FAQ on Financial Instruments and Exchange Act

Section 3 Disclosure of corporate affairs and other related matters

Scope of application of disclosure regulation, etc.

Q1.

What is the outline of disclosure regulation pertaining to issuance of Securities?

A1.

In the case of procuring funds through issuance of Securities, if the act falls under the category of “Public Offering of Securities” or “Secondary Distribution of Securities” and the total issue value or the total distribution value is 100 million yen or more, solicitations for said Securities must not be made unless a Securities Registration Statement has been submitted to the Prime Minister (Article 4(1) of the FIEA).

2.

This Securities Registration Statement must contain information on the Securities subject to said Public Offering or Secondary Distribution, as well as the overview of the issuer company, the status of business, and Financial Statements, etc.

3.

In addition, an issuer company or a Financial Instruments Business Operator, etc. must not have Securities acquired or sell Securities through a Public Offering or Secondary Distribution unless the Securities Registration Statement has come into effect. A Securities Registration Statement comes into effect on the day on which 15 days have elapsed from the day of its acceptance, in principle, but in the case of a company which has continuously filed Annual Securities Reports, etc. for one year or more, the statement comes into effect on the day on which seven days have elapsed from the day of its acceptance as an exceptional measure.

4.

Also, an Issuer submitting a Securities Registration Statement must prepare a Prospectus stating the information contained in said statement, and when having an investor acquire Securities, the Issuer must deliver the Prospectus to the investor in advance (Article 13 and Article 15(2) of the FIEA).

Q2.

What is the purpose and outline of the system of disclosing issuance of new shares, etc. through Reorganization?

A1.

From the viewpoint of enhancing the system of information disclosure concerning Reorganization in light of the recent trend of Reorganization of companies, such as an increase in the number of corporate mergers and acquisitions, the FIEA imposes the same disclosure regulation as that for a Public Offering or Secondary Distribution of Securities on certain cases of the issuance of Share Certificates, etc. through Reorganization (“Procedures Relating to Securities Issuance for Reorganization”) or delivery of already-issued Share Certificates, etc. through Reorganization (“Procedures Relating to Securities Delivery for Reorganization”) (Article 2-2 and Article 4 of the FIEA). The term “Reorganization” refers to a merger, company split, share exchange, and share transfer (Article 2-2(1) of the FIEA; Article 2 of the FIEA Enforcement Order).

2.

Specifically, when carrying out Procedures Relating to Securities Issuance for Reorganization or Procedures Relating to Securities Delivery for Reorganization, the FIEA imposes an issuance disclosure obligation and a subsequent continuous disclosure obligation to the Issuer of Securities to be issued or delivered through the Procedures Relating to Securities Issuance for Reorganization or through Procedures Relating to Securities Delivery for Reorganization in the following case (the main clause and item (ii) of Article 4(1) of the FIEA): (i) where disclosure has been made with regard to Share Certificates, etc. (Article 4(1)(ii)(a) of the FIEA; Article 2-3 of the FIEA Enforcement Order) of the Reorganized Company (a company that becomes a Company Absorbed in Absorption-Type Merger, a Wholly Owned Subsidiary Company in Share Exchange, a company consolidated through a consolidation-type merger, a splitting company in an absorption-type merger, a splitting company in an incorporation-type company split, or a wholly owned subsidiary company in a share transfer) (Article 2-2(4)(i) of the FIEA; Article 2-2 of the FIEA Enforcement Order); but (ii) no disclosure has been made with regard to the Securities to be issued or delivered through the Procedures Relating to Securities Issuance for Reorganization or through the Procedures Relating to Securities Delivery for Reorganization.

3.

The FIEA defines the Procedures Relating to Securities Issuance for Reorganization subject to disclosure regulation as “Specified Procedures Relating to Securities Issuance for Reorganization” (Article 2-2(4) of the FIEA) and provides that such procedures specifically refer to the following cases:

(i)

when the Securities issued through the Procedures Relating to Securities Issuance for Reorganization are Paragraph (1) Securities, such as share certificates or corporate bond certificates, etc., the case where the number of the holders of Share Certificates, etc. issued by the Reorganized Company (Article 2-2(4)(i) of the FIEA; Article 2-3 of the FIEA Enforcement Order) is 50 or more (Article 2-2(4)(i) of the FIEA; Article 2-4 of the FIEA Enforcement Order); or

(ii)

when the Securities issued through the Procedures Relating to Securities Issuance for Reorganization are Paragraph (2) Securities, such as beneficial interests of trusts, etc., the case where the number of holders of Share Certificates, etc. issued by the Reorganized Company is 500 or more (Article 2-2(4)(iii) of the FIEA; Article 2-5 of the FIEA Enforcement Order).

4.

