Japan’s crackdown on insider trading barely scratches the surface of a practice that allows traders to profit and brokerages to boost their underwriting business at the expense of shareholders and issuers.
The disclosures have undermined confidence in the world’s second-largest stock market, where the Nikkei 225 Stock Average (NKY) remains 77 percent below its 1989 peak and scandals such as the accounting fraud at Olympus Corp. and covered-up losses at AIJ Investment Advisors Co. deter investors from a waning economy.
In the five insider-trading cases uncovered since March, regulators have proposed fines for traders who short sold shares based on information leaked to them by underwriters before public offerings were announced in 2010. The revelations prompted at least two clients of Nomura Holdings Inc. (8604) to take their business elsewhere after Japan’s biggest brokerage acknowledged the breaches by its sales staff.
“Japan has been letting the animals run wild for two or three years now -- that wouldn’t happen in the U.S.,” said Takao Saga, a professor who studies the financial industry at Waseda University in Tokyo. “Insider trading is still going on in the Japan market.”
With the latest actions, the Securities and Exchange Surveillance Commission and its parent, the Financial Services Agency, are keen to show they are cracking down after it took them nine years to discover AIJ hid losses that reached $1.4 billion on pension money it managed. Olympus admitted to a $1.7 billion, 13-year coverup of losses after former President Michael Woodford blew the whistle last year on inflated fees the camera maker paid for takeovers.
Authorities are paying attention now because short selling by insiders is hindering corporate fundraising, not just burning investors who aren’t privy to the tips, according to consultant Robert Boxwell. The transactions involve traders selling borrowed shares, betting that the price will fall once the offerings become publicly known on concern over dilution.
“These types of insider trades cost Japan Inc. money,” said Boxwell, 54, who has lived in Japan and now studies global insider trading as director of consulting firm Opera Advisors in Kuala Lumpur. In Japan, “after years of ignoring protests from the West about cleaning up their act, they’re talking tough.”
Financial Services Minister Tadahiro Matsushita, who was appointed to his role as part of a Cabinet reshuffle on June 4, said his agency could be doing more.
“There are some deep-rooted issues,” he said at a news conference in Tokyo on July 10. “The FSA is responding severely and appropriately given the framework and economic conditions. You can never say you’ve done enough.”
Matsushita, 73, last week asked 12 securities firms including Goldman Sachs (GS:US) Group Inc., Citigroup Inc. (C:US), Deutsche Bank AG (DBK), UBS AG (UBSN) and Bank of America Corp. (BAC:US)’s Merrill Lynch unit to review how they handle confidential information.
He also ordered his agency to consider stiffer penalties for insider trading after facing criticism that existing rules are too soft. Regulators currently impose fines based on profits made from the transactions, with no punitive penalties attached, while tipsters aren’t subject to fines.
The FSA fined Sumitomo Mitsui Trust Holdings Inc. (8309) 130,000 yen ($1,630) last month after a former unit traded shares for clients before two public offerings.
The current probe focuses on a glut of stock issuances made in the aftermath of the global financial crisis. Companies in Japan sold 5 trillion yen of shares in 2010, the most in four years, according to data compiled by Bloomberg, to replenish capital. Salespeople at brokerages had to market the equities to investors reeling from new threats such as Europe’s sovereign debt turmoil.
“The market didn’t welcome the new share offerings,” said Mitsushige Akino, who oversees about $600 million at Ichiyoshi Investment Management Co. in Tokyo. “Employees were under pressure to generate and boost profits.”
Sales staff weren’t the only ones pressed to drum up business. Investment bankers who managed share sales allowed, and in some circumstances encouraged, the salespeople to pass on tips to short sellers because they created demand by buying back the stock during the public offerings, said two bankers who have worked for equity divisions at firms in Tokyo and asked not to be named because of confidentiality agreements.
Employees from equity underwriting units or coverage bankers would sometimes contact overseas hedge funds directly or through their brokers while securing a mandate, months before the offerings were announced, one of the people said.
“This brought a triple benefit as hedge funds made profit, brokers successfully completed the deals, and votes for the broker from clients went up,” Kyoya Okazawa, head of global equities and commodity derivatives at BNP Paribas SA in Tokyo, wrote in a note last week. “Japan’s insider-leaks scandal is a serious problem that will probably extend beyond its borders.”
Insider trading aided by underwriters was so prevalent in the wake of the financial crisis that the SESC may only target a few examples to use as a deterrent, said Kenji Nakanishi, former deputy president at JPMorgan Chase & Co. (JPM:US) in Tokyo.
“I received phone calls and e-mails from foreign banks and investors around 2010 saying Japan’s capital markets will get ugly,” said Nakanishi, 48, who’s now a lawmaker with the opposition Your Party. “What the SESC revealed were very minor cases that must be the tip of the iceberg.”
