i Sources of law
The sources of securities law in Japan include the Civil Code; the Commercial Code; the Companies Act; and, enacted in 2007, the Financial Instruments and Exchange Act (FIEA), which is the primary source.
The FIEA stipulates the systems for the disclosure of corporate affairs and other related matters, mandates specific matters relating to the financial instruments business and safeguards the appropriate operation of financial instruments exchanges. The FIEA is enforced by the Financial Services Agency of Japan (JFSA) and the Securities and Exchange Surveillance Commission (SESC), a commission that is under the JFSA. Both the JFSA and the SESC periodically issue and update guidelines and regulations relating to the FIEA.
In addition, the stock exchanges in Japan, such as the Tokyo Stock Exchange, the Osaka Securities Exchange, JASDAQ, and Mothers, to name some, also regulate the stock markets, including by issuing disclosure rules. Because each stock exchange has its own rules and regulations, it is important to check the rules of the stock exchange where a company is listed.
ii Regulatory authorities
Securities enforcement actions in Japan are handled mainly by two parties: the SESC and the stock exchanges.
The SESC, the supervising authority of Japan’s financial instruments markets, plays the primary role in maintaining fair, transparent and sound markets. In this regard, the SESC has broad authority to do the following:
- criminal investigations: it investigates criminal allegations of serious offences to determine whether charges should be filed before the public prosecutor’s office;
- administrative monetary penalty investigations: it investigates possible market misconduct, such as insider trading and market manipulation, through on-site inspections and interviews, to determine whether it should recommend the imposition of administrative fines;
- disclosure statements inspections: it inspects disclosure statements for possible violations of disclosure requirements to determine whether it should recommend the imposition of administrative fines;
- financial instruments business operators inspections: it examines financial instruments business operators and other operators for possible violations of laws and regulations and their financial soundness;
- day-to-day market surveillance: it collects and analyses information and transaction data from the general public to detect possible violations that may warrant further inspection or investigation; and
- filing for court injunction: it inspects FIEA non-registrants’ business for possible violations of laws and regulations. If it finds a violation, it files for a court injunction to prohibit or suspend the act in question and publishes the violator’s name and other information about the violator.
Unlike similar regulatory and enforcement agencies in other countries, the SESC does not have the power to directly prosecute and penalise companies and persons who violate the FIEA and related rules. As can be seen from the brief outline above, the SESC’s powers are largely investigative and recommendatory in nature. Nonetheless, the SESC is an influential entity in enforcing securities laws and regulations. In this regard, the SESC utilises its enforcement tools such as recommendations to impose administrative fines or file criminal charges, the filing of petitions for court injunction and the issuance of policy proposals while it promotes cooperation with self-regulatory organisations and overseas regulators.
In addition to the SESC, the stock exchanges also regulate financial exchange markets. If a stock exchange concludes that a listed company has undermined the confidence of shareholders and investors in the exchange market, it may impose a fine for violating its listing agreement. A typical example of these cases is misstatement.
iii Common securities claims
The most common securities claims in civil cases in Japan are damages claims brought by investors for alleged fraudulent or misleading statements or omissions. While there are also civil cases based on insider trading and market manipulation, they are not as common as misstatements.
Investors can claim for damages arising from misstatements or omission, not only against the issuing company and its executives, including directors and auditors, but also against public accountants and auditing firms who certify, in their audit reports prepared under the Companies Act, that financial statements do not contain any material misstatement or omit material information despite the existence of material misstatements or omissions (Article 21(1)(iii)). The burden of proof that there was no negligence or intent to mislead is on the public accountants and auditing firms. It is, however, difficult to bring a lawsuit against lawyers because there is no specific stipulation in the FIEA that allows investors to claim damages against lawyers.
II PRIVATE ENFORCEMENT
i Forms of action
Securities actions in Japan are usually in the form of damages claims in ordinary civil lawsuits. There are two grounds on which investors may bring damages claims. One is a tort claim based on Article 709 of the Civil Code. The other is Article 21-2 or other provisions of the FIEA that may apply under certain conditions. If Article 21-2 is applicable, the plaintiffs (investors) may benefit from the presumption on the amounts of damages under that provision, thereby easing their burden of proof of damages.
The respondents are usually companies that issued the securities in question. Their directors, officers, statutory auditors and accounting auditors (audit firms) may be additional respondents in these actions.
Shareholders may also bring shareholder derivative actions against company directors, officers, statutory auditors and accounting auditors. Shareholder derivative actions, however, are not common, because they are recovery actions on behalf of the issuing company, rather than for the shareholders themselves.
