Conflicts of Interest

1. General introduction

The financial services sector is divided into a number of segments, including banks, trust companies, securities companies, investment trust managers and investment advisors. Each of these segments is regulated under sui generis legislation and a different set of rules concerning conflicts of interest (see Table 1 below). The Financial Services Agency (FSA) supervises these segments.

2. Background/environment

Historical background

Japan has traditionally avoided conflicts of interest by dividing the financial services sector into segments and restricting service providers in one segment from providing services falling within the other segments (see Concurrent undertaking of other business in Table 1 below). The Glass-Steagall type separation of commercial banking and investment banking was introduced when the Securities Exchange Law (SEL) was enacted in 1948 (modelled after US securities regulations). However, it became obvious that the segmented financial services providers were not able to keep up with developments in the capital markets and the globalisation of financial markets. Since the early 1990s, the regulator has steadily liberalised the scope of services to be provided by each segment, as illustrated below. Each time a restriction on the scope of business has been liberalised, the government has introduced balancing measures, such as firewall regulations, to prevent conflicts.

From 1993, companies in the banking segment, the trust segment and the securities segment were permitted to enter the other segments through their subsidiaries. In order to prevent conflicts of interest, to avoid abuse of market power by the banks and to ensure fair competition among market players, firewall regulations were introduced.

From 1998, as part of the financial “Big Bang”, financial institutions were allowed to create bank holding companies and to enter, through their subsidiaries, a broad range of financial segments. In order to prevent conflicts of interest and to ensure the sound financial condition of banks, the firewall regulations were also amended.

In 2003, the SEL was amended to permit anyone other than a registered securities company to perform intermediate securities transactions, so as to broaden distribution channels. “Securities intermediary business” is defined as “a business of intermediating securities transactions for registered securities companies” (Art 2, para 11 of the SEL). Banks were permitted to engage in securities intermediary business in relation to government bonds. The scope of securities for which banks may perform intermediary services was expanded on 1 December 2004 to include any type of securities, including equities. This was the first time financial regulations had departed from the Glass-Steagall principles of segmentation. The firewall regulations were also amended, as discussed below.

Supervisory bodies

(i)

FSA Each piece of legislation regulating financial services providers authorises the Prime Minister to promulgate regulations and to supervise the relevant institutions. The supervisory functions include on-site investigations and disciplinary actions against the relevant institutions. The FSA is a department of the Cabinet Office, and the Prime Minister has delegated to the Commissioner of the FSA the rulemaking and supervisory authority under the regulatory legislation.

(ii)

Securities Exchange Surveillance Committee (SESC) The SESC is a department of the FSA. However, the three commissioners constituting the SESC are appointed by the Prime Minister and are required to perform their duties independently. The SESC conducts inspections of securities companies, daily surveillance of securities markets and investigations into securities fraud in order to protect investors and maintain the integrity of the securities markets.

(iii)     Japan Securities Dealers Association (JSDA) The JSDA is a self-regulatory body whose     membership consists of securities companies and financial institutions which are registered to conduct securities business. The JSDA has the authority to make rules binding on its members. The JSDA conducts periodical on-site inspections to ensure compliance with laws, regulations and self-regulatory rules. The JSDA may take disciplinary action if it discovers breaches of the compliance regime.

3. Applicable law, regulation, codes, case law etc

Duty of care

The relationship between a customer and its broker, an investment trust beneficiary and its investment trust manager and an investor and its investment adviser is a “mandate contract” which imposes a duty of care upon the service provider (Art 644 of the Civil Code). The relationship between a beneficiary and its trustee is considered to be a trust which imposes a duty of care upon the trustee (Art 20 of the Trust Law). These duties of care are considered to include a duty of loyalty under the Civil Code and the Trust Law. The legislation regulating trust companies, investment trust managers and investment advisers explicitly affirms their duty of loyalty to their respective beneficiaries and investors (see Duty of care in Table 1 below).

A trustee may not acquire ownership or any other interest in trust property unless there is a compelling reason to do so and the acquisition has been approved by the court (Art 22, para 1 of the Trust Law). This regulation reflects the duty of loyalty owed by trustees. If a trustee is a licensed trust company, the foregoing restriction is expanded to apply to any transaction between the trust company or its affiliate and the trust account. However, the restriction will be lifted without the need for court approval if the trust agreement authorises the transaction (Art 29, para 2 of the Trust Business Law).

