A New Sheriff's In Town

Securities and Exchange Surveillance Commission Chairman Takeo Takahashi

While cleaning up the mess in securities markets in itself sounds like a good idea, some industry sources told J@pan Inc that the SESC and the FSA are on a witch-hunt of foreign firms.

I've heard about the criticism often myself. But there is absolutely no way that we are stricter on foreign firms than on Japanese firms just because they are foreign. We do the same for Japanese firms; the same rules apply to both.

Previously, the SESC would examine foreign firms less frequently. But we are trying to treat them the same as Japanese firms. Now we are trying to examine them once every three years. Another factor is the growing presence of foreign firms in Japan. It looks as if we are focused only on violations of foreign firms, but it is not true. We are only doing examinations and inspections that would match their presence.

You have said several times that there are "three distrusts" of investors toward the securities markets. Why do you think investors don't trust the market?

Over the past years, activities of securities firms have been moving in the right direction, but various violations are also emerging.

The most important function of securities markets is that share prices are set in free and competitive markets. Unfortunately, there is still market manipulation, or insider trading. These activities undermine the credibility of the basic function of securities markets. Although it is an embarrassing factor for us, it also points to the question of whether we have enough control over these activities. I have to admit [we are] probably not doing enough.

Most importantly, we are not maintaining fairness in securities markets. I guess it is because those who manage and work for the industry don't have enough understanding. For example, some violations come from rank-and-file salespersons, those who work directly with individual investors. These salespersons don't seem to think enough about violations. And those who manage securities firms probably do know, but don't have enough supervision over their own organizations, or they are still lax about violations.

I've always stressed the fact that obeying laws and regulations would ultimately lead to growth.

Over the past year, SESC has dealt with various types of violations. What are you focusing on now?

In fact, nothing is really new. Similar violations have happened repeatedly. However, it is true that violations concerning new financial products are emerging. Let's take the example of EBs (equity exchangeable bonds). EBs are very complex products. Most individual investors find it hard to understand the risks related to these products. Those who sell these products need to take time to explain the risk. It seems to me that some securities firms are not explaining enough, or they are giving information that is either false or misleading.

There have been cases of manipulative transactions related to new financial products. New products, new ways of trading are emerging each day. There may be more violations related to these. This doesn't necessarily mean there are more violations concerning these products. It's just that these cases stand out just because they are emerging. As for new financial products, we will carefully determine what are considered to be violations and will take prompt actions. There is no other way.

The SESC has recently announced that it will increase the frequency of regular examinations from once every three years for medium-size firms and foreign firms to once every year and a half, the same level as large firms. When will you start?

It is difficult to say exactly when. Ideally, the regular examination should be done once every year and a half. But the SESC currently has only 122 employees. Con-sidering the fact that we only had 84 members when we started in 1992, this is still an increase. But it is almost impossible to achieve that goal with this number of people. In order for us to achieve this goal, we have asked the government to double our staff.

Even that would still be much smaller than the US Securities Exchange Commission.

That is correct. Compared to the US, it is still very small. In 2001, the US SEC had 3,285 workers. But the size of the market is different, the population is different, the diversity is different; we cannot simply compare these numbers.

Some industry sources say the division of authorities among different organizations, especially the FSA and the SESC, is not really clear to them and there seems to be confusion in who is doing what.

Well, this is indeed hard [criticism] to take. Even high-ranking SEC officials have asked me the same question. Before the SESC was born in 1992, the functions of both coach and umpire were performed by the same organization. When there was a violation, the coach suddenly became the umpire. That situation was criticized.

One objective of establishing the SESC was to separate that umpire function.

Currently, inspection of financial soundness is delegated to the FSA, while ensuring fairness, legality, and transparency of transactions is delegated to the SESC. The FSA's Inspection Bureau is in charge of inspecting the financial soundness of securities companies.

Since there is a clear legal division of power between the FSA and the SESC, we need to work in closer cooperation with the FSA in order to inspect efficiently.

Are you planning to advocate the independence of the SESC as a separate watchdog from the FSA in the future?

Unfortunately, organizational issues are dealt with by the FSA's Planning and Coordination Bureau, and we have no power to initiate a structural change. But after all, it is our own organization. Having no authority to change the structure doesn't mean we have no opinion.

The Democratic Party has been saying that the SESC should be an independent body, modeled after the US SEC, to have full power over securities houses. I think that to give one body full power is ideal in terms of functionality. It would be better as well from the viewpoint of companies that are being supervised.

But any organization has advantages and drawbacks. For example, there is an argument that examinations of a financial conglomerate cannot be done properly if a different body examines each business separately. From that point of view, getting an independent supervisory body to solely look after securities firms may be questionable.

As you know, England has a different attitude from the US SEC. Its Financial Services Authority has full power over everything -- banks, securities firms, and insurance companies. To deal with conglomerates, this model may not be such a bad idea.

I appreciate any discussion to improve our organization, but [any organizational change] needs to be discussed very carefully. It shouldn't be done whimsically. We first need to strengthen the existing body. If that isn't enough, we could consider modifying it.

The number of SESC recommendations to the FSA has been on the rise since fiscal 1998. But the number of accusations it makes to the prosecutors' office has been limited. In fiscal 2000, the SESC only filed five cases with the prosecutors' office. The US SEC filed 64 cases with prosecutors in the same year. Even taking the difference in market size into consideration, the number seems way too small in Japan.

Of course, size matters, but the number of people who are allocated to investigations is another factor. The SEC's law enforcement division alone has 400 staff members. Another factor is the difference in legal systems. The US and British system seems to be simpler and inclusive. In Japan there are just a lot of small criteria to meet before a case can begin.

The US legal system allows room for economic sanctions in the form of penalties for companies that violate rules. In the case of Japan, the only sanctions that the FSA can give are administrative orders.

There is an argument that the FSA should be given power to give penalties to those that violate regulations. But a legal system that hasn't taken root may not grow. The only governmental body that has power to give penalties may be the Fair Trade Commission.

Recent SESC investigations were dealing with cases dating back to 1998 or 1999. There seems to be a huge time lag between occurrence of violations and inspections.

That is right. We are trying to shorten the gap. One objective of establishing a criminal case is to give markets a warning. We must strike while the iron is hot. I cannot complain much that we don't have enough people. We'll just do our job.