With Japan’s banks and financial institutions carrying a heavy burden of non-performing loans, the country’s capital markets have become an increasingly important source of funding. At the end of 2006, there were 1,740 companies listed on the First Section of Tokyo Stock Exchange (TSE), 491 on the Second Section, and 185 companies listed on Mothers, the market for the high-growth and emerging stocks. With its current market capitalisation of about ¥530 trillion and a daily trading value of around ¥4.3 trillion, the TSE, founded in 1949, continues to drive Japan’s capital markets. The country has five other stock exchanges, the Osaka Securities Exchange, the Nagoya Stock Exchange, the Sapporo Securities Exchange, the Fukuoka Stock Exchange and the Jasdaq Securities Exchange (formerly the over-the-counter trading system, Japan Securities Dealers Association Quotation System, which became a stock exchange on 13 December 2004).
Foreign companies are interested in TSE listings. According to TSE’s website, as of December 2006, there were 25 foreign companies listed on the TSE. Many Japanese companies have a global presence and several are listed on local markets abroad.
Key statues and regulations affecting the securities markets include:
‘SEL Securities’ are defined to include shares of stock corporations and debt securities such as corporate bonds, as well as interests in certain types of domestic and foreign partnerships, beneficial interests in a trust or corporation which invests primarily in specified assets (which are defined to be, among other things, SEL Securities, securities derivatives, ownership or leasehold of real property, monetary claims, promissory notes, financial derivatives, and beneficial interests in trust assets consisting of the foregoing). After the enactment of the Financial Instruments and Exchange Law, the definition of SEL Securities will be expanded to include all kinds of beneficial interests in a trust and interests in certain collective investment schemes.
As summarised by the chart below, powers rest primarily with the Prime Minister (naikaku souri daijin), who heads the Cabinet Office (naikaku fu) in Japan. However, some powers are delegated to the Commissioner of the Financial Services Agency (FSA), which is established as an external organ of the Cabinet Office. Other powers of the Prime Minister are delegated to the Securities and Exchange Surveillance Commission (shoken torihiki tou kanshi iinnkai) which is established as a lower commission of the FSA, and to Local Finance Bureaus (LFBs) of the Ministry of Finance (MOF).
Prime Minister
Ministry of Finance
(naikaku souri daijin)
(zaimu sho)
Financial Services Agency
(kin'yu cho)
Commissioner of FSA
(kin'yu cho chokan)
A public offering of SEL Securities as defined in article 2 of the SEL means:
• solicitation orders for subscription to newly issued SEL Securities which is made either:
(1) to 50 or more persons (except where such persons consist exclusively of qualified institutional investors); or (2) in a manner which does not qualify as any type of private placement; or
• offering to sell or soliciting orders to purchase outstanding SEL Securities from 50 or more persons on uniform terms and conditions.
The numerical limit applies to offerees, not subscribers. If SEL Securities are simultaneously offered in and outside Japan, only offerees in Japan are counted. If SEL Securities are issued during the six months preceding the scheduled issued date of a relevant private placement, then offerees in Japan of the preceding issue will count towards the threshold number.
Apart from obtaining informal prior approval from the relevant LFB through prior discussions of the outline and structure of the public offering, a public offering (either primary or secondary) of SEL Securities requires the issuer, except in certain limited cases, to file with the relevant LFB (via an electronic filing system) a securities registration statement (an ‘SRS’) and to prepare a prospectus complying with SEL regulations. Non-compliance with such requirements or misrepresentation in or omission of material facts in an SRS or prospectus may open the issuer to liability for damages incurred by investors. SEL Securities offered in a public offering may be issued or sold only after the SRS has become effective, in principle, 15 days after its filing.
Detailed information must be submitted in the SRS. Generally speaking, the disclosure requirements for foreign issuers are similar to those for Japanese issuers, but certain additional information, including a brief summary of the legal structure of the issuer’s home jurisdiction (ie, company law, foreign exchange and tax regulations), will also be required. In addition, the financial statements included in the SRS must be audited and certified by an independent certified public accountant or an audit corporation licenced to practice in Japan or a jurisdiction deemed comparable.
