At the SK Group, the bottom of the corporate governance trough has yet to be seen. A recent regulatory action that resulted in a significant fine is a case in point.
On July 8, the Korea Fair Trade Commission (FTC) said it had fined seven affiliates of the SK Group, South Korea’s third-largest conglomerate, a total of KRW 34.6B (US$30.4M) for illicit related-party transactions. Announced deliberately on Sunday morning to limit the impact on the stock market, the news still sent out shockwaves to the international investor community. This is because it came on the heels of an earlier higher court ruling on KRW 200B (US$174M) embezzlement indictments against SK Chairman Chey Tae-won and his brother and vice chairman Jae-won, the two members of the second-generation founding family.
The enormous volume of the illegal transactions centered on one of the conglomerate’s 94 affiliates, SK C&C Company, the system integrations unit which is majority held by Chairman Chey and his family. Between 2008 and June 2012, the seven affiliates paid SK C&C a total of KRW 1.7T (US$1.4B) in construction and maintenance fees, about 72 percent higher than market value. A meagre KRW 34.6B in fines was indeed the regulatory equivalent of a slap on the hand in comparison to the depth of corruption.
The way the SK Group has responded to the government probe reveals the culture of collusion and corruption deeply embedded with the conglomerate. SK C&C’s compliance officer, himself a former government prosecutor, orchestrated a plot to steal company documents from FTC investigators that had been seized earlier by the Commission. The watchdog levied KRW 90M in penalties against the compliance officer and two executives-yet another slap on the hand.
“Cosa Nostra,”, how the Mafia likes to refer to itself, is translated as “Our Thing”. Such a term is more appropriate than any governance concept to explain why the Chey family had to prop up SK C&C and has continued to commit irregularities.
In 2005/6, after a fraud scandal involving the founding family, the conglomerate promised to unwind cross shareholdings and to create a holding company structure. It was the end of fiscal 2011 when the conglomerate finally completed the conversion.
The new ownership structure is as complex and interwoven as a ball of string, and SK C&C is its integral part. The systems integration unit, 55 percent held by SK Group Chairman Chey Tae-won and his family, controls a 31.8 percent stake in SK, the conglomerate’s de facto holding company. SK has a 23.2 percent stake in SK Telecom, the conglomerate’s biggest unit.
The disclosure at SK Telecom and SK C&C is so limited, GMI can’t calculate AGR scores for them that would compare their accounting and governance risk to peers.
The new ownership structure has placed the Chey family under pressure on three fronts. First, it constantly needs to access large amounts of cash to buy back shares of SK affiliates periodically in order to holding together its conglomerate. Second, it needs to control SK units through other methods such as a web of cross shareholdings. And third, options for real corporate restructuring are limited by the founding family’s obsession with retaining control over the conglomerate.
The founding family used SK C&C to funnel funds from other SK units into its personal coffers while it used related-party transactions to strengthen control of the conglomerate. In the past four years, SK C&C paid Chairman Chey KRW 48B in dividends. But even this was not enough, in 2011, his constant need for cash drove him to set up a shell company to misappropriate KRW 100B ($87M) in funds from a variety of SK units, including SK Telecom.
The Cheys’ “cosa nostra” was only possible at huge cost to shareholder value at other SK units. For instance, while the founding family used strong and healthy units to prop up its pet company in order to stay in control of the SK empire, SK Telecom’s position as the country’s number one wireless telephone services provider has come under threat. Although SK Telecom is still the dominating force in the market, it is being out-competed by KT in new subscriptions as the archrival has more quickly taken advantage of the rise in the use of Smartphones.
SK Telecom now finds itself further squeezed by the rise of such mobile VoIp apps as Kakao Talk, which allow users to ditch paid voice and text services in favor of talking and texting over 4G networks, free of charge. Normal business tenets would tell SK Telecom to rationalize its business by spinning off or selling underperforming units. However, SK Telecom cannot follow such norms because any restructuring on such a scale would undermine or put at risk the Chey family’s control of SK Telecom and the rest of the conglomerate. To the founding family, a materially leveraged acquisition of a high-risk business makes more sense than rationalization. And thus, on Feb. 15, 2012, SK Telecom bought a controlling 21.5 percent stake in Hynix, the troubled chipmaker infamous for wild income swings, for KRW 3.4T of which KRW 2.5T was funded with debt.
How Chairman Chey’s “cosa nostra” will detrimentally affect the finances and governance of the entire SK Group is yet to be seen. However, his time and money are running out fast. According to a regulatory filing, as of July 6, Chairman Chey has borrowed KRW 400B from brokerages against 5.75M SK C&C shares, or 11 percent of his entire holdings. The three-pronged pressure is further intensifying. Given South Korea’s lax regulatory oversight and the Cheys’ insatiable desire to control their conglomerate, there is little reason to believe that SK’s founding family will discontinue its routine irregularities in the near future.
The seven affiliates fined by the FTC on July 8 are: KRW 25B for SK Telecom Co., Ltd. (KSE: 017670); KRW 3.7B for SK Innovation Co., Ltd. (KSE: 096770); KRW 2B for SK Networks Co Ltd (KSE: 001740); KRW 1.3B for SK Marketing & Company; KRW 960M for SK C&E; KRW 900M for SK Energy Co., Ltd.; and KRW 800M for SK Securities Co., Ltd.