In the wake of headline-grabbing insider trading scandals that have plagued Japan for the last few months, a working group has finally been assembled by the country’s top financial regulator to discuss tightening its insider trading rules. However, unless harsher sanctions are put in place and implemented, some industry watchers are wary the common practice of sharing sensitive information could ever be stamped out.
Though the insider trading storm for Nomura (See box-out on p. 44) and other top securities firms in Japan has seemingly subsided for now, behind the scenes, authorities are just beginning to gear up. The Tokyo Stock Exchange (TSE) has assembled two special investigative task forces, the Securities and Exchange Surveillance Commission (SESC) has been conducting an industry-wide investigation, and lawmakers are discussing changes to insider trading laws and Japan’s Companies Act to enhance corporate governance. Will the recent media furore, enforcement efforts and possible legislative changes be successful in stamping out insider trading ahead of public share offerings? The problem has gone unchecked in Japan for years, and some industry watchers are cynical that the culture of information sharing could ever truly be altered.
Insider trading rules amendments
On July 4, financial services minister Tadahiro Matsushita instructed an advisory panel of scholars and experts to review current regulations and propose new rules, including penalising those who pass on insider information. The two key focuses of the Financial Services Agency’s (FSA) working group are: 1) Determining whether the provision of insider information to other persons should be penalised (as opposed to insider trading – acting upon the information- itself); and 2) Determining whether administrative fines on insider trading should be increased.
One senior in-house counsel at an international investment bank in Japan told ALB that while he is supportive of heavier administrative fines on insider dealings, “as they should deter violations at least to
some extent”, he is against the introduction of a new regulation on the provision of insider information: “The provision of insider regulation is already regulated and can be penalised, despite some media reports to the contrary. New regulation, if it is ever introduced, is likely to be unclear, and accordingly difficult to comply with or enforce.” On the other hand, Ashurst Tokyo partner Kensuke Inoue feels that the provision of insider information should be made illegal. “Insider information, once communicated, could trigger illegal activities. To protect the integrity of the securities market and trading, I believe simply providing insider or price sensitive information should be prohibited, at least with some substantial sanctions.”
Critics have slammed Japan’s penalties as being far too lax by global standards to act as a deterrent against insider trading. In Japan, fines are designed mainly to forfeit ill-gotten profits, and in cases where investment funds commit insider trading for clients’ accounts, fines are calculated based on fees the funds receive from the clients. For example, Chuo Mitsui Asset Trust and Banking was fined just 50,000 yen ($600) for trading on insider information ahead of Inpex Corp’s 507 billion yen ($6.4 billion) global share offering in July 2010, when it was reported to have earned 10 million yen by shorting the stock. In late May, a fund management arm of Sumitomo Mitsui Trust Holdings Inc was slapped with a fine of 130,000 yen ($1,600) for insider trading related to the Inpex share offering and a public share offering by Mizuho. And in the most recent insider trading case, no fine was even set - securities firm SMBC Nikko was given a so-called “business improvement order” for passing on information about parent Sumitomo Mitsui Financial Group’s 953 billion yen ($12 billion) capital increase.
According to an interview International Financing Review (IFR) conducted with a senior director of the committee on financial affairs in Japan’s upper house of parliament, the aim is to introduce legislation that “will act as a deterrent” not only for those acting on insider information but also those providing it. “Those who pass on insider information will also be guilty,” Tsutomu Okubo told IFR.
Under current law, those working for underwriters who leak information about deals into the market are not subject to regulatory sanctions. This leads to a situation where the authorities sanction and fine fund managers acting on inside information, while those who solely pass on tips go unpunished – making insider trading relatively easy.
The reforms on insider trading will be achieved through amendments to the Financial Instruments and Exchange Act (FI&E Act). Amendments to the FI&E Act will legalise soft-sounding investors who have signed confidentiality agreements. This change should help rights issues, which protect existing shareholders, become a more common method of raising funds by addressing Japanese houses’ concerns about the risk of underwriting transactions without first being able to talk to key shareholders. The FSA working group discussions are in initial stages, but the government hopes to submit a bill to introduce new, tougher rules at the diet ordinary meeting next spring.
Clamping down
In addition to revising insider trading rules, IFR reports that Japanese authorities and exchanges are upping their efforts to clean up financial markets, with a number of inspection teams being created to shed light on wrongdoing.
