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Monday, June 26, 2006

JAPANESE PERSPECTIVES

Laws, morals and the delay of the financial products trade law


A mid the public uproar over insider trading prompted by the arrest of investment fund manager Yoshiaki Murakami, the Diet quickly enacted a new law to regulate transactions involving financial products on June 7. The legislation combines the previous Securities and Exchange and other laws in an attempt to beef up investor pro- tection -- an area where such efforts have been long, long overdue.

One of the major legal changes concerns investment funds. Private or anonymous unions that manage investor money will now be required to register the names of their representatives and the location of their headquarters.

Rules on disclosure for shares owned by the funds were also tightened. Investment funds were previously required to report acquisitions of up to 10 percent in another company within three months. Now they have to report them every two weeks, while ordinary companies must report acquisitions exceeding 5 percent of another firm within five business days.

The new law, provisionally called the Financial Instruments and Exchange Law, also closes some of the legal loopholes used in takeover bids, including off-hours transactions, which were used to great effect in the battles for Nippon Broadcasting Corp. and Hanshin Electric Railway Co.

It also says an investment fund that has acquired more than two-thirds of the outstanding shares of a takeover target must bid for the remaining stake as well. In Britain, for example, a fund that has obtained more than half of a target company must bid for the remaining shares as well.

The penalties are heavier, too. Insider trading can now be punished with a maximum prison term of five years or a fine of 5 million yen, compared with three years or 3 million yen previously.

Falsification of financial statements or dissemination of rumors to manipulate share prices will be punishable by up to 10 years in prison, compared with five years before.

The law also spelled out a common set of rules to regulate sales of financial products that do not guarantee the principal -- including stocks, bonds, foreign currency-denominated deposits, derivatives and variable insurance.

Here I want to point out two problems.

First, a gap tends to emerge between economic and legislative realities as globalization accelerates. The alleged offenders in the recent spate of financial market shenanigans are believed to have taken advantage of legal loopholes. It is the responsibility of the Diet to take prompt legislative action to close this gap.

It is difficult to understand why the new law on financial product trade -- even though it has been approved by the Diet -- will not go into effect until the summer of 2007.

Why can't it take effect immediately?

The question even leads me to suspect that there are secret reasons why the new law has to wait. If there are justifiable reasons why implementation must be delayed, the Diet needs to explain why.

Second, today's economic environment changes so quickly that no matter how fast new laws are enacted and implemented, a disconnect will still exist between law and reality. This gap can only be filled in by the moral fiber of market players.

The law, after all, is just a set of core ethical principles. In Britain, regulations on financial transactions take the form of self-imposed rules set forth by the interested parties. They are not legally binding, but there are few violators because the awareness and compliance of the interested parties is high. Such an environment is needed in situations when "small government" is desirable.

Today, we are watching mergers and acquisitions consolidate stock exchanges across national borders. The international credibility of the Japanese economic system, meanwhile, is on the decline, marred by scandals ranging from insider trading to revelations of wasteful spending by the Social Insurance Agency and the usual bid-rigging involving government bureaucrats.

In addition to efforts to make financial markets in Tokyo more effective and transparent, the market participants themselves need to hold each other to a higher moral standard. That is the only way Japan will regain the trust of international markets.

The root of this problem lies in the poor moral education level of Japan itself. Fixing this must start in each family. While legal measures are of course important, ultimately it is the moral standard of each Japanese that will determine the quality of the nation.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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