The information to be contained in a prospectus is virtually identical to that to be required in the main part of the relevant SRS.
Under the SEL, the issuer of SEL Securities with an aggregate issue price or offer price of less than ¥100 million is exempted from the SRS registration and prospectus requirements of public offerings, but is required to make an outline of the issue in a prescribed form (an ‘SN’) with its regional LFB. The information required for an SN is much simpler than for an SRS. Use of a prospectus is optional.
In addition to the filing of an SRS or an SN, the issuer of interests in a foreign investment trust or investment corporation must file prior notification under the ITICL with the FSA.
A non-resident issuer must file a post facto report under the FEL with the MOF through the Bank of Japan (BOJ), if the offering amount is equivalent to ¥1 billion or more. This provision does not apply to a secondary offering of outstanding securities.
A ‘private placement’ in Japan of SEL Securities means the offering in Japan of newly issued SEL Securities:
• to less than 50 offerees (‘a small number placement’); or
• only to certain qualified institutional investors as defined in the SEL (this is a ‘professional placement’);
Both of these instances are subject to conditions including restrictions on transferability, which vary depending on the type of SEL Securities.
‘Qualified institutional investors’ (tekikaku kikan toshika) include Japanese securities companies, investment trust management companies, banks, insurance companies (including licenced foreign insurance companies), discretionary investment managers, managers of special accounts for the Ministry of Public Management, Home Affairs, Post and Telecommunications and the MOF, the Government Pension Investment Fund (nen-kin shikin unyou kikin), the Japan Bank For International Cooperation (kokusai kyouryokus ginkou), the Development Bank of Japan (nihon seisaku toushi ginkou), certain other government-owned financial institutions and credit associations, large corporations, and foreign financial institutions and government agencies, etc which meet certain requirements.
In small number placements, the number of qualified institutional investors will not count towards the threshold if the placements satisfy certain requirements. If the SEL Securities were issued during the six month period preceding the scheduled issued date of the relevant private placement, then the number of offerees in Japan of the preceding issue will count towards the threshold.
There have been numerous private placements of SEL Securities, subscribed to mainly by institutional investors that are prepared to make long-term investments and do not necessarily need a secondary market.
In the case of a ‘small number placement’ of shares of a foreign stock corporation or interests in a foreign investment trust or investment corporation, an SN needs to be filed if ¥100 million or more are issued in Japan. There is no requirement to file an SRS in the case of a private placement of SEL Securities.
The issuer of interests in a foreign investment trust or a foreign investment corporation must file a prior notification under the ITICL with the FSA.
As with the case of public offerings, a non-resident issuer must file a post facto report under the FEL with the MOF through the BOJ, if the offering amount is equivalent to ¥1 billion or more.
Although a prospectus is not required, the issuer or offeror may choose to publish an explanatory memorandum. If such a document is published, the issuer or offeror will be liable for damages incurred to investors due to a misstatement or omission of a material fact.
If an investor in Japan (including a qualified institutional investor) is to acquire ten per cent or more of the total outstanding shares of a foreign stock corporation or investment corporation, the investor must file a post facto report of ‘outward direct investment’ with the MOF through BOJ.
Securities
The term ‘Securities’ will be expanded to include all kinds of beneficial interests in a trust. Interests in collective investment schemes whereby participants contribute money or equivalent non-monetary assets to a certain project, profit/loss of which will be distributed among such participants, are also included in the definition of Securities.
Financial Instruments Business
Financial Instruments Business is defined to collectively include engaging in derivative transactions, providing investment management services and investment advisory services, as well as securities business under the SEL.
Shares issued/exchanged upon organisational restructuring
When shares are issued or exchanged upon organisational restructuring of a company such as mergers and acquisitions, corporate splits or share exchanges, disclosure requirements similar to public offering are imposed where (i) the number of shareholders of a company being acquired is above a certain threshold; (ii) public disclosure has been made with the shares of the company being acquired; and (iii) no such public disclosure has been made with the shares of the acquiring company.