Bankers had hoped the resignation of Nomura chief executive Kenichi Watanabe and subsequent business improvement orders for the bank might draw a line under the matter, but authorities say they will now increase their monitoring efforts across the industry.“The regulators and industry are working together to stamp out insider trading in Japan,” said Taro Takeda, standing governor of the TSE’s compliance unit, in an interview with IFR. “The TSE views insider trading as a serious issue.”
The exchange has already monitored “intensively” the shorting of stocks and other suspicious trading ahead of public offerings. Takeda said it will now work more closely with the Japan Securities Dealers
Association, the FSA, and its investigative arm the SESC.
To that end, the bourse set up in late July a new 13-staff department – the Public Offering Investigation Office – to start monitoring deals. It is led by the former head of trading supervision at the TSE, and will hold hearing sessions with underwriting banks and to be on top of the information flow before, during and after deals. On Aug. 13, the TSE also set up a special inspection team. The underwriters with the most deals will be selected for examination and be instructed on ways to improve information management. The recommendations will be mandatory for the financial institutions to follow and failure to comply will carry potential penalties within the framework of TSE membership, for example, the suspension of a firm’s stock trading licence or a fine of up to 100 million yen.
Criminal sanctions
“It’s a bit misleading to say there is no sanction on tippers of information, because there is a concept of aiding and abetting criminal parties,” says Nagashima Ohno & Tsunematsu partner Kensuke Suzuki, referring to the fact that the FI&E Act does criminally punish those found to be passing on insider trading information to eventual insider traders. The key point, however, is that the tipper must be proven to have knowledge the information would lead to an illicit action. This is extremely difficult.
The investment bank senior in-house counsel reminds that “Japanese insider regulation as currently in force already prohibits what happened at brokerage houses such as Nomura. Further, the provision of insider information to offenders could constitute ‘assistance’ for criminal conducts under existing criminal law principles, and could be penalised accordingly”. He also highlights that Japan’s regulations governing securities brokers have business conduct rules and they require, among other things, that securities companies keep control over non-public price sensitive information of listed companies, and not to solicit clients by providing such information.
Elaborating on the existence of sanctions already written into the law, Suzuki notes that since the insider trading rules were first introduced in the 1980s, the level of applicable criminal penalties for this action has become heavier and heavier, and now “it is one of the most severe levels provided under the FI&E Act”. However, nobody has ever been found criminally guilty for insider trading.
This could change in the near future. In late June, a former SMBC Nikko Securities banker, Hiroyoshi Yoshioka, was arrested for suspected insider trading. He became the first individual from a major Japanese brokerage to be detained under such charges since 2008. He and three others are accused of being involved in insider transactions while employed at SMBC Nikko in 2011. The SESC and Yokohama prosecutors are currently investigating the charge and if Yoshioka is found guilty, he faces up to five years in prison and a maximum fine of five million yen. “This might be the first case where the aiding and abetting concept will be employed on insider trading to criminally penalise securities firm personnel tipping clients,” says Suzuki.
Companies Act
Although the FI&E Act is the law directly dealing with the insider trading rules, legislators and senior officials are considering amending Japan’s Companies Act too, to further bolster corporate governance as it deals with corporate procedures. Suggested amendments to the Companies Act will force issuers and underwriters to protect existing shareholders when raising fresh equity, said Okubo, a former banker with Morgan Stanley to IFR. ”Hugely dilutive follow-ons are a corporate governance issue,” he said. Key potential amendments include shortening the subscription period for follow-on stock offerings and requiring companies to hire outside, independent directors. Compared to toughening up the FI&E Act’s insider trading regulations, reforming the Companies Act is a trickier and a more time-consuming effort. Discussions are thought to begin next fiscal year, starting April 2013. ”We are currently in talks with the Ministry of Justice to see what length of time is realistic,” said Okubo.
Can culture change?
Some legal professionals indicated a scepticism that unless the insider trading rules mete out much harsher penalties, the deeply-rooted culture of sharing information among financial institution market players would not truly change. They say the Japanese play by local rules, not international ones. “To some extent, it’s a culture thing,” says Ashurst’s Inoue. “Japan consists of very small communities and everyone knows each other in the industry. However, if the new sanctions are strong enough, that may change the picture. It really depends on what the amendments end up being.”
