Author: | Published: 12 Jan 2005
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In June 2004, the Securities and Exchange Law of Japan (SEL) was amended as part of a continued effort to reform and modernize Japanese securities law. The First Subcommittee of the Financial System Council of the Financial Services Agency (FSA) issued a report titled Working Toward a Financial System with Market Function as its Core in December 2003. The amendment is based on the findings set out in the report.

There have been three big changes to Japanese securities law: changes to the prospectus rules; issuers' civil liability to secondary market investors for misrepresentations in disclosure documents; and the introduction of monetary administrative sanctions. A more recent proposal will also enable foreign issuers to prepare certain disclosure documents in English.

Prospectus disclosure

Supplemental prospectus

The SEL generally requires a person making a public offering of new or outstanding securities to deliver a prospectus to each prospective buyer. The Council's report proposes changing the prospectus requirement for offerings of beneficial certificates of investment trusts and securities of investment corporations (investment fund securities) to reduce the unnecessarily burdensome disclosure obligations imposed on these offerings. Because investment fund securities are simple financial products, the FSA subcommittee concluded that disclosure requirements for offerings of these securities should be less onerous than for other types of securities.

Following the report's recommendations, the amendment creates two types of prospectuses for use when offering investment fund securities. First, a mandatory prospectus containing all information that is significantly material to the purchase decision must be delivered to each prospective buyer. Secondly, a supplemental prospectus containing all information that is material to the purchase decision must be delivered to any prospective buyer who requests it. A cabinet office ordinance provides that significantly material information includes all information regarding the offered securities that is required to be disclosed in a prospectus and all material information relating to the fund, such as the purpose and investment policy of the fund, relevant risk factors, applicable charges and fees and the financial highlights. Material information includes additional material information relating to the fund, such as management information and financial statements.

The amendment provides civil liability for damages based on untrue statements and omissions contained in supplemental prospectuses. To the extent information in a supplemental prospectus, which is also required to be disclosed in a securities registration statement, is inaccurate or omitted in a material respect, the issuer and its directors, officers, underwriters and any securities intermediaries that sold the offered securities under the prospectus are liable for any such inaccuracy or omission.

The amendment also made two other changes to the prospectus disclosure system. It provided additional exemptions to the prospectus delivery obligation and clarified information that may be used in the solicitation for securities even though it is not included in a prospectus. Unlike the introduction of the mandatory prospectus and supplemental prospectus, these two changes apply to all securities.

Prospectus delivery exemption

Before the amendment, no prospectus had to be delivered to a qualified institutional investor unless requested. The amendment broadened the exemption of the obligation to deliver a prospectus to purchasers who provided a waiver and either owned securities of the same class or lived with a person who had been, or will surely be, given a copy of the prospectus. However, even in these cases, if the buyer later requests a prospectus before executing the sales contract for the securities, the intermediary must deliver a copy to that person. A buyer cannot make an irrevocable waiver of the right to request a prospectus.

The amendment also provides that a preliminary prospectus does not have to fix the offer price of the securities and certain other information if the preliminary prospectus provides that the pricing and other information will be disclosed in the future and identifies the method of disclosure. Provided that the information is disclosed in the method described, only the preliminary prospectus has to be delivered to the buyer. There is no obligation to deliver an amended prospectus containing the price of the securities or the certain other information.

This revision to the law allows issuers and securities intermediaries to price securities after the date of the preliminary prospectus without incurring the cost and time of amending and delivering a revised prospectus to buyers. This exemption to the prospectus delivery requirement also avoids the loss of investment opportunities by buyers as a result of them not receiving the amended prospectus promptly.

A cabinet office ordinance sets out the method by which pricing and such certain other information can be validly disclosed. To rely on the exemption, the information must be disclosed in at least two daily newspapers or in at least one daily newspaper and on the website of the issuer or the underwriter. To avoid inadvertent prospectus liability, each issuer relying on this exemption should ensure that any prospectus containing the issuer's website address does not incorporate by reference the information contained on the issuer's website other than the pricing and certain other information. Each issuer is still required to file with the relevant authority an amendment to its securities registration statement disclosing the fixed price and the other information of the offered securities.

Use of non-prospectus information

Before the amendment, issuers and securities intermediaries avoided providing buyers with documents containing information on the issuers' business other than the prospectus, summary prospectus or tombstone advertisement in soliciting sales for securities. The selling parties were prohibited from distributing documents containing information that differed that in the prospectus, plus there is ambiguity over the meaning of different.

