A first dispute mediation decision by the financial authorities has ruled that when a securities firm, while managing a client's bond-type wrap account, buys commercial paper (CP) and bonds above market price and incurs losses through maturity mismatching, it must compensate the client for damages. A bond-type wrap is a one-on-one customized management product in which a securities firm runs money on behalf of a client.
The Financial Supervisory Service said on the 30th that it convened the Financial Dispute Mediation Committee and decided to order a securities firm that violated the duty of care of a good manager and the duty of loyalty while managing a bond-type wrap product to compensate 60% to 70% of the client's loss. This is the first dispute mediation case acknowledging a violation of the duty of care and duty of loyalty by an investment discretionary manager under the Financial Investment Services and Capital Markets Act.
The dispute arose after bond-type wrap products also suffered investment losses when market interest rates surged and bond and CP prices plunged in 2022 due to the Legoland crisis. Some securities firms provided their own compensation, but civil lawsuits and dispute mediation applications continued over the amounts.
The mediation addressed two dispute complaints filed with the FSS at the time. Company A and Company B each signed investment discretionary contracts of 80 billion won (target returns of 4.3% each) and 15 billion won (target returns of 3.6% and 3.8%) with C securities firm. However, due to the firm's management failures, the two companies suffered losses of 460 million won and 450 million won, respectively.
The committee determined that C securities firm caused client losses by purchasing CP and bonds above market prices while managing client assets, employing a maturity mismatching strategy by adding long-term bonds and CP that did not match the product maturities, and neglecting risk management for interest rate fluctuations. It also found that some high-price purchase transactions were aimed at so-called "third-party benefit promotion" to meet other clients' target returns.
Accordingly, the committee decided to award compensation equal to 70% of the loss, or 1.26 billion won, in applicant A's case, and 60% of the loss, or 390 million won, in applicant B's case.
The loss amount was calculated as the difference between the amount a client would have received had the target return been achieved normally and the amount actually repaid. The FSS explained that securities firms had historically repaid most bond-type wraps at the target return level, and clients subscribed to the products based on that trust, so the responsibility for failing to achieve the target return due to unlawful management should rest with the securities firm.
The decision drew on a recent first-instance court ruling that recognized a securities firm's liability for damages related to managing bond-type wraps. Earlier, the FSS issued institutional warnings and cautions to nine securities firms and imposed a total of 28.97 billion won in fines for unsound management of bond-type wraps and trusts.
The FSS said, "This decision by the dispute mediation committee is the first mediation ruling to determine whether a securities firm violated the duty of care and duty of loyalty under the Financial Investment Services and Capital Markets Act," adding, "It is significant in that it clarified that, if a client's property is managed unlawfully, not only administrative sanctions but also civil liability may be imposed."