[Newsmaker] How much trouble is Samsung BioLogics in?

[KH Explains]: Answers to some of the most frequently raised questions regarding Samsung BioLogics case

On Nov. 14, the market was thrown into commotion, and heated debates arose, as the South Korean financial regulator Financial Services Commission ruled Samsung BioLogics had intentionally violated accounting rules in 2015. It ordered a halt in stock trading of the biopharmaceutical company, which will go through an examination that could lead to delisting, in theory, in the worst-case scenario.

The market and the industry remain largely split over the FSC’s decision and future prospects of the firm affiliated with the nation’s largest conglomerate, Samsung Group. Here are some frequently asked questions.

1. What is the gist of the Samsung BioLogics’ accounting fraud scandal?

The main issue of the “Samba (short for Samsung BioLogics) scandal” is the timing of Samsung BioLogics’ application of new accounting standards, which the authorities found to be an international violation of the rules.

Samsung claims that its accounting changes -- including the conversion of Samsung Bioepis’ status in 2015 -- were approved by the financial authorities after the merger between Samsung C&T and Cheil Industries in September, and Samsung BioLogics’ initial public offering on the Kospi in November of the same year.

However, the Financial Supervisory Service’s inspection that began in 2017 concluded that the accounting changes could have influenced the inflation of the biotech firm’s market value and consequently undervalued Samsung C&T’s shares.

After about 20 months of investigation, the Securities and Futures Commission under the Financial Services Commission concluded last week that the accounting changes were arbitrarily made, and the regulator suspended the trading of BioLogics shares on the main bourse.

Due to the SFC’s conclusion, the controversy now centers on Samsung C&T, whose largest shareholder is Samsung’s heir apparent, Lee Jae-yong.

2. What was Samsung BioLogics’ accounting misdeed confirmed by the authorities?

Samsung BioLogics held over 90 percent of Samsung Bioepis shares in the financial year of 2015. BioLogics changed its categorization of Bioepis to an affiliate, instead of a subsidiary, citing the high possibility that Bioepis’ second-largest shareholder Biogen Therapeutics might execute a call option. If the call option was put in place, Biogen Therapeutics would take nearly half of Bioepis shares. Based on this approach, BioLogics argued that it did not recognize its majority of shares as controlling shares.

This scheme enabled BioLogics to value Bioepis shares at market value, instead of book value, and as a result, Bioepis’ stock value soared over 16 times, while BioLogics yielded profit in 2015, after staying in the red for four years until 2014. Moreover, Samsung C&T, the parent company of Bioepis, failed to reflect shares slated to be transferred to Biogen under the call option as liabilities.

Financial authorities called the scheme an intentional accounting error, while BioLogics said the issue stemmed from a discrepancy in interpreting the International Financial Reporting Standards.

3. What were legal consequences of high-profile accounting fraud cases?

The SFC, a legal entity within the FSC, is authorized to levy fines on financial companies or auditors that have committed a breach.

However, its suggestions to dismiss top executives are not legally binding. It is in the hands of the court to decide whether BioLogics executives will face legal consequences.

Former CEOs of Daewoo Shipbuilding & Marine Engineering, Nam Sang-tae and Ko Jae-ho, were found to have masterminded a combined 6.2 trillion won accounting fraud. Ko was sentenced to nine years in jail in the Supreme Court ruling, while Nam was sentenced to six years in prison.

SK conglomerate also faced the consequences of a 1.6 trillion won accounting breach by SK Global, a precursor to SK Networks. SK Chairman Chey Tae-won was sentenced to three years behind bars in the district court ruling in 2003 on charges of masterminding the accounting fraud. He was convicted of breach of trust that led to a 111.2 billion won loss for SK affiliates. But in the appellate court in 2005, Chey was placed under five years of probation.

This comes in contrast to the fate of US energy company Enron. In 2006, former CEO and COO Jeffrey Skilling was sentenced to 24 years and four months in prison. Former Chairman and CEO Kenneth Lay could have faced 45 years in prison, but his conviction was cleared after Lay died of a heart attack ahead of the court ruling.

Samsung BioLogics has refuted the SFC decision and has pledged to take legal actions.

