Japanese listed companies face higher compliance costs and more liability in the wake of a coordinated regulatory effort to stamp out lax disclosure and restore investor trust.
Recent and high profile reporting scandals have jolted the Tokyo Stock Exchange (TSE) and the Financial Services Agency (FSA) into announcing stiffer requirements for corporate officers. Their common aim is to enhance the disclosure standards of listed companies. This has further added to the extra disclosure burden on issuers generated by the unprecedented threat since December 1 of being sued by investors for damages caused by material misrepresentations or omissions in the secondary market.
Until now, investors have had to rely on general tort principles to sue issuers and are hence accustomed to bearing the burden of proof. The new law, however, does not require negligence on the issuer's part and has provisions to calculate the amount of the investor's damages.
The effect of several, coordinated initiatives will be to put a lot of pressure on issuers, says Fumitaka Eshima, managing director and head of legal at UBS in Japan, requiring them to ensure their internal reporting standards and controls are sufficient. "Issuers' disclosure is very likely to be a clear focus for the Japanese regulators in 2005," he says.
Japanese lawyers agree that the regulators need more power if they are to instill confidence in international investors, who believe existing disclosure is less reliable than it should be.
"Japan must make sure it is up to global standards to attract foreign capital, create confidence and increase analyst coverage and research in the country," says one US securities lawyer at an American law firm in Tokyo.
Two-pronged approach
Two unexpected announcements by the securities watchdogs in mid-November are intended to make this happen. First, the TSE said it would require from January that chief executives of listed companies certify the accuracy of disclosure documents. Plus, all senior officers will have to take an oath to ensure the accuracy and timeliness of financial statements.
Such action is intended prevent another case like Seibu Railway Co, which was recently found to have wrongly reported (and in some cases concealed) information about the stakes held by its top shareholders for about 40 years to disguise breaches of ownership rules. In response, the Exchange will delist the company on December 17, the first time the TSE has used these powers for an offence of false disclosure in financial statements for more than 20 years.
Secondly, the FSA is planning to bring in new measures. Already in the pipeline are civil fines enforceable from April 1 2005 against breaches of fair transactions such as market manipulation and insider trading, and expanded inspection powers for the regulator's enforcement arm, the Securities and Exchange Surveillance Commission, for disclosure breaches from July 1.
A Japanese section 404
Perhaps the regulator's most controversial move is its decision to consider implementing tough, US-influenced governance rules modeled on section 404 of the Sarbanes-Oxley Act. These would force issuers to document internal management and oversight controls and impose fines for disclosure breaches.
Japan may go further, however, with plans to require auditors to verify management assessments and also check corporate structures, according to a senior FSA official. This would prevent another Seibu Railway by requiring a privately owned parent of a listed subsidiary to release certain financial information. A review of the proposals is underway to determine the extent of the changes that will ultimately be implemented.
"I am sure issuers will cooperate with all new requirements," says the FSA official, who declined to be named. "There is so much negative press in Japan against the recent problem cases; no-one wants to lose investor confidence."
In the meantime, the FSA has given the country's 4,500-plus publicly traded companies one month to voluntarily review their financial statements and correct any errors. After December 16, each company must be expected to be in a position to certify the accuracy of the documents and pledge to continue to release information in a truthful and proper way. The agency has even set up a disclosure hotline, enabling employees and others to blow the whistle on companies with inaccurate statements via telephone, fax, e-mail and postal mail.
Issuers await clarification
But regulators must give issuers guidance on what internal checks and balances they will need to manage the vast amount of information they are now expected to monitor, says one law firm partner. US public companies have had to set up in-house disclosure committees, for example, so they are able to comply with new governance rules requiring certifications.
Fitting sanctions also need to be in place. Under what the TSE had announced by press time, the only penalty for a company providing inaccurate disclosure despite its chief executive's certification was delisting.
Japan's issuers will probably look to their financial advisers for guidance. While none of the new requirements imposes any responsibility directly on the banks for ensuring the quality of issuer disclosure in the secondary market, they all are all involved in preparing the disclosure documents in primary offerings. Plus, IPO candidates often rely on their banks to advise them on how the disclosure documents should look going forward. "We want to provide proper guidance," says Eshima at UBS. "Even if we won't be held liable, we want our status as a trusted adviser of listed companies."