“A friend of the chairman has set up a company offering prices slightly below market…would that be a problem?” “If a retired vice president continues to participate in company decision-making as a consultant, would that be considered unlawful?” These seemingly ordinary scenarios may, in fact,
“A friend of the chairman has set up a company offering prices slightly below market…would that be a problem?” “If a retired vice president continues to participate in company decision-making as a consultant, would that be considered unlawful?” These seemingly ordinary scenarios may, in fact, already be treading into the gray area of related-party transactions.
Related-party transactions are not illegal per se; the law’s core concern is that a company should not treat related parties more favorably than unrelated third parties. Put differently, a related-party transaction shall, at a minimum, satisfy the following three requirements: First, disclosure (information transparency): the company must disclose related-party transaction information in accordance with Article 18 of the Regulations Governing the Preparation of Financial Reports by Securities Issuers. Second, fairness: transaction terms must be arm’s length; pricing, payment terms, and other conditions must conform to ordinary market practice. Otherwise, the transaction may constitute an “abnormal transaction” under Article 171, Paragraph 1, Subparagraph 2 of the Securities and Exchange Act. Third, procedural transparency and avoidance of conflicts of interest: transactions must follow lawful procedures. Material transactions should be submitted to the board of directors for resolution, with interested directors recusing themselves, and should be subject to review by the audit committee or independent directors. Failure to meet these requirements may, at a minimum, violate principles of corporate governance and, in more serious cases, constitute a criminal offense.
Against this backdrop, it is essential to understand who qualifies as a “related party.” This can be divided into two categories. The first is formal related parties. International Accounting Standard (IAS) 24, Article 18 of the Regulations Governing the Preparation of Financial Reports by Securities Issuers, and Article 2 of The Statement of Financial Accounting Standards No. 6 all define related parties. Common examples include: (1) investee companies accounted for using the equity method; and (2) investors that account for their investments in the company using the equity method. The second category is substantive related parties, where economic substance prevails over legal form.
Regrettably, sophisticated offenders often exploit the law to evade it. Such actors rarely transact with formal related parties; instead, they use so-called “nominees” or “front persons” as counterparties. To pierce these arrangements, the law relies on the principle expressed in Article 2 of The Statement of Financial Accounting Standards No. 6: when determining whether a party is related, one must consider not only legal form but also the substantive relationship. In addition to using front persons and shell companies, offenders may also employ multilayered and complex transaction structures involving numerous offshore shell companies; fragment transactions to evade materiality thresholds; or rely on valuation processes that are highly subjective and difficult to verify.
How, then, should enterprises guard against these hidden legal risks? It is advisable to establish three lines of defense to effectively mitigate potential exposure. First, strengthen disclosure mechanisms. Companies should maintain a clearly defined list of “substantive related parties,” covering directors, officers, and their spouses; blood relatives within the second degree of kinship; former senior executives who continue to participate in decision-making after retirement; and indirectly controlled entities.
Second, implement robust independent review procedures. Material transactions should be approved by the board of directors; where an audit committee exists, its prior consent is required, followed by public disclosure within two days and reporting to the shareholders’ meeting. Transaction pricing must satisfy the arm’s-length standard. In particular, transactions involving special assets—such as real estate or intangible assets—should be supported by professional third-party valuation reports or opinions from certified public accountants.
Third, reinforce internal audit functions. The internal audit department should conduct annual targeted reviews of related-party transactions and establish automated “red flag” alert mechanisms. Where transaction amounts approach disclosure thresholds or where multiple transactions appear to be artificially segmented, internal investigation procedures should be promptly initiated.
In conclusion, related-party transactions should be conducted openly and transparently. They should not be carried out privately for personal gain, nor should they result in the dissipation of corporate assets. By establishing clear and transparent internal control and disclosure procedures, enterprises can not only protect themselves from the risk of asset stripping, but also safeguard corporate reputation and investor confidence. Only through such practices can a company achieve stable and sustainable long-term development.
This article was published in the Expert’s Commentary Column of the Commercial Times. https://www.ctee.com.tw/news/20250724700113-431305