Meanwhile, the FIEA defines the Procedures Relating to Securities Delivery for Reorganization subject to disclosure regulation as “Specified Procedures Relating to Securities Delivery for Reorganization” (Article 2-2(5) of the FIEA) and provides that such procedures specifically refer to the following cases:

(i)

when the Securities issued through the Procedures Relating to Securities Delivery for Reorganization are Paragraph (1) Securities, such as share certificates or corporate bond certificates, etc., the case where the number of the holders of Share Certificates, etc. issued by the Reorganized Company is 50 or more (Article 2-2(5)(i) of the FIEA; Article 2-6 of the FIEA Enforcement Order); or

(ii)

when the Securities issued through the Procedures Relating to Securities Delivery for Reorganization are Paragraph (2) Securities, such as beneficial interests of trusts, etc., the case where the number of holders of Share Certificates, etc. issued by the Reorganized Company is 500 or more (Article 2-2(5)(iii) of the FIEA; Article 2-7 of the FIEA Enforcement Order).

Q3.

Why are so-called “securities equivalents” exempt from the application of the disclosure regulation?

A1.

The disclosure regulation based on the FIEA is intended to provide investors in general with information necessary for them to make Investment Decisions concerning Securities and protect them by obligating Issuers of Securities to submit disclosure documents with information on the Securities and Issuers, and requiring that the documents be made available for public inspection.

2.

Meanwhile, interests in collective investment schemes, etc. that are deemed to be Securities under the FIEA (so-called “securities equivalents”) are generally lacking in liquidity for reasons such as that certificates of Securities are not issued and that their negotiability is limited. Therefore, the necessity of widely disclosing information concerning securities equivalents through public inspection is weak. As a result, securities equivalents are exempt from the application of the disclosure regulation (Chapter II of the FIEA) in principle (Article 3(iii) of the FIEA).

3.

However, with regard to school bonds (Article 2(2)(vii) of the FIEA; Article 1-3-4 of the FIEA Enforcement Order; and Article 8 of the Definition Ordinance) as securities equivalents, it is necessary to ensure the disclosure of the creditworthiness of incorporated educational institutions, etc. that issue the bonds in order to protect investors as in the case of corporate bond certificates, etc. As a result, school bonds are subject to the application of the disclosure regulation (Article 3(iii)(c) of the FIEA; Article 2-10(2) of the FIEA Enforcement Order).
Among other items, interests in collective investment schemes, etc. that primarily invest in Securities ("Rights in Securities Investment Business, etc.”) are subject to the application of the disclosure regulation because information concerning such interests, etc. is also important for investors other than those that directly invest therein to make Investment Decisions, which means that the necessity of ensuring periodic disclosure concerning the status of investment management, etc. is strong (Article 3(iii)(a) of the FIEA and Article 2-9 of the FIEA Enforcement Order).

4.

It should be noted that although securities equivalents are not subject to the application of the disclosure regulation in principle, information is provided to investors in accordance with the obligation for the delivery of a document prior to the conclusion of a contract (Article 37-3 of the FIEA), which constitutes regulation on activities of Financial Instruments Business Operators, etc.

Q4.

What are “Rights in Securities Investment Business, etc.” that are subject to disclosure regulation?

A1.

Basically, “Rights in Securities Investment Business, etc.” are such “securities equivalents” as interests in collective investment schemes that invest in business “mainly conducted through investment in Securities” (Article 3(iii)(a) of the FIEA) and beneficial interests of trusts, etc. which are rights similar to such interests in collective investment schemes (Article 3(iii)(b) of the FIEA). Rights in Securities Investment Business, etc. which exceed a certain scale are subject to application of the disclosure regulation (Article 3(iii)(b) of the FIEA).

2.

The FIEA provides that the specific scope of “Rights in Securities Investment Business, etc.” is to be specified by Cabinet Order, and Cabinet Order prescribes the “business mainly conducted through investment in Securities” as follows:

(i)

with regard to interests in collective investment schemes, the business of investing in Securities an amount exceeding 50% of the total investment in the scheme (the principal sentence of Article 2-9(1) of the FIEA Enforcement Order);

(ii)

with regard to beneficial interests of trusts, trusts operated by investing in Securities an amount exceeding 50% of the total value of assets that belong to the trust property (the principal sentence of Article 2-10(1)(i) of the FIEA Enforcement Order); and

(iii)

with regard to membership rights of general partnership companies, etc., business of investing in Securities an amount exceeding 50% of the total investment in the company (Article 2-10(1)(iii) of the FIEA Enforcement Order).

3.

However, investments, etc. in certain juridical persons that make commodity investments are excluded from (i) above (the items of Article 2-9(1) and Article 2-9(2) of the FIEA Enforcement Order), and beneficial interests of trusts, etc. pertaining to pensions such as employees’ pension are excluded from (ii) above (Article 2-10(1)(i) and Article 2-10(3) of the FIEA Enforcement Order), and these are not subject to disclosure regulation.

Q5.

In what kinds of cases is it necessary to submit a Securities Registration Statement and Annual Securities Reports for interests in investment-type collective investment schemes, etc.?

A1.

In the case of making a Public Offering or Secondary Distribution of interests in investment-type collective investment schemes, etc. (“Rights in Securities Investment Business, etc.”), the FIEA obligates submission of a Securities Registration Statement and subsequently obligates periodical submission of Annual Securities Reports (Article 24(1)(iii) of the FIEA as applied mutatis mutandis pursuant to Article 24(5) of the FIEA), similar to the case with other Securities.

2.

