“Samsung Biologics Trial”: With One Eye Open, It’s “Inheritance Fraud”; With Both Eyes Open, It’s “Profit-Taking”

Ignoring How the Market Economy Works ... We Must Not View It Only Through the Succession Frame

Time for Korea’s Corporate Management Environment to Change

The success stories that often become legends in business usually contain twists and dramatic elements. Such is the story of Samsung Biologics (hereafter “Samsung Bio”), whose stock price has exceeded 500,000 won and whose market capitalization is nearing 40 trillion won.

Last month, it also signed a $360 million (440 billion won) contract with a U.S. company to produce a COVID-19 treatment. Could a success myth be born in Korea’s biotech industry? Along the way, many financial and accounting variables entered the picture: R&D investment, joint ventures, call options as instruments of rights, subsidiaries and affiliates distinguished by equity ownership, book value and market value that differ depending on accounting treatment, stock listings and initial public offerings (IPOs) that realize windfall gains, and governance structures designed to secure managerial control.

Yet the reality is unfortunate. Behind the success, Samsung Bio’s legal battle over accounting fraud is still ongoing. Two years ago, the company was reported to prosecutors by the People’s Solidarity for Participatory Democracy. The allegation was that it had committed accounting fraud to inflate the value of Cheil Industries after the merger of Cheil Industries and Samsung C&T. The Financial Supervisory Service reviewed the allegations and referred the case to prosecutors, and as the trials continued, the charge has now shifted to destruction of evidence related to the alleged accounting fraud.

The trigger was Samsung Bio’s 2015 financial statements, the year in which it posted massive profits after recording losses for four consecutive years from 2011. Ahead of that year-end closing, Samsung Bio changed the status of its subsidiary Samsung Bioepis (hereafter “Bioepis”) to that of an affiliate and revalued its assets. Bioepis’s equity value jumped from around 290 billion won to 4.8 trillion won, and net income reflecting market value reached 1.9049 trillion won. Without the revaluation, it would have remained in the red on a book-value basis.

What kind of company is Bioepis? It is a joint venture established in 2012 by Samsung Bio and the U.S. company Biogen Idec (hereafter “Biogen”) with an 85:15 investment ratio. Samsung Bio, then a latecomer to the industry, took the lead. At the time, Biogen, concerned about uncertainty, chose a call option as an incentive for joint investment, while Samsung Bio secured an absolute majority stake through its cash investment. Then, in November 2015, a jackpot arrived. It was the hard-won achievement of a new drug developed after years of struggle. After seeing reports that the European Medicines Agency had approved a new treatment related to rheumatoid disease, Biogen immediately sent a letter stating that it would exercise its call option to secure 50% minus 1 share. Facing the risk of losing corporate control, Samsung Bio responded swiftly. Its response was to change Bioepis’s status from a subsidiary of Samsung Bio to an affiliate. Once revalued at market value, the company’s value jumped more than sixteenfold. The following year, Samsung Bio’s shares, which had had a par value of 5,000 won, were listed on the KOSPI at an IPO price of 136,000 won, and Biogen also exercised its call option. Bioepis’s ownership structure is now a 50:50 joint holding, but Samsung Bio retains managerial control by holding one additional share.

What lay behind the People’s Solidarity for Participatory Democracy’s suspicions? It believed that the inter-company merger and accounting fraud had been carried out to help Lee Jae-yong, Vice Chairman of Samsung Electronics, succeed to control of the Samsung Group. In fact, because Cheil Industries, which held a 46% stake in Samsung Bio, saw its corporate value rise due to the change in accounting standards, Vice Chairman Lee Jae-yong benefited. Governments have since changed, and in 2018 the Securities and Futures Commission under the Financial Services Commission, which first deliberated the accounting fraud allegations, concluded that Samsung Bio had intentionally omitted the existence of the call option from its 2012–2014 disclosures in violation of accounting standards, and that it had taken unjust gains by changing Bioepis’s book value to market value.

From the reality of corporate management, however, this is a difficult judgment to accept. First, it was disclosed that the accounting treatment had received unqualified opinions from Korea’s three largest accounting firms—Samjong, Anjin, and Samil—on whether it constituted accounting fraud. The Korean Institute of Certified Public Accountants also produced an inspection result stating that there was no problem because no unjust gain had been taken. In this interpretation, the change in accounting treatment for the subsidiary was Samsung Bio’s defense of managerial control in order to secure the initiative after the biosimilar won international sales approval, and the gain from asset revaluation was the natural reward for an investment that had borne the risk.

The timing of Samsung Bio’s accounting treatment and managerial-control defense also differs from the allegations that have been raised. Samsung was busy in the second half of 2015. At the time, the asset valuation had to be completed before the shareholders’ meeting that would decide the merger. Looking at Samsung Bio’s schedule—from reflecting the market value resulting from the affiliate conversion in the year-end closing to submitting the audit report—the board resolution on the Samsung C&T–Cheil Industries merger (2015. 5. 26) and Samsung Bio’s year-end 2015 accounting treatment are chronologically reversed. The merger was formally approved at the shareholders’ meeting on September 1, but the shareholder vote on whether to approve it had already been settled on July 17 with more than 70% support. One wonders why Samsung’s explanation has been overlooked.

Another missing element in the controversy over Samsung Bio’s alleged accounting fraud is the operating principle of the competitive market. In the market, firms are living organisms that survive and grow only by securing comparative advantage through constant innovation. Drug development is the greatest challenge and gamble in the biotech industry. It is an innovative effort to hit the jackpot and enjoy excess profits in return for taking risks. If success is assumed, struggles for control are often inherent in joint ventures that share capital and technology.

The allegations of accounting fraud are plausible only if viewed solely through the frame of irregular inheritance by family-controlled conglomerates. That is because under the current inheritance tax system, normal business succession is not easy. Countries around the world are steadily lowering inheritance taxes along with corporate taxes in order to encourage business succession. At present, 13 of the OECD’s 36 member countries have no inheritance tax at all. Korea’s inheritance tax runs completely counter to this global trend. Even when a business is passed on, the effective inheritance tax rate is actually higher than the nominal rate, and the succession conditions are also stringent. In cases where succession is made through company shares, the basic tax rate of 50% is combined with a management-control premium, pushing the top rate as high as 65%.

Last year, Samsung Bio posted 120 billion won in operating profit as its sales more than doubled. It was the company’s first annual profit in eight years since its establishment. It was the fruit of aggressive R&D, undertaken from the early stages of the business while enduring losses, to secure competitiveness in the pharmaceutical market. Accounting is a record of management activity. Recognition and measurement of the flow of money follow generally accepted accounting principles, but differences in interpretation can arise at any time. It is regrettable that entrepreneurship is not being properly evaluated because of differences in opinion between companies and financial authorities over accounting treatment. A business-friendly environment becomes possible when entrepreneurs who pay substantial taxes and create quality jobs are respected. The management environment for Korean companies should change in that direction as well.

Hee-young Hur, Professor, School of Business Administration, Korea Aerospace University

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Original title: '삼바 재판' 외눈 뜨면 '상속 분식' ... 두눈 뜨면 '이익 실현'

Author: Hee-young Heo

Date: 2020-05-06

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&pn=21&idx=22607