TOKYO With its stock in near free fall, the board of Japan's Nippon Sheet Glass met in August 2010 to weigh a couple of unpalatable options: suspend planned investments in key markets like China or go ahead with a Tokyo share offering that had somehow leaked to the market.
The board, including then-CEO Craig Naylor, a newly-arrived American, decided to press ahead with the still-unannounced plan to raise $500 million, even though the cost of doing so was shooting higher as investors, worried about the dilution to existing share value, dumped the stock.
The kind of leak that battered Nippon Sheet Glass shares was widespread by 2010, earning Japan a reputation as a haven for insider trading with a regulator willing to look the other way.
But Japan's third-largest glassmaker did something unusual: it complained.
The company summoned its underwriters, JP Morgan and Daiwa Securities and pressed for an investigation. Over the following months, Nippon Sheet Glass emerged as a crucial test case in a crackdown by Japan's Securities Exchange and Surveillance Commission (SESC) that has reset the rules of the game for insider trading in the world's third-largest stock market, according to interviews with more than a dozen participants in the probe, from lawyers and investigators to traders and brokers, and a review of related documents.
As the SESC closes out the first phase of an unprecedented insider trading investigation, its ability and resolve to tackle the problem is no longer in doubt.
Since March, the agency has announced five cases, two involving Nippon Sheet Glass. It has taken down an influential hedge fund, and, along with its parent, the Financial Services Agency (FSA), pushed for a management shake-up at Nomura Holdings, Japan's largest investment bank.
In the process, the SESC has surprised Tokyo banks and fund managers by enforcing a zero-tolerance policy in an area where many believed standards of conduct remained vague, people involved say.
The SESC's new hard line has been led by 65-year-old Kenichi Sado, a former public prosecutor who made his mark investigating the Recruit scandal in the 1980s when Japanese politicians, including two former prime ministers, were found to have taken stock and cash in exchange for political favors.
"In the past, the regulator only went after individuals, leaving institutional investors to do as they pleased. Insider trading was everywhere," said Kazuhiko Shibata, co-chief executive at Symphony Financial Partners, a hedge fund with operations in Tokyo and Singapore. "The crackdown is a very positive development. It's especially good from the point of view of foreign investors that the Japanese market is becoming more clean."
The United States, too, is clamping down on insider trading, with dozens of convictions, including consummate business insider Rajat Gupta, who faces up to 25 years in jail for leaking secrets about Goldman Sachs.
The SESC's investigation has prompted a rethink by major banks of how to police their Tokyo trading desks. Before the crackdown, many traders believed they were not passing on inside information as long as they spoke in code - "blue bank" meant one of Japan's three big lenders, "green bank" another - or couched remarks with the qualification they were talking about rumors, investigators found.
A dozen banks, including Goldman and JPMorgan Chase, have announced steps to bolster controls, including making traders use mobile phones with recording so conversations are subject to later scrutiny.
But the SESC has also generated controversy - using broad discretionary powers it was granted in 2005 to push institutions into settlements, sidestepping courts.
Key individuals, including brokers at J.P. Morgan and Daiwa identified as sources of the Nippon Sheet Glass leaks, maintain their innocence. The broker at Daiwa says he was never interviewed and believes he is being made a scapegoat, partly because he is not Japanese and is no longer with the bank.
Those apparent gaps have raised some concern about whether the SESC is at risk of pushing too far, too fast. SESC officials have expressed confidence their evidence is strong enough to beat back any legal challenge, although that has yet to be tested.
"Financial institutions are in a very weak position relative to the regulator," said Naohiko Matsuo, a lawyer at Nishimura & Asahi who used to work for the FSA and now advises financial institutions dealing with the regulator. "When an agency is so powerful it needs to proceed with caution. There are worries that punishments are being meted out too easily."
HIDDEN IN PLAIN SIGHT
When SESC officials turned up at the office of Asuka Asset Management to inform the $800 million hedge fund it was under investigation, more than a year had passed since the botched Nippon Sheet Glass deal.
Asuka, a decade-old firm founded by Mamoru Taniya and Toshihiro Hirano, had a reputation for taking short positions in Japanese shares. But Asuka executives believed the evidence against one of their fund managers in the Nippon Sheet Glass case was inconclusive. Chatter about share offerings had been everywhere in 2010.
Six months later, Asuka dropped any thought of fighting the SESC and agreed to pay a token fine of 130,000 yen ($1,700). The goal was to avoid a harsher penalty that could have prompted a flight from its funds, people involved said.
Most of the evidence regulators believed they needed in the Nippon Sheet Glass case was preserved in phone recordings, emails and a broker messaging system.
By March, the SESC had finished separately interviewing - dozens of times - the Asuka fund manager suspected of insider trading, and a JP Morgan sales trader believed to have provided the tip. Both men signed affidavits stating they had done nothing wrong.