Even in the case of not having submitted a Securities Registration Statement pertaining to a Public Offering or Secondary Distribution, the FIEA obligates the submission of Annual Securities Reports when the Public Offering or Secondary Distribution exceeds a certain scale. Specifically, even where “Solicitation for Acquisition” (Article 2(2)(iii) of the FIEA) or “Procedures Relating to Securities Issuance for Reorganization” (Article 2-2(2) of the FIEA) with regard to Rights in Securities Investment Business, etc. which are beneficial interests of trusts (Article 2(2)(i) of the FIEA), membership rights of general partnership companies, etc. (Article 2(2)(iii) of the FIEA) or interests in collective investment schemes (Article 2(2)(v) of the FIEA) do not fall under the category of “Public Offering of Securities” (Article 2(3) and Article 4(1) of the FIEA) and a Securities Registration Statement has not been submitted, an obligation to submit Annual Securities Reports subsequently arises if the number of the holders of said Rights in Securities Investment Business, etc. becomes 500 or more, and the amount of assets, etc. pertaining to said Rights in Securities Investment Business, etc. is 100 billion yen or more (the proviso to and item (iv) of Article 24(1) of the FIEA as applied mutatis mutandis pursuant to Article 24(5) of the FIEA; Article 4-2(2) to (5) of the FIEA Enforcement Order).

3.

As for the method for calculating whether the number of holders is 500 or more as mentioned above, the FIEA provides that the number to be referred to is the number of persons stated in the registry of holders for Specified Securities with the same trust property, contents of distribution claims as beneficiaries, and due date in the case of beneficial interests of trusts, the same contents of membership rights in the case of membership rights of general partnership companies, etc., or the same contents of rights of Equity Investors in the case of interests in collective investment schemes (Article 24(4) of the FIEA as applied mutatis mutandis pursuant to Article 24(5) of the FIEA; Article 26-2 of the Cabinet Office Ordinance on Disclosure of the Contents, etc. of Specified Securities).

Q6.

What is the disclosure system for the so-called asset finance-type instruments?

A1.

Securities subject to disclosure regulation can be divided into corporate finance-type instruments (securities) that place value in the creditworthiness of the issuing entity as a company, such as share certificates and corporate bond certificates, and asset finance-type instruments (securities) of which value is backed by assets held by the issuing entity, such as funds and asset-backed securities (ABS), according to their nature.

2.

In order to ensure appropriate disclosure to investors according to the characteristics of the respective Securities, it is considered desirable to develop separate disclosure regulation for each of such Securities categories.

3.

From such a viewpoint, the financial instruments legislation defines asset finance-type securities (the legal term is “Specified Securities”) as “Securities specified by Cabinet Order as those for which information that will have a material influence on investors' Investment Decisions is information on assets investment or other similar business conducted by the Issuer of the Securities” (Article 5(1) of the FIEA), and specifies their specific scope by Cabinet Order (Article 2-13 of the FIEA Enforcement Order). For such securities, the FIEA requires more detailed disclosure than for other securities concerning information on the contents of assets and information on the entity investing such assets and the contents of the investment service (Article 5(5), Article 24(5), and Article 24-5(3) and (4) of the FIEA, etc.).

Q7.

What are the requirements for exemption from the continuous disclosure obligation?

A1.

Even when a continuous disclosure obligation has arisen due to the submission of a Securities Registration Statement pertaining to a Public Offering or Secondary Distribution of Securities, if the Securities are not listed on a Financial Instruments Exchange and their liquidity has declined with a decrease in the number of their holders, there will be little need to make continuous disclosure. Therefore, if such Securities have less than 25 holders, they are exempted from application of the continuous disclosure obligation by obtaining approval from the Prime Minister (the second sentence of the proviso to Article 24(1) of the FIEA; Article 4 of the FIEA Enforcement Order; Article 16(2) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs).

2.

Also, Securities, Share Certificates, etc. have no maturity period and it is rare for a company that has submitted a Securities Registration Statement pertaining to share certificates to have less than 25 shareholders. Therefore, companies that have submitted a Securities Registration Statement pertaining to Share Certificates, etc. are exempted from application of the continuous disclosure obligation if the public interest or protection of investors would not be impaired even if they do not submit Annual Securities Reports (the first sentence of the proviso to Article 24(1) of the FIEA).

3.

Specifically, where a company needs to submit Annual Securities Reports due to having submitted a Securities Registration Statement concerning a Public Offering or Secondary Distribution of share certificates or preferred equity investment certificates (Article 3-5(1) and Article 4-10(1) of the FIEA Enforcement Order; including not only those issued by a foreign company, but also depositary receipts in the case where share certificates or preferred equity investment certificates issued by a foreign company have been brought into Japan in the form of depositary receipts), and where the number of holders (shareholders, etc.) on the last days of the five preceding business years including the current business year is less than 300 (Article 3-5(2) and Article 4-10(2) of the FIEA Enforcement Order), if the company obtains approval from the Prime Minister, it is exempted from application of the continuous disclosure obligation.

4.

In the case of a Japanese company, the number of holders of Share Certificates, etc. in this case is determined based on the number of persons stated or recorded in the shareholder registry, etc. on the last day of the business year immediately prior to the business year that includes the day of application for the approval and the last days of the business years that began within four years before the day on which that immediately prior business year began (Article 15-3(2) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs).
In the case of a foreign company, the determination is made as follows.