In 2016, new litigation proceedings for consumers’ collective recovery became available. However, these proceedings cannot be used for most securities actions, being available only for consumers who directly acquired securities from the issuing company and have contractual relationships with it. Therefore, it is not available to individuals who acquired securities at stock exchanges.
In securities actions, it is usually difficult for the issuing company to deny liability because such actions are usually brought after a false statement in the company’s accounting report is found through a public enforcement proceeding. Such official findings are fundamentally respected in private enforcement proceedings such as civil lawsuits. Therefore, the issuing company usually focuses on reducing damages it may have to pay.
On the other hand, directors, officers, statutory auditors and accounting auditors may challenge their liability by arguing that they could not have found and prevented the false statement. They may also try to reduce the damages claimed against them.
As described above, securities actions are usually in the form of ordinary damages claims in a civil lawsuit, and there are no specific procedural features that are particular to securities actions.
One of the key characteristics of a Japanese civil lawsuit is periodic hearings, which are held every one or two months. Each hearing usually takes less than 30 minutes, and sometimes they take only a couple of minutes. The aim is to have regular communications among the judges and the parties to establish a mutual understanding of the key points of the litigation. At these hearings, the judges comment on the written brief and accompanying exhibits that are submitted in advance by a party, and suggest to the other party the points that should be covered in the brief that it will submit before the next hearing. This regular communication involving judges is a key element of efficient proceedings in Japan.
Courts easily establish jurisdiction in most security actions because the defendants (i.e., the issuing companies and their directors, officers, statutory auditors and accounting auditors) have Japanese addresses. Therefore, jurisdiction is not likely to be an issue in securities actions. In addition, jurisdiction may also be based on the residences of the plaintiffs (i.e., the alleged victims). Since plaintiffs may reside all over Japan, defendants may face multiple lawsuits all over Japan on the same false statements.
A motion to dismiss is not available in Japanese civil law suits. There are no pleading requirements.
Extensive discovery, as is available in the United States, is not available in Japan. As to document production, parties may seek the production only of specific documents, which satisfy certain requirements including their necessity to the case. Depositions are not available in Japan, and cross-examinations need to be prepared based on witness statements, which are submitted in advance of witness examinations.
Japanese civil lawsuits are unique in that the judges in charge of the cases are allowed to be involved in settlement discussions, including ex parte meetings with parties. This is because of the general trust that Japanese citizens have in judges and other public entities. Judges may play an important role in settlement discussions, particularly by expressing their views on the likely outcome of the case.
Settlements are not subject to judicial review in Japan because the parties have the right to resolve their lawsuits. If the parties agree on a settlement term, it will be effective except for in exceptional circumstances, such as the settlement being contrary to public policy.
Generally, losing parties are not liable for the prevailing parties’ attorney’s fees. However, in damages claims, including security actions, the attorney’s fees of the prevailing plaintiffs may be awarded as part of the damages. In practice, the amount of the attorney’s fees awarded as damages is set at 10 per cent of the other damages awarded to the plaintiffs. On the other hand, prevailing respondents cannot recover their attorneys’ fees from the plaintiffs.
iv Damages and remedies
Available remedies for securities actions are in practice limited to damages awards. We do not typically see other remedies such as injunctive reliefs sought in securities actions in Japan.
The principle on damages awards under Japanese law is the recovery of the cost of the damage actually suffered by the plaintiffs. Punitive damages are not available under Japanese law.
Article 21-2 of the FIEA presumes the amount of damages, based on (1) the average market value during the month prior to the disclosure date, and (2) the average market value during the month after the disclosure date. The disclosure date means the date of the disclosure of the existence of the false statement in the accounting report, and in our experience the market value substantially drops after the disclosure date. If Article 21-2 of the FIEA is applicable, the plaintiffs may claim the amount calculated by deducting (2) from (1) as damages.
A respondent may challenge the presumed amount of damages calculated above. It will not be liable to the extent that it can prove that all or part of the damage sustained by the plaintiff was because of circumstances other than the decline in the value of the security that could have resulted from the false statement.
For a tort claim, a plaintiff may claim the difference between the purchase price and the sales price (or the current value) of the security as damages if it proves that it would not have purchased the security if the false statement in the accounting report had been known. However, if the decline in the price or market value is partly because of circumstances other than the decline in the value of the security that could have resulted from the false statement, then the portion attributable to the other circumstances should be deducted from the damages to be awarded. Examples of such circumstances include declines because of economic trends, market trends, and business performance of the company. This rule was set by a famous Supreme Court case, the Seibu Railway case.
