The globalisation of corporate activities coupled with borderless securities markets has created strong demand for better corporate governance of listed companies worldwide.
Both domestic and foreign investors have criticised Japan's corporate governance regime as being inferior to the US and many EU member states' regimes. Whether or not this is fair, one area of criticism is that the regime allows Japanese listed companies to obtain their funding from financial markets in an undesirable manner, and to dilute the voting rights of existing shareholders – potentially damaging their interests.
To address this criticism, the Tokyo Stock Exchange (TSE) made amendments to the Securities Listing Regulations and other related regulations which took effect on August 24 2009, and imposed new rules on private placements. The amendments' aim is to create a better market environment that will give investors security and restore the credibility of the TSE market.
(Please note that references to private placement refer to any offering of shares that is not a public offering or an offering made only to existing shareholders in accordance with their respective shareholding ratios. References to company refer to a Japanese stock company (kabushiki kaisha) with a board of directors all or part of whose shares may be acquired without the approval of the company. This is the most common type of company listed on the TSE.)
Private placements under the Companies Act
Under the Companies Act of Japan, any issuance of shares to a third party by a company requires a resolution of its board of directors approving it. However, a resolution of a shareholders meeting is not required unless such shares are to be issued at a particularly favourable price to a third party – a "Favourable Issue". If a company wishes to issue shares which would result in the total number of issued shares exceeding the total number of authorised shares in its articles of incorporation, it must amend its articles by an extraordinary resolution of a shareholders meeting to increase the total number of authorised shares.
Most companies set the total number of authorised shares in their articles of incorporation at the maximum number allowed under the Companies Act (usually this can't be more than four times the total number of issued shares – although there are exceptional cases as mentioned below). Because of this, the company's board of directors can usually issue a lot of shares without obtaining a resolution of a shareholders meeting, unless the issuance is deemed a "Favourable Issue".
Although the rules under the Companies Act allow companies to have flexible funding options, such rules have been criticised as having weak protections for existing shareholders because they allow Companies to (i) dilute the voting rights of existing shareholders by issuing shares to subscribers selected solely by the board of directors on the basis of a board resolution and (ii) conduct private placements to unidentified subscribers.
In order to address this inadequacy, some corrective measures have been taken. One such measure is a purpose-based interpretation of the Companies Act. Another measure is the disclosure requirements under securities law (the Financial Instruments and Exchange Act) and the previous TSE Regulations. However, such measures have been considered insufficient.
Preventing dilution of shares
In order to address the dilution issue above, TSE has imposed the following rule:
"When a listed company conducts a private placement, if (A) the ratio of voting rights related to the shares offered by such private placement to the number of voting rights related to the shares issued before the board resolution approving the placement (dilution ratio) equals 25% or more, or (B) the private placement is likely to result in a change of the controlling shareholder (for example, the parent company) of a listed company, the listed company must do one of two things. It must either obtain an opinion of someone independent from management (such as a third party independent committee, an outside director (shagai-torishimariyaku) or an outside company auditor (shagai-kansayaku)) regarding the necessity and suitability of the placement, or get approval for the placement from the listed company's shareholders by means such as a resolution of a general shareholders meeting".
If the listed company fails to satisfy these requirements, the TSE may, if it deems necessary, (a) make a public announcement of such failure, (b) require the listed company to pay a listing agreement violation penalty (joujoukeiyaku-iyakukin), (c) request that the listed company submit a report which explains the reason for such failure and outlines improvement measures (kaizen-houkokusho), or (d) designate the listed shares issued by the listed company as a "security on alert" (Tokusetsuchuuishijou-meigara), in which case, the listed company must promptly submit a document that sets forth the status of the internal control system and other related matters after each anniversary of such designation.
Under the Companies Act the total number of authorised shares of a company cannot be increased to four times the total number of issued shares. Because of this, shareholders or investors usually make their investments on the premise that the dilution ratio will not exceed 300%, even by an extraordinary resolution of a shareholders meeting (although there are some exceptional cases in which the ratio may exceed 300% under the Companies Act, such as where a company first cancels its existing shares by way of a reverse stock split approved by an extraordinary resolution of a shareholders meeting, whereby the total number of authorised shares will not change, and thereafter issues new shares). Thus, private placements in which the dilution ratio exceeds 300% contradict such premise and may seriously damage the interests of existing shareholders and investors. In order to address such potential harm, the TSE has imposed the following rule:
"In the event a listed company conducts a private placement where the dilution ratio exceeds 300%, the company shall be delisted unless TSE deems that such private placement is unlikely to undermine the interests of shareholders and investors."
Excluding anti-social forces
It is clear that involvement of anti-social forces in private placements should be eliminated and prohibited to make the market more credible and fair. To do this, the TSE has imposed the following rule:
"In the event a listed company conducts a private placement, not including cases in which all shares are issued to another listed company or trading member of the TSE market, the listed company must submit a written confirmation to the TSE before the board resolution. It must state that the subscribers for such shares have no connections with anti-social forces."
Rules regarding controlling shareholders
It has been acknowledged that controlling shareholders tend to use the ability to force unfair transactions for their own benefit, even at the cost of seriously damaging the interests of the company itself and existing shareholders.