Firewalls between commercial banking and investment banking

(i)

Restrictions on banks The firewall regulations applicable to banks are designed (1) to separate its securities business from banking business and (2) to separate the bank from its affiliates. In particular:

(a)

Banks may not conduct (1) any transaction with their affiliates in a manner that is detrimental to the interest of banks compared with the ordinary terms and conditions or (2) any transaction with its affiliate or customers of an affiliate which may impair the sound and proper management of the bank (Art 13–2 of the Banking Law).

(b)

Banks may not solicit securities transactions by providing information of issuers of securities which has not been disclosed to the market (“undisclosed information”; Art 42 of the SEL; Regulations Concerning Securities Business of Financial Institutions (RCSBFI), Art 21, Item 4–3).

(c)

Banks may not engage in securities transactions on which a loan of
money is conditional (Art 44, Item 3 of the SEL).

(d)

Banks may not engage in securities intermediary transactions on behalf of a company which has acted as an underwriter of such securities within the past six months without notifying the customer (1) that proceeds of the issue of securities may be used to repay the bank or another affiliate of the underwriter (RCSBFI, Art 21, Item 10, Art 27–2, Item 2) or (2) that it is the main bank of the issuer (RCSBFI, Art 27–2, Item 3).

(e)

Officers and employees of a bank who are involved in securities intermediary business may not exchange undisclosed information of issuers of securities with officers and employees of the lending division (RCSBFI, Art 27–2, Item 4).

(f)

Banks may not engage in securities intermediary transactions with any company which has acted as an underwriter of securities within the past six months by financing the purchase of the securities (RCSBFI, Art 27–4, Item 3).

(ii)

Restrictions on affiliated securities companies A securities company affiliated with a bank is subject to the following restrictions:

(a)                        A securities company may not conduct securities transactions with any affiliated bank                             on any terms other than its normal terms and conditions where such transaction might                             be unfair (Art 45, Item 1 of SEL).

(b)

A securities company may not conduct any securities transaction with a customer on which either (1) a loan of money by its affiliated bank or (2) a sale of assets or other transaction on favourable terms to its affiliated bank is conditional (Art 45, Item 2 of the SEL; Regulations Concerning Conduct of Securities Company (RCCSC), Art 12, para 3).

(c)

A securities company that has acted as an underwriter of securities of an issuer which owes a borrowing to its affiliated bank may not sell any of those securities without notifying the issuer that the issue proceeds may be used to repay the borrowing (RCCSC, Art 12, para1).

(d)

A securities company that has acted as an underwriter of securities within the past six months may not sell any of those securities (1) to a customer which is financed by its affiliated bank or (2) to its affiliate bank (RCCSC, Art 12, paras 4 and 6).

(e)

A securities company may not share with its affiliated bank (1) computer system or (2) undisclosed information of issuers of securities (RCCSC, Art 12, paras 7 and 8).

(g)

A director, officer or statutory auditor of a securities company may not be a director, officer, statutory auditor or employee of its affiliated bank (Art 32 of the SEL).

Conflicts within commercial banking

A Japanese corporation raising funds by the issuance of bonds is required to appoint a bond administration company which shall receive repayments, preserve rights and claims and administrate the bonds on behalf of the bondholders (Art 297 of the Commercial Code). The role of a bond administration company is equivalent to that of a bond trustee or indenture trustee in other jurisdictions. A bond administration company shall act fairly and faithfully for the benefit of the bondholders and owes a duty of care of good management to the bondholders (Art 297–3 of the Commercial Code).

A bond administration company shall be a licensed bank, trust company or otherwise licensed under the applicable regulations. A bank is not disqualified simply because it loans money to the bond issuer. In practice, a main bank, from which the issuer borrows a substantial amount, usually acts as a bond administration company. There is a classic conflict between its interests as lender and its role as fiduciary to bondholders. The Commercial Code includes a few provisions to prevent conflicts of interest. If a bond administration company receives collateral or repayments of its loan from the bond issuer within three months before the bond issuer fails to pay under the bonds or becomes insolvent, the bond administration company shall compensate the bondholders (Art 311–2, para 2 of the Commercial Code). The provisions in the Commercial Code relating to corporations were substantially amended in June 2005 to form a new Code entitled the Corporate Law, to become effective in 2006. According to the Corporate Law, the scope of this conflict clause will be expanded to include not only receiving collateral or repayments, but also

(1)

the sale of a loan to an affiliate which receives collateral or repayments, (2) incurring debts to the bond issuer and setting off the debts against its loan and

(3)

acquiring claims against the bond issuer and setting off the claims against its debts to the bond issuer (Art 710, para 2 of the Corporate Law).