4. What is Samsung Bioepis?

Samsung Bioepis is a biosimilar affiliate of Samsung BioLogics that had originally held a 94.6 percent stake in the company. It was launched as a joint venture between Samsung BioLogics and Biogen, a US-based biotech firm in February 2012, which held the remaining 5.4 percent stake with a call option. With its intent to exercise its call option this June, the stakes were changed to BioLogics with 50 percent and Biogen with 49.9 percent.

Bioepis planned to go public on the US Nasdaq, according to Samsung’s plan announced in July 2015. However, the plan for Bioepis’ initial public offering was delayed as the Korea Stock Exchange revised its regulations for new IPO firms in late 2015.

In the meantime, Bioepis was on track to win approval for sales of its drugs in Europe, and Biogen had reportedly wanted to use its call option at the time. Samsung says it had to convert Bioepis’ status from a subsidiary to an affiliate and applied different accounting standards to use market value instead of book value.

5. Why did Samsung BioLogics adopt IFRS as accounting standard in 2015?

Korea’s privately held companies may choose one of two accounting standards: a Korean adoption of the International Financial Reporting Standards or another set of standards loosely translated as “Ordinary Accounting Standards.”

Since it was founded in 2011, Samsung BioLogics used the ordinary standards until the financial year of 2014 and adopted the K-IFRS starting the following year.

The introduction of new standards enabled the company to recognize Bioepis as its affiliate and record a profit in the annual financial statement in 2015.

Meanwhile, BioLogics’ call option deal with Biogen first appeared in the 2014 financial statement, two years after the two Bioepis shareholders sealed an agreement.

6. Who is the largest shareholder of Samsung BioLogics?

Currently, the largest shareholder of Samsung BioLogics is Samsung C&T with a 43.4 percent stake. Another major stakeholder is Samsung Electronics with a 31.5 percent stake in the biotechnology business. Samsung heir Lee Jae-yong is at the top of the shareholding structure with a 17.08 percent stake in Samsung C&T.

Before the Samsung C&T and Cheil Industries merger in September 2015, Samsung Electronics and Samsung Everland, which was changed to Cheil Industries before the merger, had held a 40 percent stake each, while Samsung C&T and Quintiles held 10 percent each. 

7. Why has the FSS changed its position on BioLogics?

The Financial Supervisory Service in January 2017 refuted a civic activist group’s claim that Samsung BioLogics committed an accounting breach and cleared the biotech firm of the allegation.

Only two months later, the watchdog embarked on a special probe, which led to the conclusion by the authorities that BioLogics’ accounting breach was intentional.

This coincided with the impeachment of ex-President Park Geun-hye by the Constitutional Court in March and the start of the Moon Jae-in administration in May the same year.

Such inconsistency in the FSS’ handling of the issue sparked speculations that the change in leadership might have influenced the FSS’ about-face. BioLogics’ claim of innocence also comes from the FSS’ initial approval from the audit.

8. Can the Samsung C&T-Cheil Industries merger be nullified?

An appeals suit has been filed by Ilsung Pharmaceuticals and some minor shareholders of former Samsung C&T to nullify the 2015 merger. They had claimed in the first trial in October that the merger had inflicted losses to minor shareholders as Samsung had undervalued Samsung C&T’s shares with a swap ratio of 1:0.35 -- exchanging one Cheil Industries share for three Samsung C&T shares -- but the court ruled in favor of Samsung.

The likelihood of the merger being nullified is very low, according to industry officials, but the appeals court could take into account the Securities and Futures Commission’s latest conclusion that Samsung had intentionally changed the accounting standards, and the prosecutors’ investigation into the scandal.

9. What will be the focus of prosecutors’ investigation into the scandal?

The SFC has accused Samsung BioLogics of the accounting fraud, and the Seoul Central District Prosecutors Office on Wednesday was assigned to investigate the scandal. The prosecutors’ investigation is to focus on the intentionality of the incident by examining the SFC’s accusation and the FSS’ inspection into the company’s accounting practices.

If any new evidence of the biotechnology firm being used for the merger of Samsung C&T and Cheil Industries is found by the prosecutors, the probe could be expanded to scrutinize suspicions that the merger and the biotech arm were planned to help Samsung heir Lee Jae-yong’s leadership succession. 

By Song Su-hyun and Son Ji-hyoung 
(song@heraldcorp.com) (consnow@heraldcorp.com)