock increases. Stocks that have supposedly become targets recently — Harim Holdings and Daol Investment & Securities — doubled in a matter of months.

Harim traded at around 7,000 won in January and peaked above 18,000 won in April, and Daol stocks jumped from below 3,000 won to 6,000 won over the same period.

Why were these stocks targeted?

Ra claims to have targeted stocks that are “good stocks” owned by large shareholders.

By “good,” Ra said these companies engaged in stable businesses with low volatility. Seoul City Gas, Daesung and Samchully are gas utility companies. Daol and Harim are financial holdings firms. Sun Kwang and Sebang does logistics and Daou develops computer software.

Ra and his team explored stocks that were owned by large shareholders, which meant that there were fewer outstanding shares in the market, rendering them more vulnerable to price pumps.

Before the plunge, Daesung Holdings had 72.7 percent of its shares owned by major shareholders, and 27.3 percent were outstanding shares. Seoul City Gas was 58.3 percent owned by the largest shareholder, 22.3 percent as treasury shares and 19.4 percent as shares outstanding. Daou Data shares were 67.1 percent owned by major shareholders and 32.9 percent outstanding.

The blame game

Ra blamed Kiwoom Group Chairman Kim Ik-rae for the crash that resulted in huge loss from investors, including himself.

Kim had dumped 1.4 million shares of Daou Data in a block deal on April 20, two trading days prior to the 30 percent plunge. Ra claims that Kim, aware of the fact that many Daou Data shares were bought as CFDs, intentionally made the dump in short sales to lower the stock price before transferring the business ownership to his heir and to avoid tax.

Kim, on the other hand, filed a suit against Ra for defamation. Kim claimed that Ra is trying to water down the accusations against him by dragging Kim into the mess. The sale of 1.4 million Daou Data shares was a scheduled sale made to prepare for paying his children’s gift tax, Kim argued.

Kiwoom Group Chairman Kim Ik-rae announces his resignation during a press briefing held at Kiwoom Securities headquarter in Yeouido, western Seoul, on May 4. Kim apologized for sparking a social controversy in selling 1.4 million shares of Daou Data two days prior to its two-day crash of minus 30 percent. [YONHAP]

Kim convened a press conference on Thursday to announce his resignation. He apologized for sparking a social controversy with his stock sale and pledged to donate all profit resulting from the sale to the community.

A group of 180 people represented by Daegun is preparing to file a civil suit against Ra and six others of his team for fraud and dereliction of duty. These people claims to have lost 1 billion won on average, according to Daegun. The “victims” who gave Ra their personal information and trading accounts claim to have had no knowledge of Ra trading with the leveraged derivatives.

A different group represented One & Partners will file a civil case against Kiwoom Securities and eBest Investment & Securities. The group will file the suit against the securities firms for not informing the investors of the dangers of CFDs and other infractions, the law firm said Monday.

Ra told media outlets that matched orders his firm engaged in were not intended to manipulate the market, but rather aimed at injecting a high buying force to attract other market players to take part in the purchase. Ra argues that this was part of his buy-and-hold strategy.

But multiple media outlets have reported on a voice recording sent by anonymous sources in which Ra boasted that he is the mastermind of a plot that is impossible for market regulators to detect.

Singer Im Chang-jung is another public figure at the center of the incident. Im claims to be a victim as well, with a bank account plummeting from 2 billion won to 189 million won in two days. Im told media on April 28 that he and his wife gave 1.5 billion won each to Ra, thinking that his firm was just a normal investment firm with good performance.

He insisted that he was unaware of how the firm made money and had no knowledge of stock at all, but footage of Im showing up at a promotion event hosted by Ra was reported by a news outlet. In the video, Im praised Ra’s group as a “religion,” to which the participants replied “Hallelujah.” Im’s agency denied accusations that Im encouraged people to invest in Ra’s company, though he did make some inappropriate remarks, carried away by the mood of the event.

A local news outlet JTBC reveals a video of singer Im Chang-jung referring Ra Deok-yeon as a ″religion″ during a promotion event for Ra's firm held in December. [SCREEN CAPTURE]

How do CFDs work?

CFDs are a derivative product that allows traders to trade live market prices without owning the asset itself. In Korea, a stock trader is required to deposit 40 percent of the stock price for a CFD trading. The rest are sourced by the securities firm in contract with the trader.

To put it simply, if a trader wishes to trade a stock worth 10,000 won, he will only have to deposit 4,000 won to a securities company to trade the stock. If the stock price rises to 11,000 won by the end of the contract period, the trader is entitled to earn the difference — 1,000 won. The stock price rose by 10 percent, but the trader actually reaped a 25 percent profit, earning 1,000 won from a 4,000-won deposit.

But like all leveraged trading, CFDs can go the opposite direction. If the stock price in the example above fell to 9,000 won, the 1,000-won difference is paid to the securities firm from the trader’s deposit. The stock price fell by 10 percent, but the trader suffered a 25 percent loss.

If the deposit falls below 60 percent, below 2,400 won in this case, the financial firm requires for an additional deposit to fill in the loss. If the extra payment is not made by the next day, the firm liquidates the stock. If the deposit falls below 40 percent, or 1,600 won, the stock is liquidated right away.

Because of its high-risk nature, CFDs are only open to individuals who have the “ability to take risks accompanying an investment,” according to Korea’s financial law. These individuals must possess financial investment instruments worth more than 50 million won and must satisfy one of the following: have an annual income of more than 100 million won, net assets worth more than 500 million or be certified professionals, such as a certified public accountant or a lawyer.

BY SOHN DONG-JOO [sohn.dongjoo@joongang.co.kr]