Conflicts within investment banking

The JSDA published its board resolutions dated 19 October 2004 containing requirements for securities analysts’ report, which follows the rules in the US to reinforce the independence of securities analysis. The resolutions require each member to:

(a)

adopt an organisational structure and compensation scheme so that analysts may provide independent opinions;

(b)

ensure that the independence of analysts’ opinions should not be
jeopardised by interference with their reports by underwriting,
investment banking, corporate clients or sales departments; and

(c)

oversee analysts so as not to represent anything contrary to their
independent opinions, with particular regard to the interests of any
customer.

The resolutions further require each member to ensure the independence of analysts from underwriting or investment banking departments and to prevent: (a)analysts from being involved in presentations to corporate clients in relation to the business of underwriting or investment banking; or (b)analysts from being involved in presentations to investors by the member or its client in relation to its underwriting or investment banking business.

4. Requirements

Requirements to avoid conflicts of interest differ, as Table 1 below illustrates, depending on the type of financial service sector. Between banks and securities companies, a firewall should be established. Securities companies are permitted to deal on their own accounts with their brokerage customers, if the deal satisfies the requirements of the best execution rule. Trust companies should disclose to, and obtain authorisation from, beneficiaries with whose interests there is a potential conflict.

5. Outlook

Comprehensive investment services legislation

Table 1 below illustrates that different statutes govern different segments of the financial markets. The government has initiated a feasibility study of comprehensive legislation entitled the Investment Services Law, which would regulate a broader range of investment products and investment services. The legislation is designed to introduce fiduciary duties which should apply equally to providers of asset management services whether in the form of investment trusts, investment corporations or any other form of investments.

Regulations on financial conglomerates

Bank holding companies have been permitted since 1998. It is expected that financial institutions will operate as conglomerates which consist of entities engaged in different types of financial services. The existing legislation regulates an entity in a business sector and does not regulate a group as a whole. However, there are reasons why a conglomerate should be regulated as a group. Such reasons include risk management and conflict of interests. The FSA issued in June 2005 guidelines for the supervision of financial conglomerates, which requires management of conflicts of interest within the group. The FSA will examine conflicts within the group closely pursuant to these guidelines.

6. Useful references

English language materials relating to financial regulations, including policy statements and press releases, are available at the website of the FSA: http://www.fsa.go.jp/indexe.html.

English language materials relating to the enforcement of securities regulations, including press releases, are available at the website of the SESC: http://www.fsa.go.jp/sesc/english/index.htm

English language materials relating to the rules of the JSDA are available at its website: http://www.jsda.or.jp/html/eigo/index.htm

Table 1: Analysis of each financial service sector

1. General introduction

Large stock corporations, ie those with a capital of 500 million yen or more or total liabilities of 20 billion yen or more, must have their financial statements audited by external accountants (Art 2 of the Law Concerning Special Exceptions to Commercial Code Concerning Audit of Stock Corporations (Audit Special Law)). External accountants must be either certified public accountants (CPAs) or audit corporations (Art 4, para 1 of the Audit Special Law). An audit of financial statements of a large stock corporation pursuant to the Audit Special Law is referred to as a Corporate Law audit.

A public company, ie a listed company or other issuer of publicly traded securities, is required to file a securities registration statement with respect to securities offerings and annual or semi-annual securities reports. These issuers must have their financial statements audited and certified by CPAs or audit corporations (Art 193–2 of the SEL). An audit of financial statements of a public company pursuant to the SEL is referred to as an SEL Audit.

CPAs must be registered at the Japanese Institute of Certified Public Accountants (JICPA). An audit corporation is a corporation established jointly by CPAs (Art 1–3, para 3 of the Certified Public Accountants Law (CPA Law)). CPAs and audit corporations are required to be independent from audit clients under the Audit Special Law, the SEL and the CPA Law. The FSA is responsible for the supervision of CPAs and audit corporations.