(i)

In the case of a foreign company whose share certificates have been listed on a Japanese Financial Instruments Exchange in the past and are currently listed on a Foreign Financial Instruments Market, the number is determined based on the number of persons who had held share certificates of said foreign company on the day of the delisting from the Japanese Financial Instruments Exchange and who have continued to hold the share certificates after the delisting (Article 15-3(3)(i) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs).

(ii)

In the case of a foreign company whose share certificates have never been listed on a Japanese Financial Instruments Exchange and are currently listed on a Foreign Financial Instruments Market, the number is determined based on the number of persons who have acquired share certificates of said foreign company through a Public Offering or Secondary Distribution and who have continued to hold the share certificates thereafter (Article 15-3(3)(ii) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs).

(iii)

In the case of a foreign company whose share certificates are not listed on a Foreign Financial Instruments Market, the number is determined based on the number of all persons who hold share certificates of said foreign company in Japan (the main clause of Article 15-3(3) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs).

Quarterly disclosure

Q8.

What is the quarterly disclosure system?

A1.

The FIEA provides that companies subject to the quarterly reporting system are Issuers whose Share Certificates, etc. are listed on a Financial Instruments Exchange or registered with an over-the-counter market (Article 24-4-7(1) of the FIEA; Article 4-2-10(1) of the FIEA Enforcement Order).

2.

The contents of disclosure under the quarterly reporting system (“Matters to Be Stated in a Quarterly Securities Report”) are specified by Cabinet Office Ordinance; they are basically information on a consolidated basis such as Quarterly Consolidated Financial Statements (Article 24-4-7(1) of the FIEA; Article 17-15(1), Form 4-3 for Japanese companies and Form 49-3 for foreign companies of the Cabinet Office Ordinance on Disclosure of Corporate Affairs). However, the report for the second quarter to be submitted by companies that engage in business specified by Cabinet Office Ordinance such as banks and insurance companies (“Company Engaged in a Specified Business”) (Article 17-15(2) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs) must include not only information on a consolidated basis (“Matters to Be Stated in a Quarterly Securities Report”), but also non-consolidated Interim Financial Statements, etc. (Article 24-4-7(1) of the FIEA; Article 17-6(1) of the Cabinet Office Ordinance on Disclosure of Corporate Affairs). Disclosure of such information is required because such information is also considered to be important investment information for investors in the case of companies that are subject to a capital adequacy ratio regulation or the like on a non-consolidated, semiannual basis.

3.

Quarterly Consolidated Financial Statements and Quarterly Financial Statements must undergo an audit certification by a certified public accountant or auditing firm, and the specific procedures, etc. are provided by the Cabinet Office Ordinance on Audit Certification of Financial Statements, etc. (Article 193-2(1) of the FIEA; Article 3 of the Cabinet Office Ordinance on Audit Certification of Financial Statements, etc.).

4.

The time limit for submitting a Quarterly Securities Report is within 45 days from the end of a quarter (Article 24-4-7(1) of the FIEA; Article 4-2-10(3) of the FIEA Enforcement Order). However, the time limit for Companies Engaged in a Specified Business, such as banks and insurance companies, to submit a Quarterly Securities Report for the second quarter is within 60 days from the end of the second quarter, because they also need to disclose non-consolidated Interim Financial Statements, etc. (Article 24-4-7(1) of the FIEA; Article 4-2-10(4)(i) of the FIEA Enforcement Order).

5.

A Quarterly Securities Report is made available for public inspection for three years from the day of submission, as in the case of a Semiannual Securities Report (Article 25(1)(vii) of the FIEA).

Q9.

Which companies are obligated to submit Quarterly Securities Reports?

A1.

The purpose of the quarterly disclosure is to provide information on the business performance, etc. of a company to investors in a more timely manner as information that contributes to making Investment Decisions regarding the company.

2.

Companies for which information on business performance, etc. needs to be provided more frequently as investment information are considered to be companies in a high-liquidity trading market where a wide range of investors are expected to participate. Therefore, it is appropriate to make companies whose Securities are listed on a Financial Instruments Exchange or registered with an over-the-counter market subject to the quarterly reporting system, in principle. Cabinet Order provides for Issuers who have the following Securities listed on a Financial Instruments Exchange or registered with an over-the-counter market as target companies (Article 24-4-7(1) of the FIEA; Article 4-2-10(1) of the FIEA Enforcement Order):

(i)

share certificates;

(ii)

preferred equity investment certificates;

(iii)

Securities issued by a foreign entity which have characteristics of the Securities set forth in (i) or (ii) above;

(iv)

beneficiary securities of a Securities trust (Article 2-3(iii) of the FIEA Enforcement Order) of which the entrusted Securities are any of the Securities set forth in (i) through (iii) above; and

(v)

depositary receipts which indicate rights pertaining to any of the Securities set forth in (i) through (iii) above.

3.

A company submitting an Annual Securities Report may voluntarily submit Quarterly Securities Reports even if its Securities are not listed on a Financial Instruments Exchange or registered with an over-the-counter market (Article 24-4-7(2) of the FIEA). However, an Issuer of Specified Securities (Article 5(1) of the FIEA; Article 2-13 of the FIEA Enforcement Order) may not submit Quarterly Securities Reports even voluntarily.

