LH scandal and conflict of interest in public sector

 The latest impropriety to roil the Moon jae-in government pertains to irregularities by Korea Land & Housing Corp. (LH) employees regarding large urban development projects near Seoul.

State-owned LH was established in 2009 as a comprehensive organization responsible for the development, construction, renovation and management of land, housing properties and cities in South Korea. Since then, it has developed residential areas, new towns and industrial complexes, including the inter-Korean Kaesong industrial park in North Korea.

Earlier this month, two civic groups – People’s Solidarity for Participatory Democracy and Lawyers for a Democratic Society -- alleged that LH employees bought land worth about 10 billion won ($8.88 million) in the cities of Gwangmyeong and Siheung in Gyeonggi Province between April 2018 and June 2020, before plans for transformative development projects -- aiming to decentralize Seoul by turning farmland into a self-sufficient town powered by an industrial complex and full infrastructure -- were announced. 

Their role in using insider information to snatch precious property before word got out brought into sharp focus the conflict of interest in public sector and effective measures to tackle the issue. 

A conflict of interest here involves the public duty and private interest of public officials, in which their private-capacity interest could improperly influence the performance of their official duties and responsibilities.

Since then, the police have raided LH headquarters and other regional offices, but the ensuing commotion has refused to subside. With public mistrust growing before crucial mayoral by-elections in Seoul and Busan on April 7, undermining his continuing attempts to cool the property market, President Moon was forced to issue a public statement. 

He encouraged the ruling party to pass a conflict of interest law, noting that “the people are infuriated” and the “unacceptable act destroyed society’s fairness and trust.” 

Moon said that although the current anti-graft law, also known as the Kim Young-ran law, paved the way for the country to clean up corruption, and the latest scandal “should serve as an opportunity to create a strong conflict of interest prevention system.”

It took an unforeseen public embarrassment just before crucial elections to come to this sudden realization. Efforts to bring a stringent law to tackle conflict of interest in the public sector have been put on the backburner for years now, mostly due to reluctant lawmakers across the ideological spectrum.

In fact, there is already a public service ethics law which seeks to establish the ethics of officials by preventing conflict of interests through the prevention from acquiring unlawful property and securing fairness in the execution of their official duties. It prescribes matters necessary for the regulation of property acquisition by public officials who take advantage of their office, a report on gifts and blind trust of the stocks by officials, and restrictions, etc. on the employment and acts of retired officials.

Article 2-2 of the law states that the central and local governments shall strive to promote the smooth progress in the performance of duties of public officials in relation with their property interests, so as not to cause any difficult situation in their fair performance of duties.

“Public officials shall appropriately and faithfully perform their duties with a preference of public interests, so as not to cause any difficult situation in the fair performance of their duties in relation with their property interests,” it notes.

It further adds that no public official shall pursue private interests or grant illegal preferential benefits to any individual, institution or organization using his or her public position, and unfairly use the information acquired during his or her incumbency for private purposes or have another person use such information unlawfully.

 However, the law has not been very effective in tackling conflict of interest and it is widely accepted that there is need to further strengthen it.

It was in this context that a clause to prevent conflict of interest among public officials in the current anti-graft law was shelved when it was initially taken up for discussion in the National Assembly five years ago. Subsequent efforts to introduce it have since been ignored.

Therefore, it is unclear whether a related law will be expedited, although Moon is right in noting that it is indeed an opportunity to do so. While one can expect strict action to be taken against the public officials involved in the LH scam, there is a possibility that the issue will die down after elections.

The government has so far identified 20 public officials suspected of buying land for speculation in the Gwangmyeong-Siheung area, and Prime Minister Chung Sye-kyun has pledged to declare a “war” against real estate crimes.

A government task force has confirmed 13 of the LH officials identified by the civic groups and found seven more after looking into 14,000 employees of LH and the Ministry of Land, Infrastructure and Transport.

The detailed findings will be transferred to a special police investigative team, which will expand the probe to include spouses and relatives of the officials in question.

The latest scandal comes in the backdrop of soaring property prices in since May 2017 when Moon came into office, despite repeated government interventions to cool down the market. Housing affordability has become a headache, as his high levels of support have started slipping due to scandals, high unemployment and slow economic growth.

Historically, real estate has been the safest and most lucrative investment vehicle in Korea. Believing that the rise in housing prices is triggered more by speculation than real demand, the government has on various occasions stepped in to curb the price rise and crack down on speculation.

Market watchers expect the property market to continue to attract public attention and policy focus in 2021 as house prices will maintain their upward trend.

As noted by analysts, two factors will drive the anticipated growth in housing prices. On the supply side, the housing stock will sustain the persistent increase in prices for new properties and also add upward price pressure in the second-hand property market. On the demand side, property remains a favorite investment asset and will continue to be so.

If the government is really keen to curb housing prices and gain back public confidence, it must ensure that its real estate policies are in tune with reality and not just stopgap measures. More importantly in the context of the current scandal, it must beef up its checks and balances on conflict of interest in the public sector.

