South Korea eases hedge fund disclosure rules while leaving door open for stake concealment, report warns

Amid a series of regulatory moves to ease disclosure requirements for institutional investors such as hedge funds and activist funds, a new report argues that complementary legislation is urgently needed to close loopholes that allow these investors to conceal stakes through derivatives and evade disclosure obligations.

The Korea Federation of Industries said Wednesday it had commissioned the report — titled "Improvement Plans for the Shareholding Disclosure System" — from Oh Sung-keun, a professor at Jeju National University School of Law.

South Korea amended the Enforcement Decree of the Capital Markets Act in January 2020, introducing a "general investment purpose" category and extending the reporting deadline for institutional investors' shareholder activities from five business days to 10 days to reduce their compliance burden.

Under the current Capital Markets Act, derivative instruments such as total return swaps are not subject to shareholding disclosure requirements. Hedge funds and activist funds can therefore split contracts across multiple financial firms to accumulate large stakes without triggering any disclosure. By suddenly emerging as a major shareholder on the back of such hidden positions, these investors can infringe on the right of ordinary shareholders to be informed.

The United States and Japan have determined that such derivatives can be exploited as tools for exerting undue influence in corporate control disputes, and have amended their laws to require disclosure of all derivative contracts linked to listed companies' securities.

The US Securities and Exchange Commission revised its large shareholding reporting rules in October 2023 to recognize beneficial ownership even when a stake is held indirectly through derivatives tied to specific shares, effectively blocking the use of derivatives as a means of avoiding disclosure.

The SEC also requires that investors who accumulate shares for a common purpose be treated as joint holders and that their stakes be aggregated — even in the absence of an explicit contract or agreement.

Japan similarly amended its Financial Instruments and Exchange Act in May 2024 to bring derivative financial instruments that can be used to conceal share ownership within the scope of mandatory reporting. The shareholding disclosure threshold in the United Kingdom and Germany stands at 3 percent, lower than the 5 percent applied in South Korea, the United States and Japan.

South Korea currently determines joint shareholding based on whether the parties involved have reached an explicit agreement, but the SEC has made clear that an implied agreement is sufficient to establish joint holder status. Circumstantial evidence that multiple investors acted in a coordinated manner toward a common purpose is enough to classify them as joint shareholders and require aggregation of their stakes.

Japan likewise treats not only explicit agreements on the joint acquisition or disposal of shares or the joint exercise of voting rights, but also implied agreements, as constituting joint holding subject to aggregated reporting. Germany, too, aggregates the voting rights of third parties who cooperate through means other than explicit agreement.

Oh, the report's author, said that as share ownership has become increasingly dispersed with the growth of market participants and the spread of online trading, even a 3 percent stake should in effect be considered a large holding. He said a system capable of effectively identifying beneficial ownership through various derivative instruments is therefore necessary.

He said the law should be amended to cover implied agreements and substantive relationships when determining joint holder status, as is the case in Japan and Germany.

"Shareholding disclosure should be redesigned not as an obstacle to shareholder activism, but as an early-warning mechanism that filters out information asymmetry between ordinary shareholders and institutional investors in the stock market," Oh said. "As a wide variety of financial products are being introduced to the market, legislation is needed to close the blind spots that allow stake concealment and disclosure evasion through derivatives."