III PUBLIC ENFORCEMENT
i Forms of action
As explained in Section I.i, both criminal actions and administrative actions could be taken against a potential defendant for violations of the FIEA. See Section III.iv for the major types of actions and possible consequences of those actions.
The SESC has the authority to conduct investigations for criminal prosecution and for administrative enforcement. These investigations are conducted by two principal divisions of the SESC. When the SESC considers bringing cases to the public prosecutor’s office for the filing of criminal charges, the cases are dealt with by the Investigation Division of the SESC. In administrative enforcement cases, it is the Disclosure Statements Inspection Division of the SESC that conducts the inspection and makes recommendations to the SESC to issue an order to impose administrative penalties on a potential defendant. The Investigation Division and the Disclosure Statements Inspection Division sometimes collaborate with each other to a certain extent, but such collaboration is limited because under Japan’s procedural due process, inspections for administrative enforcement must not be conducted for the purpose of filing a criminal prosecution.
The number of cases where the Disclosure Statements Inspection Division of the SESC recommended the imposition of administrative penalties for violations of disclosure rules under the SESC is decreasing slightly, but has basically remained constant in a range of between five and nine cases per year from 2012 to 2016, according to a report published by the SESC in 2017.
As mentioned above, in cases of administrative enforcement, the Disclosure Statements Inspection Division of the SESC conducts the inspection (FIEA, Articles 26 and 177) and makes a recommendation to the JFSA Commissioner on the imposition of administrative penalties. If the JFSA Commissioner finds a violation, he or she will order the commencement of administrative proceedings (id., Article 178). The administrative proceedings are conducted by a panel comprising three examiners designated by the Commissioner, unless the case is a simple case, in which case the proceedings are conducted by a single examiner (id., Article 180). The examiners are tasked with preparing and submitting to the Commissioner a draft of their decision. The Commissioner will issue an order, based on the draft decision, for the defendant to pay an administrative penalty (id., Articles 185-6 and 7). A lawsuit for the rescission of the order to pay an administrative penalty should be filed within 30 days from the date on which the order comes into effect (id., Article 185-18).
In an inspection by the Disclosure Statements Inspection Division of the SESC, it may instruct relevant persons to report on matters or submit documents concerning the case, and conduct a dawn raid. Although the Disclosure Statements Inspection Division does not have any authority to arrest anyone or to conduct any search and seizure with a warrant, it is difficult in practice to refuse to cooperate in Division inspections because anyone who refuses, hinders, or avoids inspections can be punished by imprisonment for not more than five months or by a fine of not more than ¥500,000, or both (id., Article 205(vi)).
In cases of criminal enforcement, the Investigation Division of the SESC conducts criminal investigations, and if it finds a violation, it will file a criminal complaint before a prosecutor. The Investigation Division does not have the power to arrest anyone, but it can conduct a search and seizure with a warrant issued by a judge of a district court or summary court that has jurisdiction over the location of the SESC (id., Article 211(1) and (2)). The criminal prosecution of securities-related enforcement actions is subject to the general rules of criminal procedure.
As seen above, in a securities-related enforcement action in criminal cases and administrative cases, the SESC has strong powers to collect evidence and investigate cases, compared with private actions, where extensive discovery as in the United States is not available (see Section II.ii).
There is no system of settlement between the government and the defendant in administrative actions or criminal actions. However, the Criminal Procedure Code was amended in May 2016. The amendment, which will become effective on 1 June 2018, introduced a new plea-bargaining system in Japan. Under this new system, a prosecutor may enter into a formal plea-bargaining agreement with a suspect or defendant (either a natural person or a corporate entity) who provides certain evidence or testimony in relation to certain types of crimes, including violation of the FIEA, to drop criminal charges or agree to a predetermined punishment. This system is different from the US plea-bargaining system because a suspect or a defendant who only admits his or her own crimes, and not to the criminal acts or liabilities of others, is not entitled to use this plea-bargaining system. A suspect or defendant is required to disclose what he or she knows about the crimes committed by others to have the charges against him or her dropped or reduced or the possible punishment against him or her reduced.
iv Sentencing and liability
Generally speaking, administrative penalties are determined according to calculation methods set by the FIEA, and criminal penalties are determined by courts within the range set by the FIEA by taking into account the seriousness and maliciousness of the violations. The following are examples of administrative and criminal penalties for major types of violations.
If a company’s annual securities report contains false statements, that company can be punished by an administrative penalty of ¥6 million or 0.006 per cent of the total amount of the value of the company, whichever is higher (FIEA, Article 172-4(1)).