Another lawyer cites the Olympus scandal as an example of cultures remaining stagnant despite regulatory efforts to introduce global standards: “There were efforts to enhance corporate governance years ago, with companies adapting a committee system and boosting the independence of a company auditor. But as you can see from the Olympus incident, the whole company culture never changed.”
Inoue is not very confident financial players will be deterred without significant changes to the law. “The FSA group talks are in the very initial stages about the possible amendments. If the amended law simply ends up saying only that the providers of information who knew the recipient would make inside trades can be held liable or guilty of insider trading, it does not change the whole picture,” he says. He comments that it is a very common practice in the Japanese securities market for bankers to contact prospective IPO investors to see whether there is sufficient demand for new shares. Another Japanese lawyer who wished to remain anonymous says that it is quite common that all major market participants, including prospective buyers, know about IPOs before they are announced. The senior legal officer at the international investment bank corroborates this: “The problem is not so much about lax regulations, but is about non-compliance by some brokers with the regulations. I am not sure whether an even stricter insider regulatory regime will reduce offenders of laws in this area.”
Suzuki of Nagashima Ohno & Tsunematsu remains a bit more optimistic. “The various corrective measures that the Japanese regulators have recently been taking on securities firms would send out a message that they will not tolerate these types of [insider trading] actions,” he says. “Through these measures, the Japanese market will hopefully regain the trust and credibility from non-Japanese investors.”
And in-house counsel at the banks and issuer companies, along with help from external counsel can aid speed the process along.
Lawyers’ roles
The FSA recently issued a formal order to have Japanese brokers review their compliance procedures and supervisory frameworks in the relevant business areas. The international bank in-house counsel
says that as a result, 10 major houses’ internal assessments have been published. “Their improvement plans include a wide range of actions such as the tightening of trade surveillance, closer monitoring over communication (both internal and external), and enhanced compliance training,” he says.
With regards to insider trading regulations specifically, the in-house counsel says he does not use external law firms much. “Investment banks are already familiar with what the law says, and how it is interpreted by the courts and by commentators. The key focuses of our efforts here are to enhance internal controls and to improve compliance awareness among employees.” Suzuki agrees that in-house counsel should focus on education and training because “it’s very important that the business people have a correct understanding of what the insider trading rules are”. He notes that within the securities space, there are still some misconceptions or misinterpretations of the rules. “For example, one of the administrative orders recently issued by the Japanese FSA mentioned a case where there was an understanding by certain business people that as long as you don’t name the issuer, even if everyone knows which company you’re talking about, it’s not insider information. This is not a correct understanding of the law,” he says. He emphasises the seriousness of the crime, and that in-house need to stress this up and down the ranks.
Suzuki also hopes that, in light of the recent scandals and tighter regulatory scrutiny, the bankers will pay more respect to their in-house lawyers and compliance professionals, and allow them to do their jobs. “The recent scandals may raise awareness of the risks involved in insider trading violations and may lead business people to double check with the lawyers if their actions are appropriate from a legal or
compliance perspective,” he says.
The way Inoue views it, regardless of whether tippers can be sanctioned in a new, tougher law, in-house counsel can use the recent scandals as leverage to demonstrate that there are huge reputational risks related to the provision of insider information. “Even if merely providing insider information is not currently in violation of the law, in-house lawyers have a stronger position to say that these actions will harm the company due to reputational damage. For example, companies could be subjected to the cessation of business by a large customer. Now, in-house counsel have a stronger position to require employees behave more in conformity with what the laws expect. It’s not simply complying with the minimum requirements of the law, but rather to not damage the reputation of the company,” he says. Inoue also recommends that in-house counsel begin adopting procedures to control the dissemination of information, and to notify and put relevant employees on a “watch list” to ensure that they would not become involved in the sale of securities or exchange of information that may lead to insider trading.
So education and training are the key roles in-house lawyers play in bolstering its defences against further insider trading scandals. What about private practice lawyers?
External counsel tell ALB they could play a supporting role as inhouse teams work to strengthen their compliance frameworks and procedures, and educate staff. These jobs include conducting training sessions (“especially if new insider trading rules come into force”), working with in-house on compliance manuals or guidelines, implementing new compliance measures, and advising on the treatment of insider information, among other issues. “The Japanese insider trading rules are still quite vague in certain aspects,” says Suzuki. “We can be of help to clients in advising on what the insider trading rules are and how these rules will be applied in a certain situation.”
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