Deemed securities’
So-called ‘deemed securities’ (with respect to which certificates are not issued but which are deemed by operation of law to be ‘securities’) such as beneficial interests in a trust are, in principle, exempted from the public disclosure requirements. However, interests in collective investment schemes investing mainly in such ‘securities’ are not so exempted.
Exemption
Public disclosure requirements may be lifted with the approval of the FSA if the number of the holders of the securities with respect to which public disclosure is required has been less than a certain threshold number for a consecutive period of five years.
Reports on internal control
Listed companies will be required to submit a report on the effectiveness of their internal control structure annually as from the business year starting in or after April 2008. Such report must be accompanied by an audit certification by public accountants.
Quarterly disclosure
Listed companies must provide a quarterly report on their financial conditions on a consolidated basis. Non-listed companies are not so required, but entitled to choose to provide a quarterly report.
Those who are engaged in the financial instruments business must be registered with the FSA. Relevant registration requirements are illustrated in the chart below.
Financial Instruments Business Adequate staffing is required
(Type I) Minimum capital requirement of ¥50 million Capital adequacy requirement is applicable The scope of eligible business is restricted
Financial Instruments Business Adequate staffing is required (Type II) Minimum capital requirement of ¥10 million Depositing requirement of ¥10 million Investment Management Business Adequate staffing is required Minimum capital requirement of ¥50 million
Investment Advisory Business Depositing requirement of ¥5 million
* Trading of securities (other than ‘deemed securities’) fall under Financial Instruments Business (Type I), and trading of ‘deemed securities’ fall under Financial Instruments Business (Type II).
A foreign entity seeking to list on the TSE must meet requirements including:
TSE listing rules stipulate that at least 20,000 ‘trading units’ must be listed. A trading unit is fixed according to the average closing price of shares on the entity’s home stock exchange on a record date before the listing application.
Shareholders in Japan
At least 1,000 shareholders in Japan must be expected by the time of listing.
Market capitalisation
The market capitalisation must be expected to be ¥2 billion or more at the time of listing.
Shareholders’ equity
A shareholders’ equity of ¥1 billion or more as of the end of the latest business year is required.
Profit or total market capitalisation
The foreign entity must meet either profitability or capitalisation criteria.
Amount of profit test
The foreign entity must satisfy either of the following:
Profits are calculated on both a consolidated and non-consolidated basis, in accordance with TSE listing rules.
Total market capitalisation
The total market capitalisation of such foreign entity is expected to be ¥100 billion or more at the time of listing, with revenues in the latest business year exceeding ¥10 billion.
Audited financial statements
There shall be no misstatements contained in the latest two year financial statements. In principle, a ‘fair’ opinion must be issued by an accounting firm as auditor for the latest two year financial statements. A ‘non-qualified opinion’ must be issued by an accounting firm for the latest financial statement.
Corporate history
The entity should have been incorporated for at least three years.
7.1.2 Non-numeral criteria
These include good corporate management, fair profitability and appropriate corporate disclosure in accordance with TSE rules.
Generally speaking, a foreign applicant should arrange for a preliminary examination of its application at least four months prior to the targeted listing date. After the examination, the foreign entity should file its application for listing, which should be granted around a month before the targeted listed date, in time for the statutory timeline of a public offering as set out in section 4 above.
8. SANCTIONS AND DISPUTES
8.1 Rescission rights of purchasers and legal actions
The rescission of a purchase of securities is covered by the Civil Code (Law No. 89 of 1896, as amended) (Civil Code) and the Consumer Contracts Law (Law No. 61 of 2000, as amended) (CCL). The Civil Code applies when the rescission is between general purchasers and sellers; the CCL where the purchaser is a consumer. Under the Civil Code, rescission could be exercised in cases of fraud (which has a legal limitation of five years from the time the fraud became possible to detect, or 20 years from the time of the occurrence of fraud), or mistake (which has no written limitation).
