Knowledge is power

IFR Review of the Year 2012
9 min read

A string of insider-trading scandals in recent years has tarnished the reputation of Japan’s banking community and prompted the country’s Financial Services Agency to review regulations on insider information. Observers hope the efforts will clean up the industry and restore faith in Japanese banks.

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Japan has seen an uptick in insider-trading cases, with regulators publicly identifying at least five incidents since 2010 involving major domestic and foreign financial institutions.

Until recently insider trading was virtually embedded in the Japanese approach to the financial markets. That attitude appears finally to be changing – and observers suggest the increase in cases is due to the government taking the issue more seriously.

Japanese authorities have been looking at ways to improve regulation, even considering increased fines as well as jail time for more serious cases. In November, Nomura was fined ¥200m (US$2.5m) by the Tokyo Stock Exchange for compliance issues surrounding insider trading – the largest such punishment ever handed down.

Regulators say greater transparency in dealing with cases will boost deterrence. But those close to the situation agree that the biggest flaw in Japan’s regulation is that it ignores those who leak insider information, only treating trading on such information as criminal.

This has encouraged a culture in which banks have little incentive not to pass on privileged information to important clients. Many suspect such tip-offs (about upcoming share sales, for example) are tacitly encouraged, with short-selling arguably advantageous for the underwriters in creating liquidity as well as a buzz around a stock.

Currently the FSA’s fines are imposed on profits earned by insider trading, not on the act of leaking insider information. Instead, banks, whose employees leaked such information are penalised by a business improvement order from the FSA, exclusion from government-related business deals, imposition of fines/penalties by an industry organisation, etc.

“The real problem is that the underwriting banks have an excessively cosy relationship with short-sellers at other firms,” said Lance Miller, regional managing partner for Asia at law firm DLA Piper. “There is a suspicion that this problem is endemic across Japan.”

The FSA’s working group on insider trading is determined to address these issues and is considering various changes to the law, including making it a crime to pass on privileged information, said Taro Takeda, standing governor of the Tokyo Stock Exchange’s compliance unit and a member of the group.

If the FSA does clamp down on leakers of privileged information as expected, Japan will be well equipped to deal with the insider-trading problem, said Akihiro Wani, a partner at Linklaters in Tokyo.

Nomura, for example, has now been implicated in three of Japan’s insider trading scandals. (JP Morgan, Daiwa and Nikko SMBC are among others censured for insider trading). Besides the reputational damage Nomura has suffered, the bank lost mandates as bond underwriter for government deals from the Japan Housing Finance Agency and the Development Bank of Japan. It also failed to get a mandate for the government’s planned selldown of Japan Tobacco shares, expected early next year, and it lost the global co-ordinator position for Japan Airlines’ IPO in September.

In August, shortly after being issued with an improvement order by the FSA, the bank pledged in a statement to implement and “firmly establish the preventative measures described in the internal investigation report”. It said it would give regular updates on the progress implementing those measures, along with regular reviews of their effectiveness, in line with regulatory demands.

“If a bank or securities company gets that call from the FSA, they take it very seriously,” said Miller. “There is a lot of time and effort associated with that kind of an investigation, it is a long and traumatic process. So even without any additional fines, it is not like there is no pressure being exerted.”

Who’s to blame

But the idea of shifting the emphasis of the punishment on to individuals is contentious, said Nobuhiko Sugiura, professor and associate director at the Chuo Graduate School of Strategic Management and special research fellow at the FSA. There are difficulties ascertaining where blame lies, and there is always the possibility of employees being pressured by superiors. It is likely such matters must be judged on a case-by-case basis, and currently this question is under discussion in the Financial System Council, Sugiura said.

Meanwhile, the internal structures of Japanese banks can allow insider trading to flourish. Compliance departments are less powerful in Japan than elsewhere, and Sugiura said they should be given more power to enforce the rules. But the FSA is loath to legislate about this, and would much prefer the banks to reach this conclusion themselves, he said.

“The crisis has intensified calls for increased transparency but financial institutions tend to resist this trend,” said Richard Portes, professor of economics at the London Business School and president of the Centre for Economic Policy Research.

“Even if nothing illegal is being done, a lot of profit is generated by information asymmetries, and the less transparency you have, the greater the opportunity for profit.”

It is not a black and white issue, Portes believes. Many financial institutions have access to more information than sole traders, and top-tier investment banks have often generated healthy profits through their trading. Insider trading is just an extreme manifestation of this advantage, said Portes. The best protection against insider trading is greater transparency, he said, in conjunction with increasing prosecution, wiretaps, inducement of whistleblowers and other such tools.

Don’t hold your breath

The FSA is expected to present its proposals some time next summer, having started its investigations in July 2012. But what happens next is unclear, with a general election on December 16 creating some uncertainty. If politicians leave it for the next government, it could be 2014 before a new regime is in place.

A full change of law may not necessarily be required. Some minor amendments to the Financial Instruments and Exchange Act could be enough to take care of the incidents of passing on information that have not been charged with insider trading offences, said Wani.

In fact, Japan is standing on the brink of broad financial regulatory reform that will look to address overall systemic risk issues, said Wani. Japan has been under a regime akin to Glass-Steagall since the end of World War II, but more is needed to bring its securities and shadow banking sectors into the regulatory mainstream. There are also growing calls from banks to take this opportunity to simplify rules governing financial institutions, with excessive complexity seen as an unnecessary cost burden on banks, Wani said.

In the meantime, the scandals could cause other profound changes. With Nomura reeling from the damage to its reputation, there has been talk of its acquisition by Mitsubishi UFJ – a merger that would have a transformational impact on the banking landscape in Japan.

Yet there remains considerable scepticism as to whether such a union will ever come to pass: one Tokyo-based consultant suggested it was about as likely as Goldman Sachs being acquired by JP Morgan. The FSA is also reticent about a tie-up between a bank and a securities company, with the two subject to different regulations, said Sugiura. And Japan is already wrestling with questions around bank concentration, having seen 13 megabanks in the mid-90s dwindle to just three.

Regulatory action in 2012
DateInstitutionDetails of insider tradingFine (¥)
03-DecChuo Mitsui Asset Trust and BankingUS$6bn share sale by energy firm Inpex50,000
05-DecAsuka Asset ManagementUS$500m stock offering of Nippon Sheet Glass130,000
05-DecChuo Mitsui Asset Trust and BankingUS$9bn share offering of Mizuho Financial Group80,000
06-DecSMBC Nikko TraderInsider Trading of shares of companies, including Vantec and EnotecaSESC filed criminal charges
06-DecFirst New York SecuritiesUS$6bn share offering by Tokyo Electric Power Co14.68m
06-DecJapan AdvisoryInsider trading of Nippon Sheet Glass issues370,000
11-DecJapan AdvisoryInsider trading of Elpida Memory issues120,000
DateInstitutionDetails of leakImprovement Order Issued?TSE Fine (¥)
04-DecSMBC NikkoLeaked details of IPO to retail clients, believed to beYes80m
US$12bn offering by Sumitomo Mitsui Financial Group
05-DecJP MorganLeaked details of IPO for Nippon Sheet GlassNo
05-DecDaiwaLeaked details of IPO for Nippon Sheet GlassNo
08-DecNomuraLeaked details of various IPOsYes200m