The convertible bonds (CB) in the stock market have been pointed out as a hotbed for market manipulation, but financial authorities seem to have few means to regulate CBs. It is common for entities that have underwritten CBs issued by listed companies for fundraising to artificially inflate stock prices to gain trading profits. After CB investors exercise their conversion rights and gain undue benefits, stock prices plummet, leading to investment losses, but there is essentially no way for authorities, including the Korea Exchange, to regulate this.
Experts point out that measures need to be in place to regulate unfair practices during the CB conversion and new stock listing process when suspicions arise. In cases where market manipulation is suspected, authorities should intervene to delay new stock listings, or the Financial Supervisory Service should review the exercise of CB conversion rights as thoroughly as they do for capital increases that infringe upon existing investors' rights. One proposed measure includes requiring shareholder consent to resell CBs after early redemption.
An industry insider noted, "Under the current system, once a CB is issued, there is no 'brake' until the conversion rights are exercised," adding, "Whether from financial authorities or a shareholders' meeting, regulations are needed to halt the process of CB conversion into stocks and new listings when unfair transactions are suspected."
The increasing calls for strengthening regulations on CBs are due to a rise in cases where indiscriminately printed CBs by listed companies are misused for stock manipulation. According to a report on unfair trading abuses of private placement CBs published by the Financial Supervisory Service in 2023, there have been significant cases where stock prices were deliberately inflated to sell newly converted stocks at high prices for undue benefits. For instance, investors in Company A, a new drug developer, used false promotions of its COVID-19 treatment's clinical trial passing prospects to sell CB conversion stocks at elevated prices.
CBs, which are issued as bonds but can be converted into stocks at a predetermined price after a certain period, can be issued with only the approval of the board of directors. When bondholders request conversion into stocks, the company must decide the listing date within a month for the newly issued stocks. Although the value of existing stocks is diminished when new stocks are listed, the issuance of CBs and the listing of new stocks are determined solely by the company's decisions.
Moreover, even if there are suspicions that the entities that underwrote CBs have engaged in deliberate market manipulation, there is no way for financial authorities, including the Korea Exchange, to prevent the new stock listing.
A representative from the Korea Exchange explained, "The new stocks issued as a result of exercising CB conversion rights are created when the company designates a listing date and registers it with the Korea Securities Depository," adding, "The only time the exchange can postpone the CB listing date is when there are legal disputes, such as a petition for provisional injunction being filed."
A capital market expert familiar with stock manipulation explained, "Recently, the methods used by stock manipulation entities to acquire stocks have mostly evolved to using CBs," noting, "Buying CBs under the guise of an investment group with a proxy representative makes it easier to avoid investigation by authorities."
The Korea Exchange already has the authority to suspend trading or prevent transactions in accounts for stocks suspected of market manipulation. However, suspending trading of a stock impacts regular investors, and account suspensions must be judged by the courts, thus taking time. It has been pointed out that the current system makes it difficult to quickly respond to unfair trading practices utilizing CBs.
A capital market insider pointed out, "CB conversion rights are directly tied to individual property rights." However, another insider remarked, "Since it significantly affects other investors, there is likely to be less legal issue regarding the introduction of regulations," emphasizing, "With President Lee Jae-myung mentioning strict punishment for stock manipulation, now is the right time for implementation."