2. Background/environment

Historical background

CPAs were recognised as audit and accounting professionals in 1948. The SEL was amended in 1950 to require SEL audits by CPAs. The establishment of audit corporations has been authorised since 1966. In 1966, the Audit Special Law was enacted to require Corporate Law audits.

After the bubble burst for the economy in the 1990s, a number of financial institutions and corporations went insolvent, even though their audited financial statements did not indicate any financial problems. The reliability of audited financial statements was therefore questioned. The US capital market reforms after the Enron and Worldcom collapses further supported the argument for tightening regulations on accountants. The CPA Law was amended in 2003 to implement the requirement for independence of accountants from audit clients and the effective surveillance of accountants by Certified Public Accountants and the Auditing Oversight Board (CPAAOB). The amendments regarding the independence of accountants include restrictions on non-audit services to audit clients, audit partner rotation and cooling-off periods, as discussed below.

Supervisory bodies

(i)

FSA The FSA has responsibilities to supervise the accounting profession. CPAs and audit corporations are subject to on-site investigations and disciplinary actions of the FSA.

(ii)

CPAAOB The CPAAOB monitors quality review by the JICPA. It may investigate CPAs and audit corporations and, if necessary, may make recommendations to the FSA to take disciplinary action against CPAs and audit corporations.

(iii) JICPA All qualified CPAs should be registered with the JICPA, which may review the quality of audit of its members and report the results to the FSA.

3. Applicable law, regulation, codes, case law etc

Independence requirements of CPAs and audit corporations

CPAs and audit corporations are required under the CPA Law, the Audit Special Law and the SEL to be independent from their audit clients.

(i) CPA Law A CPA may not audit financial statements of any client if the CPA or their spouse:

A CPA or his or her spouse has “substantial interests” in the client if that person (1) was an officer of the client during the audit period; (2) is or was a government official that had a close relationship with the client during the past two years; (3) owns stock of the client and/or debt or credit; (4) has a special economic interest such as office rent or borrowing with free or unreasonably low rent or interest; (5) provides to the client tax services or other non-audit services and receives remuneration continuously; (6) receives special economic interests or remuneration from any officer of the client; (7) is, or was, a director of an affiliate of the client during the past year; or (8) is an employee of the parent or subsidiary of the client (Art 24 of the CPA Law; Art 7 of the CLA Law Enforcement Order).

An audit corporation may not audit financial statements of any client if:

(a)

it owns stock of, or otherwise invests in, the client;

(b)

a member of the audit corporation is prevented from auditing the client pursuant to the restrictions set out above;

(c)

a member who was involved in the audit of the client for the past or current accounting periods becomes an officer of the client; or

(d)

has substantial interests in the client. An audit corporation has “substantial interests” in the audit client if (1) it is either a debtor or creditor of the client; (2) it has special economic interests such as office rent or borrowing with free or unreasonably low rent or interest;

(3)

it has been provided special economic interests within the past year or during the audit period; (4) any of the members is an employee of the client;

(5)

any of the members is an officer or employee of the parent or subsidiary of the client; (6) any of the members receives remuneration continuously for tax advice; (7) any member involved in the audit of the client or their spouse is prevented from auditing the client; or (8) the majority of the members are prevented from auditing the client (Art 34–11 of the CPA Law; Art 8 of the CPA Law Enforcement Order).

(ii)

Audit Special Law The following persons are not eligible to conduct a Corporate Law audit: (a) a CPA or audit corporation which is prevented from auditing the large stock corporation pursuant to the CPA Law; (b) a CPA or their spouse continuously receiving fees for services other than services of the CPA from any subsidiary of the large stock corporation, its director, officer or statutory auditor; or (c) an audit corporation or the majority of its members continuously receiving fees for services other than services of the audit corporation or CPA from any subsidiary of the large stock corporation, its director, officer or statutory auditor (Art 4, para 2 of the Audit Special Law).