In response to this issue, the TSE has imposed the following rule:
"If (i) a private placement results in a change of the controlling shareholder (for example, the parent company) of a listed company, and (ii) TSE deems within the following three years that there is considerable damage to the ability of the listed company to conduct sound transactions with the controlling shareholder, the company shall be delisted."
The TSE has also imposed some reporting rules in connection with the above rule.
Rules on disclosure
The Companies Act requires a company to obtain an extraordinary resolution of a general shareholders meeting when its issuance of shares to a third party is deemed a favourable issue. If the company fails to obtain an extraordinary resolution of a general shareholders meeting in spite of a favourable issue, any existing shareholder of the company that is likely to suffer harm because of such favourable issue may demand, among other things, that the company stop issuing shares. While standard for determining whether or not an issuance of shares will be deemed a favourable issue is not objectively clear, it is generally understood that even if the paid-in amount is approximately 10% lower than the market price at the time of the issuance, it may not be recognised as a favourable issue depending on the circumstances.
In light of this, because there is no objectively clear standard, it is difficult to determine whether or not an issuance of shares would be deemed a favourable issue. While the TSE Regulations require a listed company to make disclosures in any private placement where (i) the total paid-in amount or total offering value is expected to be ¥100 million ($1.1 million) or more, or (ii) it introduces or implements takeover defence measures, the TSE has imposed the following rule:
"In the event a listed company is required to make a disclosure regarding a private placement as mentioned above, the listed company must disclose (a) the calculation basis of the paid-in amount and the details of such calculation and (b) if the TSE deems necessary, an opinion of a statutory auditor or an audit committee which opines that the paid-in amount is not particularly favourable to the subscribers."
There are also some cases where private placements are cancelled after disclosure because of non-payment by intended subscribers to the shares. This can sometimes cause confusion in the market and damage its credibility and may even be a form of manipulation of share prices.
In order to ensure fairness in the market and protect the interests of shareholders and investors, the TSE has imposed the following rule:
"In the event a listed company is required to make a disclosure regarding a private placement, the listed company must confirm and disclose the availability of the subscribers' funds for the their paid-in amount."
Current trend
Because listed companies' corporate governance should be more stringent than that of non-listed companies, related laws and regulations may also be progressively reviewed from the same perspective in the near future. In fact, as part of an attempt to enhance disclosure requirements of listed companies, the Financial Services Agency amended the Cabinet Office Ordinance on Disclosure of Corporate Information under the Financial Instruments and Exchange Act on December 11 2009. Under the amended Cabinet Office Ordinance on Disclosure of Corporate Information, a listed company which conducts a private placement is required to make a disclosure regarding the private placement in the Securities Registration Statement to be filed with the Financial Service Agency, including information such as (i) the general background of the subscriber (including any relationship between the subscriber and anti-social forces) and the reason the listed company selected the subscriber, (ii) the policy as to whether the subscriber intends to hold or transfer the shares acquired by the private placement, (iii) the funding sources of the subscriber, (iv) a detailed description of the intended application of the funds acquired through the private placement, (v) the terms and conditions applicable to the private placement (including the listed company's view as to the fairness of such terms and conditions and the basis of its view as to whether the private placement is deemed as a favorable issue), (vi) in cases where the issuance is a large-scale private placement in which (a) the dilution ratio (the calculation method of which is different from that used in the new TSE Regulations) equals 25% or more, or (b) it is likely to result in a change of the controlling shareholder of the listed company, the purpose of such large-scale private placement, the expected effect on existing shareholders and any means supporting the fairness of the board's decision such as a resolution of a general shareholders meeting and hearing from a third party independent committee, and (vii) the schedule of any intended cash-out. It should also be noted that one of the main aims of introducing the "Public Companies Act" (the concept of which has been proposed by the Democratic Party of Japan, the newly elected governing party of Japan), is to enhance of corporate governance of listed companies.
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About the author
Tsuyoshi Shimizu is a partner at Nagashima Ohno & Tsunematsu, one of the largest law firms in Japan. His practice focuses on corporate matters, including M&A, joint ventures and corporate governance.
He graduated with an LL.B. from the University of Tokyo in 1996 and with an LL.M. from New York University School of Law in 2003. He was admitted to practice law in Japan in 1998. He worked at Pillsbury Winthrop Shaw Pittman LLP in New York as a visiting foreign attorney from 2003 to 2004, and worked at Japan’s Ministry of Justice from 2006 to 2008. |
Contact information
Tsuyoshi Shimizu
Nagashima Ohno & Tsunematsu
Kioicho Building,
3-12, Kioicho,
Chiyoda-ku
Tokyo 102-0094, Japan
Tel: +81-3-3288-7000
Fax+81-3-5213-7800
Web: www.noandt.com |
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About the author
Kiyotaka Tajima is an associate at Nagashima Ohno & Tsunematsu. His practice focuses on corporate matters, including mergers and acquisitions and corporate governance.
He graduated with an LL.B. from Kyoto University in 2005 and was admitted to the Bar in Japan in 2006. |
Contact information
Kiyotaka Tajima
Nagashima Ohno & Tsunematsu
Kioicho Building,
3-12, Kioicho,
Chiyoda-ku
Tokyo 102-0094, Japan
Tel: +81-3-3288-7000
Fax+81-3-5213-7800
Web: www.noandt.com |