The Council's report, however, argues that securities markets now place more importance and value on continuous disclosure than in the past, especially in relation to the effect of such information on the securities' market price. The report advocates the disclosure of information that might influence a security's market price, but that is not disclosed in the prospectus, provided that there are clear rules for the use of this information. The amendment provides that the use of information, written or oral, other than that in the prospectus is allowed so long as it is not inaccurate or misleading.

The amendment also abolishes the concept of a summary prospectus and tombstone advertisement. This change in law is intended to encourage issuers to provide additional disclosure in relation to public offerings. To address the concern of inappropriate use of information not contained in a prospectus, a warning should be included on any additional written disclosure document warning buyers that their investment decision should be based on the information contained in the prospectus and informing purchasers where they can obtain a copy of the prospectus. The FSA is expected to issue guidelines further clarifying the proper use of information not contained in prospectuses.

The provisions of the amendment relating to prospectus disclosure are effective December 1 2004.

Issuers' disclosure liabilities

Before the June 2004 amendment, primary market buyers had the right to sue issuers and their directors, auditors and underwriters for damages on the basis of a misrepresentation contained in an offering disclosure document, such as a securities registration statement or prospectus. Also, directors and auditors of issuers were subject to civil liability to secondary market buyers, including those who acquired securities through a stock exchange, for misrepresentations contained in an offering document or continuous disclosure document. However, secondary market buyers could not sue issuers for damages for misrepresentations contained in any offering document or continuous disclosure document.

Some proponents of the SEL argue that secondary market buyers should have no right of action against issuers for misrepresentations because issuers do not receive any payment from secondary market trades. But, without civil liability for continuous disclosure, there will probably be a discrepancy between the standard of care given to the preparation of offering documents and continuous disclosure documents.

Although the law provided buyers with a means of recovering damages they incurred due to misrepresentations contained in certain disclosure documents, the buyers rarely commenced legal action because the onus of proof was too high. To establish a claim for damages based on a misrepresentation contained in a disclosure document, an aggrieved buyer had to prove the existence of an inaccurate material statement or omission of material information, the quantum of damages and that the buyer's reliance on the misrepresentation caused the damage incurred.

The purpose of the amendment is to provide secondary market buyers with a right to sue issuers for damages based on misrepresentations contained in an offering or continuous disclosure document and to provide certain presumptions regarding damages, reliance and causation to assist aggrieved buyers in their claims.

Secondary market liability

The amendment imposes statutory civil liability on issuers for misrepresentations contained in any of their disclosure documents. The amendment provides secondary market buyers with a right not only to sue directors and auditors, but also to sue the issuers themselves for damages on the basis of a misrepresentation contained in an offering or continuous disclosure document. Although the amendment addresses secondary market buyers, technically, primary market buyers of private placements can, under the amendment, also sue issuers for damages for misrepresentations in issuers' previously filed offering or continuous disclosure documents.

Under the amendment, an issuer that files an offering or continuous disclosure document containing inaccurate material information is liable to any person that acquires the issuer's securities in the secondary market (or in a private placement) during the period in which the document is available for public inspection at the applicable local finance bureau. For example, annual securities reports are available for five years and semi-annual securities reports are available for three years. The buyer must commence an action within two years of learning of the misrepresentation. If a person sells a security at a lower price because of a material misrepresentation, the person cannot sue the issuer or its directors or auditors for damages.

Liability applies to offering and continuous disclosure documents filed on or after December 1 2004. If a document filed by an issuer before this date is incorporated by reference in a securities registration statement or a shelf registration statement filed by the issuer on or after December 1 2004, the amendment will apply to the document that is incorporated by reference.


The amendment also creates a presumption of the amount of damages. These are presumed to be the difference between the average market price for the month preceding the day the issuer publicly corrects the misrepresentation and the average market price for the month after the correction. Liability is limited to the amount paid by the buyer less the price at which it disposed of the securities or the market price at the time of the claim for damages, if the buyer was still holding the securities. Issuers can avoid liability by proving either that the depreciation in the value of the securities was not caused by the misrepresentation, or that the buyer had knowledge of the misrepresentation when it bought the securities. The presumption of the amount of damages applies only to buyers who acquired the securities within a year before the day the misrepresentation is corrected and continues to hold the securities up to this day.

The amendment also creates a presumption regarding reliance, negligence and causation for secondary market trades and private placements by shifting the burden of proof of these elements from the aggrieved buyer to the defendant issuer.

The introduction of issuer liability for misrepresentations for secondary market buyers and the presumption of the amount of damages, reliance and causation will probably encourage more actions for damages based on misrepresentations contained in disclosure documents, as well as deterring issuers from making untrue or misleading statements in their disclosure documents. The provisions of the amendment relating to statutory civil liability are effective December 1 2004.