(iii) SEL The independence requirements for an SEL Audit are more stringent than the requirements under the CPA Law. If the spouse or any relatives within two degrees of a CPA or of a member of an audit corporation involved in the audit of the public corporation is prevented under the CPA Law from the audit, the CPA or the audit corporation may not audit that public corporation. If any assistant of a CPA or audit corporation involved in the audit of the public corporation is prevented under the CPA Law from the audit, the CPA or the audit corporation may not audit that public corporation. If a CPA, their spouse or assistant is prevented from auditing any of the consolidated subsidiaries of the public corporation or other companies accounted for by equity methods, the CPA may not audit the consolidated financial statements of the public corporation. If an audit corporation, the member involved in the audit or their spouse or assistant or the majority of the members or their spouses is prevented from auditing any of the consolidate subsidiaries or other companies accounted for by equity methods, the audit corporation may not audit the consolidated financial statements of the public corporation. If any member of an audit corporation is a director, officer, statutory auditor or employee of any of the consolidated subsidiaries of the public corporation or other companies accounted for by equity methods or any member of an audit corporation continuously receiving fees for tax advice, the audit corporation may not audit the consolidated financial statements of that public corporation (Art 193–2, para 2 of the SEL; Art 2 of the Regulations Concerning Audit Certificates of Financial Statements).

Regulations on non-audit services

An audit corporation may not provide any services other than audits and ancillary services such as compilation of financial statements, research, advice and consultation on financial matters (Art 34–5 of the CPA Law). These restrictions are designed to prevent audit corporations from providing consulting services to their audit clients.

The 2003 amendments to the CPA Law tightened the regulations on audit of certain categories of entities including (1) large stock corporations; (2) public corporations; (3) banks; and (4) insurance companies (large corporations). If a CPA, their spouse, an audit corporation or any of its subsidiaries or affiliates continuously receives fees for the following services from a large corporation, the CPA or the audit corporation may not audit the financial statements of the large corporation: (1) bookkeeping or preparation of financial documents and accounting books; (2) designing and maintaining financial or accounting information systems; (3) appraisal of assets which are contributed in kind; (4) actuary services; (5) internal audit outsourcing services; (6) securities brokerage services; (7) investment advisory services; and (8) other services which may result in involving financial documents to be audited by that auditor or involving management decisions of the client (Arts 24–2, 34–11-2 of the CPA Law).

Audit partner rotation

If a CPA or a member of an audit corporation is involved in audit related services of a large corporation for seven consecutive accounting periods, the CPA or the member may not provide the large corporation with audit related services for the next two accounting periods. Audit related services include: (1) auditing financial statements; (2) assisting an audit by another CPA where the assistant is materially involved in the audit to the same extent as the CPA; (3) reviewing and providing an opinion on the audit at the request of another CPA; and (4) assisting an audit by a member of an audit corporation where the assistant is materially involved in the audit to the same extent as the member (Arts 24–3, 34–11-3 of the CPA Law).

Cooling-off period

A CPA or a member of an audit corporation who is involved in the audit of a client may not be a director or accept any other management position with the client until at least one year elapses after the end of the audited accounting period (Arts 28–2, 34–14-2 of the CPA Law).

4. Requirements

The following disclosure requirements are designed to ensure the independence of external accountants from the client. A CPA or audit corporation shall disclose in the audit report the following information:

(a)

whether it has any interest in or with the client;

(b)

the details of any such interest in or with the client; and if the client is a large corporation, whether the CPA or audit corporation continuously receives remunerations for non-audit services from the client (Art 25, para 2 of the CPA Law and Art 8 of the Regulations Concerning Interests Relating to CPA).

Further, large stock corporations which prepare for consolidated financial statements shall disclose in their annual business reports to shareholders the amounts of:

(a)

fees or other economic benefit which it or its subsidiaries paid or granted to the external accountants which conducts the Corporate Law audit;

(b)

fees paid or payable as remuneration for audit (including any
Corporate Law audit and any SEL audit); and

(c)

fees paid or payable as remuneration for the Corporate Law audit (Art 105, para 1 of the Commercial Code Enforcement Regulations).

5. Outlook

Disciplinary action

On 31 March 2005, the FSA published guidelines in respect of disciplinary action against CPAs and audit corporations with regard to false statements in audit reports or breach of regulations. The FSA is expected to enforce the tightened regulations to ensure the independence of auditors.

Derivative actions

CPAs and audit corporations are liable to the client if they breach the duty of care of good management. There have been few cases where accountants have been sued by their clients for their audit services, partly because the Commercial Code does not permit shareholders to sue external accountants on behalf of the company. Auditors will become more vulnerable to lawsuits under the new Corporate Law, which will allow such derivative actions (Arts 423 and 847 of the Corporate Law).