Q10.

Are foreign companies also obligated to submit Quarterly Securities Reports?

A.

Foreign companies are also obligated to submit Quarterly Securities Reports as in the case of Japanese companies if Share Certificates, etc. they have issued are listed on a Financial Instruments Exchange or registered on an over-the-counter market in Japan (Article 24-4-7(1) of the FIEA; Article 4-2-10(1)(iii) through (v) of the FIEA Enforcement Order).

Q11.

Are there penal provisions concerning Quarterly Securities Reports?

A1.

A person who submits a Quarterly Securities Report containing false statements on important matters is punished by imprisonment with work for not more than five years or a fine of not more than five million yen, or both (individual) and a fine of not more than 500 million yen (juridical person) (Article 197-2(vi) and Article 207(1)(ii) of the FIEA). A person who fails to submit a Quarterly Securities Report is punished by imprisonment with work for not more than one year or a fine of not more than one million yen, or both (individual) and a fine of not more than 100 million yen (juridical person) (Article 200(v) and Article 207(1)(v) of the FIEA).

2.

In addition, a person who submits a Quarterly Securities Report containing false statements on important matters must pay an Administrative Monetary Penalty (Article 172-4(2) of the FIEA).

Internal control over financial reporting

Q12.

Why was the Internal Control Report system introduced?

A1.

In order for the Securities market to fully demonstrate its functions, it is indispensable that corporate information is properly disclosed to investors. However, incidents of inappropriate corporate financial disclosure have occurred in succession recently. It has been pointed out that companies' internal control over financial reporting may not have been functioning effectively in such incidents. Enhancement of internal control over financial reporting is an important task for ensuring proper disclosure.

2.

From such viewpoint, the FIEA introduced the Internal Control Report system as a measure to enhance internal control over financial reporting (Article 24-4-4 and Article 193-2(2) of the FIEA). The Internal Control Report system obligates Listed Companies, etc. to ensure that assessment by the management and audit by a certified public accountant or an audit firm are conducted with regard to the effectiveness of the internal control over financial reporting.

Q13.

What are the details of the Internal Control Report system, and from when is it applied?

A1.

Cabinet Order provides that listed companies (see Article 24(1)(i) of the FIEA) are basically the entities subject to the Internal Control Report system (Article 24-4-4(1) of the FIEA; Article 4-2-7(1) of the FIEA Enforcement Order).

2.

As for the matters to be disclosed under the Internal Control Report system, an Internal Control Report containing the results of assessment of the system necessary for ensuring appropriateness of documents on finance and accounting and other information (prepared on a consolidated basis) is to be submitted together with the Annual Securities Report (Article 24-4-4(1) of the FIEA). The matters to be stated in the Internal Control Report are specified by Cabinet Office Ordinance. Specifically, they are as follows: (1) matters concerning the basic framework of the internal control over financial reporting; (2) matters concerning the scope, Reference Date, and procedure of the assessment; (3) matters concerning the assessment results; and (4) supplementary matters (Article 24-4-4(1) of the FIEA; Article 4 and the item (i) form of the Cabinet Office Ordinance on the System for Ensuring Appropriateness of Documents on Finance Calculation and Other Information (hereinafter referred to as the "Internal Control Ordinance").

3.

The Internal Control Report is required to undergo an audit process (internal control audit) by a certified public accountant or an audit firm and receive the certification (Article 193-2(2) of the FIEA).

4.

The Internal Control Report and other disclosure documents are to be made available for public inspection for five years from the date of their submission (Article 25(1)(vi) of the FIEA).

5.

The provisions on the Internal Control Report system came into effect on September 30, 2007 (the date of enforcement of the FIEA), and have been applied to business years starting on or after April 1, 2008 (Article 15 of the Supplementary Provisions of the Revising Act).

Q14.

What is the scope of companies that are obligated to submit an Internal Control Report?

A1.

Since the purpose of introduction of the Internal Control Report system is to ensure proper disclosure of corporate information to investors, it is appropriate to apply the system basically to companies listed on highly liquid secondary markets where a broad range of investors are to invest. Accordingly, the target companies are to be companies whose Securities, such as share certificates and preferred equity securities, are listed and traded on securities markets or over-the-counter markets (including Cooperative Structured Financial Institutions) (Article 24-4-4(1) of the FIEA; Article 4-2-7(1) of the FIEA Enforcement Order).

2.

A company submitting an Annual Securities Report (excluding such report pertaining to a certain type of securities) may submit an Internal Control Report voluntarily, even if it is not a listed company, etc. (Article 24-4-4(2) of the FIEA).

Q15.

Are foreign companies also obligated to submit an Internal Control Report?

A1.

If a foreign company is a listed company, etc. in Japan, it is obligated to submit an Internal Control Report and documents to be attached thereto, as in the case of a Japanese company (Article 24-4-4(1) and (4) of the FIEA; Article 4-2-7(1)(iii) through (v) of the FIEA Enforcement Order).

2.

In certain cases, such as where the Commissioner of the Financial Services Agency gives approval, a foreign company may submit a report assessing the internal control over financial reporting that has been disclosed in its home country, etc. as the Internal Control Report (Article 24-4-4(1) of the FIEA; Article 11 of the Internal Control Ordinance).