If a company’s Quarterly Securities Report, Semiannual Securities Report, Extraordinary Report or Internal Control Report contains false statements, that company can be punished by an administrative penalty of ¥3 million or 0.003 per cent of the total amount of the value of the company, whichever is higher (id., Article 172-4(2)).
If a company’s annual securities report contained false statements, any person who submitted that report can be punished by imprisonment of up to 10 years, or a fine of up to ¥10 million, or both (id., Article 197 (1)(i)). If a representative of an entity or an agent, employee, or other worker of a company violated the same rule, both the individual person and the company can be punished by a fine of up to ¥700 million (id., Article 207(1)(i)).
In cases where a company’s Quarterly Securities Report, Semiannual Securities Report, Extraordinary Report or Internal Control Report contains false statements, any person who submitted that report can be punished by imprisonment of up to five years, or a fine of up to ¥5 million, or both (id., Article 197-2(iv)), and the company can be punished by a fine of up to ¥500 million (id., Article 207(1)(ii)).
IV CROSS-BORDER ISSUES
i Private enforcement
Although there is no special law on cross-border securities litigations, a foreign issuer of securities may be sued in Japan if it has its principal office or a business office in Japan or the domicile of its representative or any other principal person in charge of its business is in Japan.
Even if the issuer has no office, director or employee in Japan, it may be sued if the tortious act was committed in Japan. However, depending on the circumstances and amount of damages involved, it may not be effective or worthwhile to bring a suit against such a foreign issuer, given that litigation against a foreign defendant would be time-consuming and costly, and sometimes practically impossible (especially in terms of service of process and the execution of a judgment).
ii Public enforcement
Japanese courts generally have jurisdiction over crimes committed in Japan. If the criminal act or omission or event relating to a foreign issuer of securities occurred in Japan, the issuer may be prosecuted in Japan.
V YEAR IN REVIEW
With respect to private enforcement, one of the remarkable decisions relating to securities litigation in 2016 was the decision issued by the Tokyo District Court on 20 December 2016. In this case, an issuer of newly listed stocks had window dressed its financial conditions and the Securities Registration Statement submitted by it contained material false statements. Both the issuer and the security company that acted as the wholesale underwriter for the offering were sued. The court found the underwriter liable for the false statements. Although the FIEA stipulates that a wholesale underwriter may be liable for any false statement on important matters related to a public offering in which the underwriter is involved, this is the first case where an underwriter was found liable.
As to public enforcement, according to statistics on criminal investigations conducted by the SESC, the SESC filed five criminal complaints in 2016: three for market manipulation and two for insider trading. There were no complaints on false statement in 2016, while there were three false-statement complaints in 2015.
VI OUTLOOK AND CONCLUSIONS
In May 2017, a bill for the amendment of the FIEA was approved by the Diet of Japan, which introduces new rules requiring fair information disclosure by an issuer of listed securities to investors (the Fair Disclosure Rules). The amendment came into force on 1 April 2018. Basically, the new Fair Disclosure Rules require a listed company, etc., to disclose ‘material information’ to the public if a listed company provides such material information to a specific recipient.
As a background of the amendment, in 2016, the Working Group on Corporate Disclosure, one of the Financial System Councils established by the JFSA, issued a report on various matters for the reform of the current corporate disclosure system, including the introduction of fair disclosure rules to ensure fair and timely disclosure. The JFSA established the Task Force on Fair Disclosure Rules, which released a report and proposed the introduction of fair disclosure rules to ensure that when an issuer provides inside information to a third party before its public disclosure, that information is also provided to other investors. Based on the released proposal, the scope of information that would be subject to these fair disclosure rules will include material information that may influence investment decisions, such as information that is subject to the insider trading regulations and other non-public information concerning the issuer of the financial instrument. Note that information that may have an effect on investment decisions when combined with other information, but would have no immediate effect on investment decisions in and of itself will not be within the scope of information that would be subject to the proposed fair disclosure rules. The report stated that the adoption of fair disclosure rules has three positive purposes, as follows:
- ‘Developing and clarifying disclosure rules that would apply to issuers, which will encourage the prompt disclosure of information by issuers and eventually promote dialogue between issuers and investors’;
- ‘Laying a foundation for more objective and accurate analyses and recommendations by analysts’; and
- ‘Promoting changes in the mindset of investors by ensuring a fair timing for the disclosure of information by issuers, to encourage investors to make more investments from a mid- to long-term perspective, rather than just from a short-term perspective, based on the hayamimi information [‘quick-ear’ information]’.
1 Mugi Sekido, Shinichiro Yokota, Shiho Ono and Yuko Kanamaru are partners at Mori Hamada & Matsumoto.