6. Useful references

English language versions of 2003 amendments to the CPA Law are available on the website of the JICPA: http://www.jicpa.or.jp/n_eng/index.html.

1. General introduction

Only attorneys or Bengoshi who are licensed and registered at the Japan Federation of Bar Associations (JFBA) may practice law in Japan (Art 72 of the Practicing Attorney Law (PAL)). Attorneys’ conduct is regulated by a local bar association and the JFBA. The primary sources of rules regulating conflicts of interest are the PAL and JFBA Basic Rules of the Duties of Practicing Attorneys (the Basic Rules).

2. Background/environment

The government has implemented major reforms to the judicial system since 2002. The reforms were, inter alia, devised to increase the number of legal professionals and make their services more available to the public as well as to enhance the quality of service and ethical standards. Large law firms have emerged recently to meet the demand for sophisticated legal services. Attorneys working as in-house counsel are also increasing in number.

The JFBA is the self-regulatory body of the legal profession and is independent from any department of the government. It is responsible for the supervision of local bar associations and attorneys. To meet public expectations, the JFBA has codified ethical standards applicable to attorneys and adopted the Basic Rules, which took effect on 1 April 2005. Attorneys are subject to disciplinary action of the local bar association and the JFBA.

3. Applicable law, regulation, codes, case law etc

Duty of care

An attorney-client relationship is a “mandate contract” which imposes a duty of care upon the attorney (Art 644 of the Civil Code). The PAL states that attorneys shall perform their duties faithfully (Art 1). The obligation to avoid conflicts of interest is implied in this duty.

Matters that attorneys may not undertake

The PAL and the Basic Rules contain a list of matters which attorneys may not undertake due to conflicts of interest (Art 25 of the PAL and Art 27 of the Basic Rules). Such matters include:

(a)

a matter in which the attorney assisted the opposite party in the consultation, or requested or accepted a mandate from the opposite party;

(b)

a matter in which the attorney was consulted by the opposite party and the extent and form of the consultation is considered sufficient to establish a fiduciary relationship;

(c)

a matter in which consultation is for a party who is the opposite party in another matter in which the attorney is engaged;

(d)

a matter which the attorney handled in the past as a public servant; or

(e)

a matter in which the attorney is involved as a person who conducts arbitration, mediation, settlement or arrangement or other forms of alternative dispute resolution proceedings.

In addition, an attorney may not undertake, without waiver by client(s), the following matters (Art 28 of the Basic Rules):

(a)

matters in which the interests of a client conflict with the interests of another client; or matters where the interests of a client conflict with the economic interests of the attorney. There is little guidance as to what constitutes an interest. The JFBA has explained that it should mean an interest which deserves legal protection and that mere emotional feeling or human relationship should not constitute an interest (Liberty and Justice Vol 56, No 6, p 51).

Corruption

A practising attorney may not receive, demand or promise to receive any benefits from the opposite party in connection with the cases in his or her charge (Art 26 of the PAL).

Rules applicable to law firms

The PAL regulates conflicts of interest of attorneys as individuals without regard to the firms to which they belong. The Basic Rules expand the scope of conflicts to firms, which is defined to mean offices where two or more attorneys run their practices jointly. An attorney shall not undertake any matter in which another attorney or former attorney of the firm may not undertake the matter due to conflicts, except where the attorney seeking to undertake the matter can maintain impartiality (Art 57 of the Basic Rules).

Note that these regulations apply to an attorney who has left the relevant firm. According to the JFBA, however, the regulations should not apply if the conflicts arise after the attorney has left the firm (Liberty and Justice Vol 56, No 6, p 98).

Rules applicable to in-house counsel

If an in-house attorney becomes aware of an attempt by anyone within the organisation to perform an action in violation of any law, the in-house attorney shall provide full disclosure or a recommendation to the head of the department of the offending person or of the in-house attorney, the head of the organisation, the board of directors, governing body or other superior organisation, or take other appropriate steps within the organisation (Art 51 of the Basic Rules). This rule reflects provisions of the American Bar Association Model Rules of Professional Conduct which were adopted after the Enron scandal.