3.

In certain cases, a foreign company submitting an Annual Securities Report in Japan may submit documents stating the matters to be stated in an Internal Control Report, etc. which are prepared in English, in lieu of an Internal Control Report and other related documents prepared in Japanese (Article 24-4-4(6) of the FIEA). In order to implement this provision, required revisions will be made to relevant Cabinet Orders and Cabinet Office Ordinances in around spring of 2008.

Q16.

What are the standards for assessment and audit of the internal control over financial reporting?

A1.

The FIEA and regulations provide that, when preparing an Internal Control Report and an internal control audit report (a report on audit certification of the Internal Control Report), matters not specified by Cabinet Office Ordinance should be stated in accordance with the "generally accepted assessment standards for the internal control over financial reporting" and the "generally accepted audit standards and practices for the internal control over financial reporting" (Article 24-4-4(1) and Article 193-2(2) of the FIEA; Article 1(1) and (3) of the Internal Control Ordinance).

2.

The standards and the practice standards published by the Business Accounting Council are regarded as generally accepted assessment and audit standards for the internal control (Article 1(4) of the Internal Control Ordinance).

3.

On February 15, 2007, the Business Accounting Council compiled and published "On the Setting of the Standards and Practice Standards for Management Assessment and Audit concerning Internal Control Over Financial Reporting."

4.

The standards and practice standards for assessment and audit concerning internal control over financial reporting consist of three sections: "I. Basic Framework of Internal Control," "II. Assessment and Report on Internal Control Over Financial Reporting," and "III. Audit on Internal Control Over Financial Reporting." The practice standards cite the standards and indicate practical guidance concerning the cited standards.

5.

The outline of the standards and practice standards for assessment and audit concerning internal control over financial reporting is as follows:

• (1)Basic framework of internal control
  Internal control is a process basically performed in order to provide reasonable assurance of achieving four objectives: (i) effectiveness and efficiency of business operations, (ii) reliability of financial reporting, (iii) compliance with applicable laws and regulations relevant to business activities, and (iv) safeguard of assets. Internal control consists of six basic components: (i) control environment, (ii) risk assessment and response, (iii) control activities, (iv) information and communication, (v) monitoring, and (vi) response to IT.

• (2)Assessment and report on internal control over financial reporting
  Management has the role and responsibility to design and operate internal control. It is particularly vital for management to assess the effectiveness of the internal control over financial reporting and report its conclusion externally. In evaluating the effectiveness of internal controls, management should first assess internal controls that have a material impact on overall consolidated financial reporting ("company-level controls") and, based on the results, assess the "operational process-level controls." Management is then to prepare an "Internal Control Report" and state the results of said assessment on the effectiveness of the internal controls over financial reporting, etc. (such as "effective" or "not effective due to the presence of material deficiencies that should be disclosed").

• (3)Audit on internal control over financial reporting
  The auditors audit the results of the management’s assessment of the effectiveness of internal control over financial reporting. They first examine the appropriateness of the scope of assessment as determined by the management, and then examine the management's assessment of company-level controls and the assessment of operational process-level controls performed by the management based on the result of assessments of company-level controls. The auditors prepare an “internal control audit report" and express their opinion ("unqualified opinion," "qualified opinion," or "adverse opinion") and other matters therein.

Q17.

What was the background behind the establishment of the standards and practice standards for assessment and audit concerning internal control over financial reporting?

A1.

In order to ensure appropriate implementation of assessment of the effectiveness of internal control over financial reporting and audit by a certified public accountant or an audit firm in practice, it is necessary to formulate assessment/audit standards and practical guidance.

2.

From such viewpoint, the Internal Control Committee (chair: Shinji Hatta, professor, Aoyama Gakuin University) of the Business Accounting Council studied the details of internal control practices in Japanese companies as well as internal control standards in the United States and other countries, and made deliberations. On December 8, 2005, the committee compiled "Draft Standards for Management Assessment and Audit concerning Internal Control Over Financial Reporting." At that time, many comments were offered requesting development of a set of practical guidance (practice standards) which will assist in application of the standards to actual practice. Therefore, a task force was set up within the committee, and discussions were held on draft practice standards.

3.

Following such discussions, on February 15, 2007, the Business Accounting Council (chair: Hideyoshi Ando, professor, Hitotsubashi University) finally published "About the Setting of the Standards and Practice Standards for Management Assessment and Audit concerning Internal Control Over Financial Reporting (Council’ Opinion)."

Q18.

What points should be kept in mind when operating the standards and practice standards for assessment and audit concerning internal control over financial reporting?

A1.

Ensuring proper disclosure is primarily the responsibility of management, and management has the role and responsibility to design and operate internal control. From such viewpoint, the design and operation of internal control should not be uniform, but should vary by company, in accordance with the environment surrounding the company, the characteristics of its business, its size, etc. Management is expected to undertake appropriate efforts to effectively fulfill the functions and the roles of internal controls in accordance with the specific circumstances of the company.

2.