8.2 Liability for misstatement in SRS
If an SRS contains a material misstatement or an omission of a material fact, the issuer of the SEL Securities will be liable, pursuant to the provisions of the SEL, for damages sustained by a purchaser of such SEL Securities through the public offering, unless the purchaser was aware of the untruth or omission at the time of purchase. Strict liability applies, so there is no need to prove the issuer’s negligence. Damages are calculated as being the difference between the purchase price of the securities and the current market price (or the estimated sales price if no market price is available). If the purchaser has already sold the securities, the price obtained will be used as the basis of the calculation. The issuer can reduce the damages by proving that there was some reason for the fall in the value of the securities other than the misstatement or omission. Liability may also attach directly to the responsible officers of the issuer, the vendor of shares in secondary offerings, and independent auditors who certified false financial statements.
In this context, ‘officers’ is defined in the SEL to include directors, corporate auditors or any other officers of the issuer. Unlike the issuer, officers, selling shareholders and independent auditors may only be liable if damage was actually caused by the material misstatement or omission. In their case, the measure of damages is not provided for statutorily. Also, officers and shareholders who are selling their shares have a defence if they did not know, and despite exercising reasonable care could not have known, of any material misstatement or omission. Independent auditors similarly have a defence if their certification of false financial statements was neither intentional nor negligent. It is our view that officers of the issuer could use the above defence if an SRS prepared in the Japanese language contained a material misstatement or an omission of a material fact due to an incorrect translation from the English international offering circular.
It is possible that the liability of officers and independent auditors for misstatements or omissions in an SRS may extend to purchases not made in a public offering (such as purchases in the secondary market). Although the SEL is silent on this issue, and there is no judicial precedent on point, an argument for such liability could be made on general tort principals.
Statutory liability under the SEL is also applicable to material misstatements or omissions in continuing disclosure reports incorporated by reference into an SRS of a seasoned issuer and certain documents for a ‘shelf’ registration and the reports for continuous disclosure referred to in such documents.
The SEL provides for similar liability with respect to a ‘securities report’ and other documents which are prepared as part of the ‘ongoing disclosure’ requirements (see section 9.1 below).
8.3 Penalties and court procedure
There are no special court procedures for liability under the SEL or for the criminal penalties described below. Regular Japanese civil or criminal procedure is applicable.
8.4 Criminal penalties
Issuers and officers of issuers knowingly responsible for material misstatement in an SRS filed for a public offering of securities in a foreign corporation may be punished by penal servitude of up to ten years and/or a fine of up to ¥10 million, under the SEL. Failure to file an SRS is punishable by penal servitude of up to five years and/or a penal fine up to ¥5 million. Failure to file an amendment to an SRS is punishable by penal servitude of up to one year and/or a fine of up to ¥1 million. Violations of the ‘shelf’ registration system attract similar penalties. When a representative, agent or other employee of a juridical person is guilty of any such offences on behalf of that person, the juridical person may be fined as well. For example, if a representative, officer or employee of the issuer knowingly prepared and filed with the LFB an SRS containing a material misstatement, he/she would be subject to penal servitude and/or a penal fine, and the issuer would be subject to a penal fine of up to ¥700 million.
8.5 Other penalties
In addition to the criminal penalties described above, a surcharge (administrative penalty) system was introduced on 1 April 2005. Those subject to the surcharge include:
9. ONGOING COMPLIANCE REQUIREMENTS
9.1 Ongoing disclosure
The foreign issuer of SEL Securities is required to make continuous disclosure by filing a ‘securities report’ for every annual fiscal period and a ‘semi-annual report’ for the first six months, within six months and three months respectively from the end of the period (in addition, a quarterly report is required under the Financial Instruments and Exchange Law: see section 6.2 above). Filing may only be discontinued if the number of holders of the SEL Securities in Japan falls to 25 or fewer and with MOF approval. (This requirement is expected to be relaxed under the Financial Instruments and Exchange Law). Like the SRS, the securities report must contain audited financial statements certified by an independent certified public accountant or an auditing corporation licensed in Japan or a comparable jurisdiction. (In addition, audited reports on internal control procedures are required under the Financial Instruments and Exchange Law: see section 6.2 above)
Interim financial statements of a foreign filer as a component of the semi-annual report need not be audited, although a domestic issuer must file audited interim financial statements. A ‘review’ by an accountant is not regarded as an audit, and therefore an accountant’s review report does not need to be attached to a semi-annual report, regardless of the rules in the foreign filer’s jurisdiction. However, a review report is expected to be attached to quarterly financial statements prepared under the Financial Instruments and Exchange Law.