Monetary sanctions

According to the FSA, the Securities and Exchange Surveillance Commission (SESC) has penalized far fewer persons for securities law violations than the US Securities and Exchange Commission. The Agency said that the limited types of penalties the SESC could impose have led to this discrepancy; although the SESC can impose criminal penalties for SEL violations, the stigma and severity of these penalties has meant they have been used only in exceptional cases.

The amendment authorizes the SESC to impose monetary administrative sanctions on persons for: including material misrepresentations in primary market disclosure documents; trading securities based on price volatility created by circulating rumours or using deceptive schemes; manipulating the market; and insider trading.

The amount of each sanction is prescribed in the SEL and depends on the benefit gained from the violation. For example, the penalty for a misrepresentation in a primary market disclosure document is 2% of the total issue price of a public offering of shares and 1% of the total issue price of a public offering of any other security. Before the FSA can impose a penalty, it is required to hold a public adjudication hearing by a panel consisting of three commissioners. The FSA commissioner will impose the prescribed penalty if concluding that the relevant violation occurred based on the findings of the panel.

The SESC still cannot impose an administrative sanction on an issuer for a misrepresentation contained in a continuous disclosure document because it is difficult to quantify the economic benefit issuers gain from these misrepresentations. However, following a recent case in which inappropriate information was included in continuous disclosure documents, the FSA announced in November 2004 that it would evaluate introducing monetary administrative sanctions on issuers that violate continuous disclosure obligations.

The monetary administrative sanction provisions in the Amendment are effective April 1 2005.

Foreign issuer disclosure

In June 2004, the FSA subcommittee issued a report proposing that qualified foreign issuers be allowed to file certain disclosure documents in English. The objective of the proposal is to attract foreign issuers to the Japanese market by reducing the costs of preparing disclosure documents in Japanese.

Japanese securities law provides that foreign issuers must prepare all of their disclosure documents in Japanese in accordance with Japanese disclosure rules and file them with the Kanto Local Finance Bureau (KLFB). Preparing these documents typically involves sorting, reformatting and translating large amounts of information. Therefore, the report recommended that foreign issuers from prescribed countries be permitted to prepare certain disclosure documents in English in accordance with the disclosure requirements of their home jurisdictions. Only limited Japanese documentation would be required. The new disclosure rules will apply only to annual and semi-annual securities reports and not to extraordinary reports or primary market disclosure documents, such as securities registration statements and prospectuses.

Under the proposal, the FSA will identify the jurisdictions that have sufficient reporting requirements to protect investors and the public interest in Japan. Issuers from these jurisdictions will be permitted to file English securities reports provided the issuer has been providing continuous disclosure in accordance with disclosure requirements of its home jurisdiction for a specified period of time.

For foreign issuers to file an English securities report, issuers will have to prepare additional documents in Japanese and file them with the KLFB. The issuer must file a supplemental document containing all of the information required under Japanese disclosure rules that is not contained in the English report, together with a summary of the report. The summary must contain all of the information contained in the English report that is essential to a purchaser's buying decision. The issuer must also file a comparison sheet that identifies the section in the English report containing the information required under Japanese disclosure rules.

The proposed disclosure rules are to be implemented in multiple phases. The new rules will be effective April 2005 for foreign issuers of exchange-traded funds and in 2007 for all other foreign issuers.

Author biographies

Hiroyuki Ishizuka

Nagashima Ohno & Tsunematsu

Hiroyuki Ishizuka is a partner at Nagashima Ohno & Tsunematsu. His practice focuses on securities transactions such as cross-border equity and debt offering transactions, including US registered offerings of shares of Japanese corporations and public offerings of Samurai bonds in the Japanese market, as well as mergers and acquisitions involving Japanese listed corporations.

He graduated in 1989 with an LLB from Chuo University, Department of Law and in 1997 with an LLM from Columbia University School of Law. He was admitted to practise law in Japan (1993) and in New York (1998). He worked at Schulte Roth & Zabel in New York City as a foreign associate from 1998 to 1999.

Masaki Konishi

Nagashima Ohno & Tsunematsu

Masaki Konishi is an associate at Nagashima Ohno & Tsunematsu. His practice focuses on securities offering, including international debt and equity offering.

He graduated in 1995 with an LLB from The University of Tokyo, Department of Law and in 2001 with an LLM from Columbia University School of Law. He was admitted to practise law in Japan (1997). He worked at Simpson Thacher & Bartlett in New York from 2001 to 2002, and at Linklaters in London from 2002 to 2003 as a foreign associate.

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 site: http://www.noandt.com/