The Basic Rules do not contain similar provision for external counsel. However, an external counsel is also obliged to make every effort to prevent illegal action if it becomes aware of an attempt to commit such action during the course of a professional engagement (Tokyo District Court decision, 15 October 1987).

4. Requirements

Attorneys are required to take the following means to avoid conflicts of interest.

Waiver

Clients may waive rights in the event of potential conflicts under the PAL and the Basic Rules.

Resignation

If an attorney has more than two clients who are parties to the same matter and there are potential conflicts between the clients, the attorney shall notify each of them in advance that the attorney may withdraw from representation and there may be adverse effects on their interests (Art 32 of the Basic Rules). If the conflict materialises after the attorney begins representation, the attorney shall promptly notify each of the clients about the situation and resign or take other appropriate steps (Art 42 of the Basic Rules).

Chinese walls

According to the Basic Rules, conflicts should be considered in the context of each firm and not merely of each individual attorney. Nevertheless, an attorney is permitted to undertake a matter which conflicts with the interests of a colleague’s client if there are reasons to show that the attorney can maintain impartiality (Art 57 of the Basic Rules). The JFBA comments that if the firm establishes Chinese walls segregating information flow and discloses such a system externally, the system may be considered sufficient to maintain impartiality (Liberty and Justice Vol 56, No 6, p 97).

Conflict check systems

Attorneys practising at a law firm shall work with fellow attorneys to maintain lists of clients, opposite parties and case names so as not to accept matters which the attorney may not undertake (Art 59 of the Basic Rules).

5. Outlook

Role of attorneys in the context of corporate governance

Public corporations shall choose one of the following corporate governance schemes: (1) a statutory auditor scheme, where statutory directors audit management by directors; or (2) a committee structure, where the board of directors shall appoint a nomination committee, an audit committee and a remuneration committee. Corporate law disqualifies a director, manager, employee or officer of the corporation or any of its subsidiaries from acting as a statutory auditor. A statutory auditor may represent the corporation as external counsel before court proceedings (Supreme Court decision, 18 February 1986). Further, there is case law that an external counsel is not disqualified as a statutory auditor (Osaka High Court decision, 24 October 1986). It is questioned, however, whether the statutory auditor may effectively audit a business to which he or she has provided legal advice.

If the statutory auditor scheme is chosen, the majority of statutory auditors should be outside statutory auditors. If the committee scheme is chosen, the majority of directors constituting each committee should be outside directors. “Outside statutory auditors” and “outside directors” are persons who are not and have not been a director, manager, employee or officer of the corporation or any of its subsidiaries (Art 18, para 1 of the Audit Special Law and Art 188, para 2, Item 7–2 of the Commercial Code). External counsel would not be considered as “outside” by this definition. However, the Welfare Pension Funds Association, a major institutional investor, requires independence of outside directors and an attorney should not meet its voting standard if it receives legal fees from the corporation (Voting Criteria dated 8 March 2004). The role of attorneys in the context of corporate governance will be an issue to be discussed.

Rules applicable to foreign law firms

Foreign lawyers are authorised to practice in Japan the laws of their own jurisdictions if they are registered at the JFBA as foreign legal consultants or Gaikokuho Jimu Bengoshi. The Basic Rules are applied to registered foreign legal consultants in the same manner as to Japanese attorneys (Art 30–2 of the JFBA Basic Rules Concerning Foreign Special Members). A joint venture between foreign legal consultants and Japanese attorneys has been permitted since 1 April 2005. If foreign legal consultants form a joint venture with Japanese attorneys, neither the foreign legal consultants nor the Japanese attorneys may undertake matters which the other may not undertake due to conflicts (Art 6 of the JFBA Rules on Foreign Law Joint Enterprise). This regulation requires law firms to clear conflicts as a joint venture and not as individuals, but does not require them to clear conflicts as global law firms.

Major US and UK firms operate joint ventures in Japan under a global brand name. Clients may seek fiduciary relationships with the global law firm, and not with the joint venture, and such expectation may need to be protected. It will be an issue to be discussed whether the regulations should require conflict checks on a global basis for such firms and, if so, an issue will be as to the proper law governing lawyers’ code of conduct.

6. Useful references

An English translation of the PAL, the Basic Rules and the other rules of the JFBA is available on its website: http://www.nichibenren.or.jp/en/index.html.