Korea Due Diligence
Korea remains a problematic destination for foreign capital and for global companies looking to enter its markets. Its opaque business culture, closely held companies, and highly concentrated economy make due diligence both challenging and an absolute necessity for any organization wishing to do business in the country.
The Korean Economy
The Korean economy has some broad characteristics that define the competitive environment in the country, including
- a high level of industrialization
- a high level of technological competitiveness
- a weak and inefficient services sector
- a maturing economy
- negative demographic trends
- and domination of the economy by a few large business groups.
Today’s Korean economy is a highly industrialized, technologically advanced, export-reliant machine. Korea’s major exports are now electronic circuits, large transport and cruise ships, automobiles, smart phones, networking gear, and digital displays. Since 2011, Korea has been one of the top five patent filing countries on the planet.
Korea’s economy is very competitive in the industries it focuses on, but has just a few competitors who dominate those industries, leaving the country with one of the most concentrated economies among developed nations. South Korean market concentration remains high compared to other OECD countries with the few big business groups (Chaebol) proving very resistant to past government attempts to restrain their growth and domination of the economy. These groups, despite diverse ownership in the public financial markets, remain very much in the control of their founding families.
Korea’s service sector is a drag on the economy as service sector productivity remains just a fraction of that in most OECD countries. According to the Institute for International Trade, Korean services sector output per work hovers around 70% of that in EU countries. The economy is largely bifurcated into highly attractive and profitable industries that attract young, highly-educated knowledge workers and its service industry, which is populated by less educated, older workers in smaller, often self-owned, companies.
Some Risk Factors in Korea
Insufficient and Inefficient Corporate Governance
Tight control by founders and heavy competition between domestic groups make for an opaque business culture with less developed corporate governance than would be expected for a country of similar wealth and modernity. Shareholders don’t often show the level of activism they do in the West and majority owners/management don’t show the same concern for fiduciary duty to general shareholders. Governance Metrics International ranked Korea 29th among 39 countries in 2010, just one spot ahead of Brazil, and Russia.
Corruption and Bribery
Transparency International’s 2013 Corruption Perceptions Index (CPI) ranked South Korea 46th out of 177 countries. Koreans still consider the public sector to be quite corrupt, with political parties perceived to be the most corrupt category in the country. Countries ranked close to Korea on the CPI include Malta, Hungary, and Slovenia. Korea was given a ‘moderate enforcement’ rating by Transparency International for enforcement of the OECD Anti-Bribery Convention of 2011. The Convention requires parties to make bribery of foreign public officials in international business transactions a crime.
Today, Korea is a member country of both the Financial Action Task Force (FATF) and the Asia Pacific Group on Money Laundering (APG). Korea has been a FATF member since 2009, after having been an observer nation since 2006. FATF’s “Mutual Evaluation of Korea” report stated, “The ML offences are largely in line with international requirements but penalties available and applied are not sufficiently effective, proportionate or dissuasive and there is a lack of focus on ML investigations.” The report went on to state, “Customer identification and verification represents a strength in the Korean preventive measures but issues such as beneficial ownership, politically exposed persons and correspondent banking have yet to be addressed. In addition, the obligation to file suspicious transaction reports (STRs) only applies to transactions over KRW 20 million.”
Corporate fraud is a problem in Korea just as it is in most countries. Fraud cases are often handled internally, and therefore, never come to light outside the companies in which they occur. Actual corporate fraud levels in Korea are, therefore, difficult to gauge. The cases that do make it into the public eye are often only the largest or most damaging incidents, while thousands of smaller cases occur and are handled without the knowledge of shareholders, partners, or customers. Some of the largest areas for corporate fraud in Korea include, conflict of interest, procurement fraud in various forms, kickbacks and illegal gratuities, and sales channel/commission fraud.
Intellectual Property Protection
The theft of proprietary information or intellectual property is one of the largest threats companies in Korea face. According to Korean authorities tasked with combatting information theft and industrial espionage, the overwhelming majority of information theft cases in Korea are perpetrated by insiders and ex-employees. Vendor partners are the second largest group of perpetrators. In cases where individuals have close ties to the company, they are more likely to know what proprietary information is available, how it is managed, who inside has access to it, and how it is protected. This is what makes the threat from insiders, ex-employees, vendors, and partners so great.
The Challenges of Doing Due Diligence in Korea
Korea has extremely strict privacy rules, which must be adhered to at all times while performing due diligence. Personal and corporate information is regulated by a variety of legal frameworks, including the Communications Network Act (CNA), the Location Information Act (LIA), and the Credit Information Act (CIA). The latest act impacting the way companies gather, store, and protect information in Korea is the Personal Information Protection Act (PIPA).
Some of the effects of Korea’s strict privacy regulations on the availability of information in the public domain include the following.
- Korean newspapers do not publish the names of the alleged perpetrators of crimes, and in most cases do not publish names even after convictions.
- Searches of civil litigation by individual name are not legally performable.
- Korean national ID numbers may not be held or used by non-authorized third parties at any time.
- Criminal records on individuals are not available to the public or any party other than the individuals, themselves, even with a release.
- Korea’s strict defamation laws often lead to self-censorship, thereby precluding individuals from making verbal or written statements, even statements of fact, about third parties. This makes reputation/reference interviews very difficult.
- Identifying the true beneficial owners of Korean companies and assets is still a challenge. Koreans routinely register assets and shareholding in other’s names in order to avoid taxation.
- Reverse directorship searches aren’t always conclusive.
Due Diligence in Korea is a must.
If you are planning on doing business in South Korea, such as investing, sourcing product or components, entering the market directly, entering the market through a local partner, or licensing your brand or technology, it is crucial to know all you can about the status, environment, and history of the parties you will be doing business with. Due diligence is not a luxury, it is a risk mitigation necessity.