In designing the Internal Control Report system, the important point of how the system should be efficiently operated while securing its effectiveness was discussed. Therefore, with regard to operation of the standards and practice standards, very specific guidelines are indicated for the development, assessment, and audit of internal control over financial reporting, including indication of numerical examples (such as the guideline for determining a "material deficiency that should be disclosed" (around 5% of consolidated pretax profit)), while taking into account the opinions of people who are actually engaged in such assessment or audit and maintaining the basic idea of respecting the original efforts of the individual companies.

3.

Meanwhile, the following points need to be kept in mind upon operation of the standards and practice standards:

• (1)the basic idea indicated in the standards and practice standards should be observed sufficiently, and the standards and practice standards should not be applied in a formal, uniform, or inflexible manner deviating from the basic idea;

• (2)since the standards and practice standards have been prepared to be commonly applied to all companies, how internal control should be designed and operated in accordance with the type of business and the company's characteristics should be determined based on the original efforts of the individual companies.

Q19.

What is the scope of "internal control over financial reporting"?

A1.

The Internal Control Report system introduced by the FIEA requires assessment by management and audit by auditors with a specific focus on "internal control over financial reporting," from the viewpoint of ensuring proper disclosure. Therefore, if the internal control system developed by a company also covers processes other than financial reporting, the part of the system irrelevant to financial reporting is not subject to the assessment and audit.

2.

"Financial reporting" is external reporting of both 1) financial statements and 2) disclosure information and others that could have a material effect on the reliability of financial statements. "Internal control over financial reporting" is the system to ensure that financial reporting in a company is properly prepared according to laws and regulations (Article 24-4-4(1) of the FIEA; Article 2(i) and (ii) of the Internal Control Ordinance).

3.

The practice standards specifically indicate the scope of financial statements and disclosure information and others that could have a material effect on the reliability of financial statements. Other than financial statements, the following are mentioned as matters covered by the scope: (1) disclosure information to be provided as a summary, excerpt, or breakdown of the values presented in the financial statements; and (2) matters that are closely related to the decision of whether an entity is an affiliate, decision on the scope of consolidation, and other decisions involved in preparing the financial statements.

Q20.

How does the Japanese Internal Control Report system differ from the Internal Control Report system pertaining to financial reporting that was introduced in the United States by the Sarbanes–Oxley Act of 2002?

A1.

The U.S. Internal Control Report system under Section 404 of the Sarbanes–Oxley Act of 2002 (SOX) requires that the companies registered with the U.S. Securities and Exchange Commission (SEC) include an Internal Control Report stating the results of assessment of the effectiveness of internal control over financial reporting in the annual report, and that such Internal Control Report undergo audit by an auditor. It is presumed that there is hardly any difference in the basic framework of the Japanese and U.S. systems.

2.

In the United States, the Internal Control Report system has been acclaimed to contribute to raising the awareness of the management, enhancing investors' confidence in financial reporting, and increasing the efficiency of companies' business operations. At the same time, however, it has been pointed out that the cost of assessment and audit is swelling, and is affecting the international competitiveness of the U.S. capital market. Accordingly, in June 2007, the U.S. SEC newly formulated and put into effect guidance on management assessment, and in July 2007, the Public Company Accounting Oversight Board (PCAOB) reviewed the system, including revision of the audit standards.

3.

Due to such circumstances, when the Business Accounting Council developed the standards and practice standards, it verified the status of operation of the system that was already being introduced in the United States, and incorporated the following measures so as to prevent an excessive cost burden:

• (1)Using top-down/risk-based approach
  Operational process-level controls are assessed based on the assessment of the results of company-level controls (internal controls that have a material impact on overall consolidated financial reporting), focusing on the risks that could create material misstatements.

• (2)Simplifying classification of deficiencies of internal controls
  Classification of deficiencies in internal control was simplified into two categories: "material deficiencies that should be disclosed" and "deficiencies" (the deficiencies are classified into three categories in the United States: "material weakness," "significant deficiencies," and "deficiencies").

• (3)Not adopting direct reporting
  Audit is conducted only on assessment of the internal control that has been conducted by management. The direct reporting, which was adopted in parallel with the audit of management’s assessment in the United States at first and where auditors directly assess the internal control (audit irrelevant to management’s assessment), was not adopted in Japan. (Later, based on PCAOB's new auditing standard (Auditing Standard No. 5; approved by SEC in July 2007), the United States abolished audit on management’s assessment of the internal control, and adopted direct reporting only.)

• (4)Integrated implementation of internal control audit and audit of financial statements
  Internal control audits are to be performed by the same auditors responsible for auditing the company's financial statements, in principle. Audit evidence obtained in an audit may be used in both audits. (In the United States, the two audits must be performed by the same audit firm, but not necessarily by the same auditors.)

• (5)Preparation of internal control audit report and financial statement audit report in a unified form
  The internal control audit report is, in principle, to be prepared in conjunction with the report of financial statements audit.

• (6)Coordination between auditors and audit committee / internal auditors
  Auditors are to appropriately coordinate with the audit committee, etc. and, when necessary, make use of the work of internal auditors.

Q21.

Are there penal provisions against those who violate provisions of Internal Control Reports?

A.