After certain material events, the foreign issuer should file an extraordinary report.
9.2 Public inspection of filed documents
Japanese versions of SRS, securities reports, semi-annual reports and extraordinary reports are made generally available for inspection on the FSA’s website. SNs, however, are not open for public review.
10. CORPORATE GOVERNANCE
10.1 Board structure
The new Corporation Act has come into effect as of 1 May 2006, which modified a number of corporate systems formerly existing under the Commercial Code.
Flexibility in internal governance system
The Corporation Act allows for a wide variety of selection and combination of internal governance systems for a Japanese stock corporation (kabushiki kaisha), particularly in the case of small and medium sized companies, while the choice of the internal governance scheme for large sized and public companies remains substantially the same as those permitted under the Commercial Code.
Establishment of internal control system
Under the former regime, only companies who opted for a committee system are expressly required to establish certain internal control systems. On the other hand, establishment of such internal control systems by non-committee system companies is left to the judgements of directors who need to exercise a duty of care.
The Corporation Act requires large size companies with non-committee systems, as well as committee system companies, to establish internal control systems with respect to particular matters as described in certain government ordinances.
(Definition of a ‘large size’ company is a company having either (i) ¥500 million or more paid-in capital, or (ii) ¥20 billion or more debt on its balance sheet as of the end of the immediately preceding fiscal year.)
10.2 Role and duties of the board of directors
Public companies need to establish a board of directors. The board of directors, which consists of individuals appointed at the shareholder’s meeting, determines the corporation’s business and supervises the actual business operations. The board of directors appoints one or more representative directors from among its directors. The relationship between the corporation and its directors is governed by the law relating to mandates, and directors have a duty to conduct the business of the corporation ‘faithfully’ with the standard of care of a good manager. The standard of care is higher than that expected in one’s own business. Directors also have a duty to abide by the law, the articles of incorporation of the corporation and the resolutions of the general meetings of the shareholders.
10.3 Liabilities of board of directors
Directors, corporate auditors and officers (shikko-yaku) who violate the Corporation Act may face severe penalties such as criminal fines of up to ¥10 million and/or penal servitude for periods of up to ten years in cases of serious and deliberate breaches of trust against the corporation and causing damage to the corporation. Several less serious offences attract lighter penalties.
Third parties dealing in good faith with a corporation in transactions in the ordinary course of business will be protected even when such transactions were not duly authorised by the board of directors and, in principle, the corporation will be bound by actions taken on behalf of the corporation by a representative director.
11. INSIDER TRADING
11.1 Laws and regulations
The SEL prohibits an affiliate of a listed company who obtains significant inside information as a result of the affiliate’s relationship to the listed company from purchasing or selling any listed security of the company until the information has been publicly disclosed. The SEL also prohibits the purchase or sale of such listed securities by recipients of significant inside information who obtain such information from affiliates.
Affiliate includes:
| (i) | directors, corporate auditors, agents and employees of a listed company; |
| (ii) | shareholders or members of a listed company who hold three per cent or more of the |
| company’s shares and are entitled to inspect its financial records; | |
| (iii) | persons entitled by law to obtain certain information concerning the company, |
| including government officials in charge of licenses and reports relevant to the listed | |
| company; | |
| (iv) | persons who have entered into or are negotiating a contract with the company; and |
| (v) | officers and employees of companies that meet criteria in subparagraph (ii) or (iv) |
| above. |
11.1.1 Recipients
A recipient is any person to whom an affiliate in possession of any significant inside information intentionally transmits such significant inside information. Where the recipient is an officer or employee of a company who has received the significant inside information in connection with his/her employment functions or duties, the insider trading rules will apply mutatis mutandis to any other officers and employees of such company who have received the Significant Inside Information in connection with their employment functions or duties.