But SESC investigators zeroed in on a meeting between the two at Doichan, a Japanese-style pub chain in the basement of the building housing JP Morgan's Tokyo offices on August 4, 2010. It was the first time they had met.
Rumours had been circulating for weeks that Nippon Sheet Glass would need to raise equity to shore up a balance sheet stretched by its acquisition of Britain's Pilkington in 2006. That was one of a handful of rumors the two had discussed at the bar, the JP Morgan sales trader told investigators
The trader, like others targeted by the SESC, spoke on condition he not be named due to concern it would hurt his prospects of finding a job. He has not been charged with any wrongdoing.
On August 5, 2010, before the market opened, the Asuka fund manager messaged the JP Morgan trader asking if the Nippon Sheet Glass offering would be announced that afternoon. The trader said no and then offered: "I think it's Daiwa and JP Morgan." That would be interpreted as material information by investigators who determined he was relaying the two underwriters on the deal. That same day, the Asuka fund manager took out a short position on Nippon Sheet Glass stock.
The trader said he had reason to believe that JP Morgan might have the Nippon Sheet Glass mandate but that he was not certain. The JP Morgan division handling share offerings had started to ask about trading conditions in Nippon Sheet Glass stock in near daily "flow checks". A sales manager had also made comments suggesting JP Morgan would be working on another deal with Daiwa, which had a strong relationship with the glassmaker and was seen as a shoo-in to manage its expected offering. Investment banks have so-called Chinese Walls designed to prevent advisory work leaking to sales teams.
"In hindsight, I was careless with my words," the former sales trader told Reuters. "But that was just market rumor and my own prediction. I didn't think I was passing on inside information."
In Japan, it is not illegal to provide inside information unless the individual also directly profits, although that may change as part of a raft of new regulations being considered with the aim of bringing penalties closer to the tougher standards in force in Britain and the United States.
JP Morgan fired the sales trader in June, partly due to pressure from the regulator to dismiss him, according to a person with knowledge of the matter. The trader is considering a lawsuit claiming wrongful termination. The bank declined to comment on the former trader, but referred to a June 29 statement in which it said it took the regulator's findings seriously and vowed to take steps to bolster its controls.
Asuka also declined to comment. The Asuka fund manager involved in the case left the firm at the end of May.
THE DAIWA CONNECTION
Two weeks after the Asuka fund manager started shorting Nippon Sheet Glass, the stock was tumbling in heavy volume. That grabbed the attention of another hedge fund, Japan Advisory, and a broker at Daiwa, Japan's No. 2 investment bank.
At 10:13 a.m. on August 20, the broker called Japan Advisory head Edward Brogan and told him he had just found out Daiwa would be managing a stock offering on August 24, but he didn't know the name of the issuer. The broker then noted speculation Nippon Sheet Glass would raise equity and the possibility a deal was coming given the active trade in the stock.
The Daiwa broker had just come from a meeting in which he heard that a company planning to issue shares would be holding a kind of explanatory meeting on August 24. Along with open chatter in the department about public offerings there was enough information for the broker to connect the dots, according to a Daiwa internal investigation made public last month.
After that phone call, Japan Advisory sold 2.65 million shares of Nippon Sheet Glass through another securities company, according to the SESC, which fined and revoked the hedge fund's license on June 29. Brogan could not be reached for comment.
The broker, a German national who left Daiwa in December 2010 for personal reasons, said he was informing a client of a big move in a stock he had recommended as a 'buy' just weeks before. At the time, he had only been at Daiwa a few months and was not privy to such confidential information, he said.
The broker was not interviewed for the case and didn't know he was involved until a Japanese newspaper identified the source of the leak as a fortysomething German. While he has not been charged with any wrongdoing, he is considering legal action against Daiwa, which he says gave his name to reporters, and media. "I was the only person of that nationality at Daiwa so everyone in the community knows it is me they are talking about," he said.
Daiwa's internal investigation concluded that other members of the equity sales team passed on information about the offering to clients other than Japan Advisory, but also said it did not find the problem of tipping to be "systematic" - a claim that has been questioned by some experts.
"People reading this report may wonder if the problem is much wider than just Nippon Sheet Glass," said Yoichi Namekata, a lawyer and compliance expert at Blakemore & Mitsuki.
A spokesman for Daiwa said the brokerage takes the findings of its internal investigation seriously and is taking steps to improve internal controls.
The SESC may announce more insider trading cases in the coming months. In addition to submitting compliance improvement plans, brokers were also required to report to the regulator on their dealings with Japan Advisory and other hedge funds.
When Sado took over as SESC commissioner in 2007, he said he wanted the agency to be a "frightening presence" to anyone looking to manipulate the market.
"There are probably not many people who thought we could achieve what we have," a senior SESC official told Reuters looking back on the two-year investigation. The official added the SESC believed there were still offenders who needed to be purged from the market. "I'd say we're about halfway there."