Conflicts of interest in the public sector are particularly important, because if they are not recognized and controlled appropriately they can undermine the fundamental integrity of the government. 

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GameStop frenzy amid shorting debate in Korea

 Retail investors across the world, including South Korea, were captivated recently with the revolt targeting short selling by Wall Street hedge funds, which jacked up the stocks of a few firms, video game retailer GameStop in particular.

Shorting refers to transactions when an investor borrows stocks and sells them soon in hopes of buying back later at a lower price, taking advantage of perceived arbitrage opportunities.

In the case of GameStop, institutional short sellers got very greedy. They bet against the game retailer and hoped its price would plummet by shorting more stocks than were available through its float.

Frustrated at watching the manipulations by big fish to rake in moolah, retail investors banded together -- through online brokerage apps and anonymous social media messaging boards -- and drove the price higher through a short squeeze, in turn pocketing windfall profits. The financial institutions were forced to unwind their short positions, losing an estimated $20 billion.

Although a course correction is widely anticipated -- GameStop stocks have cooled down from a high of 140 percent two weeks ago -- with calls for a probe by regulators rising, the David vs. Goliath battle that rattled the US and European stock markets has now spread to Asia.

The uprising caught the attention of White House, even as retail investors, celebrities and lawmakers have decried any move to impose restrictions. Meanwhile, the Securities and Exchange Commission has vowed to protect individual traders and also promised to scrutinize the unfair actions of large brokerages.

This showdown between retail investors and FIs, which has peaked now, is not something new. Korea is no exception, and is in fact turning out to be the new battleground for this face-off.

During the global financial crisis in 2008, more than half the financial markets tightened their regulations to restrict shorting. The measures included a ban on naked shorting -- transactions without borrowing the asset from someone else or ensuring that it can be borrowed -- and short selling of financial companies’ stocks, and strengthened disclosure rules related to the practice.

When stock prices sharply fell, Korea banned covered and naked shorting of all stocks from Oct. 1, 2008.

This followed vehement opposition by many retail investors who stated that shorting increased unfair practices and would increase market volatility.

The stock market in Korea is perceived as being asymmetric due to the limited market access of retail investors. While foreign and institutional investors can borrow stocks for a year with lower fees, retail investors must pay hefty fees and sell borrowed stocks within 90 days, leading to an unleveled playing field.

As the financial crisis subsided, most countries eased or lifted their restrictions and Korea followed suit, allowing short selling of all stocks with exceptions.

Since then, the Financial Services Commission has continued to tighten regulations. However, retail investors have pointed out flaws in the system and the situation finally came to a head last year.

As a result, one of the world’s longest bans on shorting was imposed in March last year. Following a six-month extension which lapses on March 15, the financial regulator has announced that the temporary ban will be lifted in May, while pledging a stringent monitoring system to detect illegal shorting.

This has sparked an intense debate between FIs that have been severely hit by the ban, academicians, market analysts and retail investors. While retail investors are pushing for a total ban on shorting, the move does not find much support from other market players and experts.

The debate on shorting has political implications too.

With interest in trading equities growing and retail investors being the primary force for the bullish trend during the COVID-19 pandemic, more than 203,000 people have signed a petition imploring President Moon Jae-in to make shorting illegal -- a threshold of 200,000 compels him to officially respond.

The country’s benchmark Kospi hit a historic 3,000 points earlier last month, continuing a yearlong upward trend. Retail investors purchased a net 67.7 trillion won ($60.5 billion) worth of stocks on the country’s main Kospi and secondary Kosdaq markets last year. 

A market crash would bode badly for the ruling party in April by-elections to elect mayors for Seoul and Busan. But the FSC sees little justification to continue the current ban as the stock market has continued to outperform. The regulator has vowed to improve market transparency by enhancing monitoring and establishing additional safety nets by the time the cap is removed.

The regulator, meanwhile, plans to level the playing field and invite more retail investors to take part in shorting activities as they are mostly carried out by foreign and institutional investors now.

Even the International Monetary Fund has pitched in, urging Korea to end its shorting ban, saying it risks making the market less efficient.

Most economists are of the view that there is nothing wrong with shorting. They insist that a ban not only undermines market efficiency and quality, but also causes overpricing and substantial deterioration of market quality.

It is a vital investment strategy that responds to market fundamentals, facilitates efficiency, mitigates price bubbles and promotes risk management activities.

In fact, shorting is not all that bad and is a very useful scheme for individuals who know how to use it to their advantage. It can be an opportunity for retail investors to earn a profit when stock prices decline. They should equip themselves with sufficient know-how about the market and utilize the system for gains when appropriate.

As they say, the stock market is not for the faint-hearted. Unfortunately, in Korea most of the retail investors are ignoring the accompanying risks. And when they get blindsided they look for convenient scapegoats like shorting.

A total ban on the practice goes against international capital market practices and a more prudent approach is required for devising shorting regulations and setting the level of restrictions in the future.

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