The five cases earned a total of 118 million yen for the investors, the commission says. Shares of Japan’s 10 biggest stock issuers in 2010 declined an average five times more than the benchmark Topix (TPX) index in the two weeks before their offerings were made public, erasing 800 billion yen of market value, according to data compiled by Bloomberg. In the three months before the announcements, the shares declined an average 10 percent, compared with a 0.2 percent drop for the Topix.
The ruling Democratic Party of Japan wants a wider investigation after finding spikes in trading volumes of 20 stocks before public offerings were unveiled between July 2009 and July 2011, said lawmaker Tsutomu Okubo. Share prices “clearly moved before the announcements, which looks odd,” Okubo, a former Morgan Stanley banker who heads a DPJ panel examining the issue, told reporters on July 5.
While equity offerings have declined since 2010, reducing the opportunity for wrongdoing, All Nippon Airways Co. (9202) last week raised an alarm regarding unusual trading that occurred before it announced plans on July 3 for a 211 billion yen share sale. The SESC is examining whether there was insider trading, a government official with direct knowledge of the matter said, asking not to be named as the investigation is still under way.
The trading volume of ANA shares reached a three-month high on July 2, moves that spokesman Ryosei Nomura described as “unnatural.” The airline currently has no plans to take action after receiving assurances from the four underwriters -- Nomura, JPMorgan, Goldman Sachs and Deutsche Bank -- that they didn’t leak information on what would be Japan’s biggest sale this year. Spokesmen at the four banks declined to comment.
Nomura said in a June 29 statement that it had cut top executives’ pay, forced two managers to step down and suspended some operations following an internal probe into leaks ahead of 2010 equity offerings by Mizuho Financial Group Inc. (8411), Inpex Corp. and Tokyo Electric Power Co. Sales staff appeared to have been “willing to do anything to meet sales targets,” lawyers hired by Nomura to investigate the breaches said in a report.
The Japanese firm relied on domestic operations to sustain a return to profitability after posting a record 708 billion-yen loss in the year ended March 2009, when it bought Lehman Brothers Holdings Inc.’s Asian and European businesses.
The revelations have cost the company business including bond underwriting for the state-run Development Bank of Japan Inc. Japan Housing Finance Agency said on July 9 that it excluded Nomura from managing bond issuances.
Nomura Chief Executive Officer Kenichi Watanabe, 59, told reporters on June 29 that he wasn’t sure whether there were additional leaks. The Tokyo-based company doesn’t plan to pursue any more investigations by outside lawyers, he said.
The SESC also found that two managers of a share sale by Nippon Sheet Glass Co. (5202) gave tips in separate cases, without identifying them. JPMorgan and Daiwa Securities Group Inc. (8601) were the lead underwriters. New York-based JPMorgan said on May 29 that it’s cooperating with regulators, while Tokyo-based Daiwa, Japan’s second-biggest brokerage, said on June 29 that it would examine the incident and strengthen controls.
Moody’s Investors Service said losing the bond-underwriting business following the leaks is credit negative for Nomura and Daiwa. “We expect a mounting loss of confidence from this scandal will have a lasting impact on all players in the Japanese market,” Moody’s said in a note dated July 9.
Japanese regulators have also been active recently in the global investigation into interest-rate manipulation. Last year, the FSA became the first regulator to punish banks as part of the probe, banning Citigroup from trading tied to the London and Tokyo interbank offered rates for two weeks, and Zurich-based UBS for a week.
The penalties were dwarfed by the record $451 million fine U.S. and U.K. regulators handed Barclays Plc (BARC) last month in a case that sparked a British government inquiry and led Chief Executive Officer Robert Diamond to resign.
In Japan, SMBC Nikko Securities Inc. (8316) is the only brokerage that has been punished for leaks so far in the insider-trading probe, after the SESC found that 23 of its sales staff informed clients about an unidentified company’s plans to sell shares.
Japan’s handling of tipsters contrasts with that of the U.S., where former Goldman Sachs director Rajat Gupta was convicted last month of leaking inside information to hedge-fund manager Raj Rajaratnam. Gupta, who will be sentenced in October, faces as many as 20 years in prison for securities fraud.
“No fine, unless it’s extremely punitive, can approach prison as a deterrent,” said Boxwell of Opera Advisors. “Japan needs serious reforms to make their capital markets not seem rigged.”
There are signs that authorities are getting tougher. Former SMBC Nikko executive Hiroyoshi Yoshioka in June became the first banker from a major local firm since 2008 to be arrested on suspicion of insider trading. He and three others conspired to buy shares in a takeover target for 2.4 million yen before the bid was announced, according to the SESC.
“It’s encouraging to see Japan regulators shine a light on some gray areas and highlight the responsibility of brokerages to safeguard information,” said Naoki Fujiwara, chief fund manager at Shinkin Asset Management Co., which manages about 500 billion yen. “But it’ll take time to restore confidence.”
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