11.1.2 Listed security
A listed security includes a corporate debt security, convertible bond, bond with warrants, warrant, share certificate (stock), or security representing a subscription right to new shares or stock option that is listed on a securities exchange or is an over-the-counter security in Japan.
11.1.3 Listed company
A listed company is a company that issues one or more types of listed securities. The definitions of ‘affiliates’ and ‘significant inside information’ of a listed company may include affiliates and significant inside information of the parent company or a subsidiary of the listed company.
11.1.4 Significant inside information
Significant inside information is any information that has not been publicly disclosed regarding the operations, business or assets of a listed company that would have a material influence on an investor’s decision to buy or sell the company’s securities. It includes: dividend changes, earnings estimates, changes in previously released earnings estimates, significant merger or acquisition proposals or agreements, significant new product developments, product recalls, major litigation, financial or liquidity problems and extraordinary management developments. Significant inside information with respect to a straight bond is limited to certain information regarding the issuer’s credit standing (such as the filing of a petition for insolvency procedures).
11.1.5 Disclosure
Significant inside information is disclosed to the public when it is included in certain disclosure documents filed pursuant to the SEL or after 12 hours has passed since an announcement (eg by press release) made by the listed company to any two or more media outlets which are daily, general topic newspapers, news wire services, daily industrial or economic newspapers or radio and television service companies. If the press release is made through an electronic disclosure system operated by a stock exchange (such as the ‘TDnet’ system operated by the TSE), the information is regarded to have been ‘disclosed’ immediately.
11.2 Codes of conduct
Some companies bolster their insider dealing controls with internal codes of conduct. Generally, employees must keep the information confidential, only disclose significant inside information to other employees who need to know it, and refrain from trading in the company’s listed securities. Corporate compliance departments monitor the market for prohibited trades.
11.3 Sanctions and defences
Penalties for insider trading include imprisonment for up to five years and/or a fine of up to ¥5 million. Confiscation of property acquired through insider trading, or an amount equivalent to the value of such property, is another possible penalty.
12. TAKEOVERS
12.1 Laws and regulations
When an investor acquires shares of a listed company, or bonds convertible into, warrants exercisable over, deeds of subscription to, options for purchase of, or depository receipts for such shares, otherwise than through trading on the stock exchange or over-the-counter market, the investor must file a tender offer registration statement and follow the procedures stipulated in
12.2 below. In this connection, ‘investor’ includes not only a party who beneficially acquires securities, whether in its own name or in the name of others, but also:
12.2 Tender offer procedures
A foreign investor must appoint an agent in Japan, customarily a Japanese law firm, who shall be responsible for filing the tender offer registration statement. An investor must also appoint a tender offer agent who handles custody of the shares tendered and payment of the purchase price. When filing the tender offer registration statement, the investor must publish a public notice about the tender offer in a newspaper in Japan. Following the publication of the public notice (usually on the same date), the investor must file with the relevant LFB a tender offer registration statement for public inspection. The investor must also deliver a prospectus to offerees. The tender offer period starts on the date of the public notice and lasts for a period between 20 and 60 days. As a result of recent amendments to the SEL, the target company is now required to express an opinion about the tender offers. They must file an opinion statement with the relevant LFB for public inspection. At the end of the tender offer period, the investor must issue a public notice or press release disclosing the results of the tender offer, and submit such results to the relevant LFB.
12.3 Exemptions
Tender offer procedures are not required, however, in the following cases:
FOOTNOTES
1 The author would like to acknowledge the assistance of Shinji Nakamura, Etsuko Hara, Tomoki Debari, Ken Kobayashi, Yosuke Fujisawa and Hanim Hamzah incorporated into the Financial Instruments and Exchange Law.);
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