By Cho Jin-seo

Where there’s smoke, there’s likely fire. Data from Korea Exchange shows that investors are right to dump stocks when they hear rumors of financial trouble or corrupt management. Since last year, about 70 percent of bad rumors spotted by the market operator eventually turned out to be true, and ended up in bankruptcy or delisting from the bourse.

When it discovers a rumor about a firm’s possible bankruptcy or a serious corporate crime, the stock market operator issues a “request for inquired disclosure” on the firm to make them confirm it. And the issuing of the request is statistically relevant with the possibility of the firm going south, its data between January 2010 and June 2011 showed. Among 130 listed firms that received this request to respond to bad rumors during this period, 92 were later delisted from the stock market for the very reasons speculated or were forced into debt restructuring programs, though many of them denied the rumors at the time of the inquiry.

Officials of Korea Exchange stress that investors should be worried when a firm is issued the “request” on a bad rumor, even if denied by the firm. In June 2010, the bourse asked E&Tech, a manufacturer of electronics parts, to respond to rumors of embezzlement by its major shareholder.

Over the next two months, the company denied any wrongdoing. “Though there is an investigation by prosecutors, there is no confirmed charge,” it said in a responding disclosure. On Aug. 31, however, the major shareholder was arrested on the charge of stealing 5.9 billion won from the company. The firm was expelled from the exchange, leaving many minor shareholders who had ignored the warning in jeopardy.

“When there is a request for inquired disclosure for a firm, this should be taken as a bad signal,” the exchange said in the report. “Investors should check not only how a firm answers our inquiry, but also how much time they take to do so.”

The KOSPI bourse’s rule is that if there is embezzlement of over 5 percent of a firm’s equity capital, then it is expelled from the market. The rule is tighter in the junior Kosdaq market at 3 percent, and firms where any embezzlement over 1 billion won takes place are kicked out too.

For foreign investors, the exchange provides English disclosure on its website but only the headlines are translated. And in most cases, the headlines give little information and the exchange does not guarantee the accuracy of the translation.

“If and when there is a discrepancy between the titles and headings in English and in Korean, the Korean text takes precedence. Therefore, it is essential for the investors to consult the Korean text before making any decision,” it says, which suggests that foreign investors should hire someone who can understand Korean when buying Korean stocks.

The bourse’s inquiries are not always bad signs for firms receiving them. The report on rumors and disclosures show that on the KOSPI, about a half the inquiries were about mergers and acquisitions. In most M&As, the share price of companies on sales is likely to go up as buyers usually pay premiums for management control.

But on the Kosdaq, only 31 percent of inquiries were about M&As. The rest were about rumors of embezzlement, the possibility of bankruptcy and problems in audit reports.