When a person submits an Internal Control Report including a misstatement on important matters or fails to submit an Internal Control Report, the person is punished by imprisonment with work for not more than five years or by a fine of not more than five million yen, or both (in the case of an individual) or a fine of not more than 500 million yen (in the case of a juridical person) (Article 197-2(v) and (vi) and Article 207(1)(ii) of the FIEA).

Confirmation Letter

Q22.

Why was the Confirmation Letter system introduced concerning the contents of Annual Securities Reports, etc.?

A1.

In light of the recent cases of inappropriate practices related to disclosure, the Internal Control Report system was introduced under the FIEA in order to enhance internal control over financial reporting by Listed Companies, etc.

2.

On the premise of developing an effective internal control system, the Confirmation Letter system aims to enhance the appropriateness of Annual Securities Reports, etc. by obligating the management themselves to confirm the appropriateness of the contents thereof and attach to Annual Securities Reports, etc. a Confirmation Letter containing a statement to that effect (Article 24-4-2, Article 24-4-8 and Article 24-5-2 of the FIEA).

3.

As the new Confirmation Letter system became applicable for business years starting on April 1, 2008, and later, the previous voluntary Confirmation Letter system (introduced in April 2003) was abolished. However, it is prescribed that when a Confirmation Letter is attached to Annual Securities Reports, etc. submitted on or before March 31, 2008, the procedures under the previous system should be followed (Article 3(1) through (3) of the Supplementary Provisions of the Cabinet Office Ordinance for Partial Revision of the Cabinet Office Ordinance on Disclosure of Corporate Affairs, etc.), so a Confirmation Letter may therefore be attached to Annual Securities Reports, etc. submitted by then on a voluntary basis.

Q23.

What kind of system is the Confirmation Letter system?

A1.

Companies subject to the Confirmation Letter system are specified by Cabinet Order and they are basically listed companies (see Article 24(1)(i) of the FIEA) as in the case of the Internal Control Report system (Article 24-4-2(1), Article 24-4-8(1) and Article 24-5-2(1) of the FIEA; Article 4-2-5(1) of the FIEA Enforcement Order).

2.

With regard to the contents of a Confirmation Letter, a letter confirming that statements contained in the Annual Securities Reports, etc. are appropriate under the Financial Instruments and Exchange Act and Related Regulations is to be submitted together with Annual Securities Reports, etc. (Article 24-4-2(1) of the FIEA, etc.).

3.

A Confirmation Letter is to be provided for public inspection for five years from the day of submission (Article 25(1)(v) of the FIEA).

Q24.

Which companies are obligated to submit Confirmation Letters?

A1.

The purpose of introducing the Confirmation Letter system is to ensure proper disclosure of corporate information. Therefore, it is appropriate to target listed companies whose Securities are listed on a high-liquidity trading market where a wide range of investors are expected to participate, as in the case of the Internal Control Report system. From such a viewpoint, the FIEA makes companies (including Cooperative Structured Financial Institutions) whose Securities, such as share certificates and preferred equity investment certificates, are listed on a Financial Instruments Exchange or registered with an over-the-counter market subject to the Confirmation Letter system (Article 24-4-2(1), Article 24-4-8(1) and Article 24-5-2(1) of the FIEA; Article 4-2-5(1) of the FIEA Enforcement Order).

2.

A company submitting an Annual Securities Report (excluding a report pertaining to Specified Securities) may voluntarily submit Confirmation Letters even if the company is not a Listed Company, etc. (Article 24-4-2(2), Article 24-4-8(1) and Article 24-5-2(1) of the FIEA).

Q25.

Are foreign companies also obligated to submit Confirmation Letters?

A1.

Foreign companies are also obligated to submit Confirmation Letters as in the case of Japanese companies, if they are Listed Companies, etc. (Article 24-4-2(1) of the FIEA).

2.

In certain cases, foreign companies (“Reporting Foreign Companies”) may submit, instead of Confirmation Letters, documents which are prepared in English and which contain matters to be stated in Confirmation Letters (Article 24-4-2(6) of the FIEA). In order to implement this provision, necessary revisions are to be made to Cabinet Order and Cabinet Office Ordinance in around spring of 2008.

Q26.

What kinds of disclosure documents require submission of a Confirmation Letter?

A1.

Disclosure documents for which a Confirmation Letter must be submitted together are (i) Annual Securities Reports (Article 24-4-2 of the FIEA), (ii) Quarterly Securities Reports (Article 24-4-8 of the FIEA) and (iii) Semiannual Securities Reports (Article 24-5-2 of the FIEA).

2.

Also when a company submits an amendment report for its Annual Securities Report, Quarterly Securities Report or Semiannual Securities Report, the company needs to submit a Confirmation Letter with regard the amendment report together (Article 24-4-2(4), Article 24-4-8(1) and Article 24-5-2(1) of the FIEA).

Q27.

Which members of the management need to include their titles and names in the Confirmation Letter?

A.

The form of and the matters to be stated in a Confirmation Letter are specified by Cabinet Office Ordinance (Article 24-4-2(1), Article 24-4-8(1) and Article 24-5-2(1) of the FIEA). It is provided that members of the management whose titles and names must be included in a Confirmation Letter are the representative person(s) (representative director/representative executive officer) of the company submitting Annual Securities Reports, etc. and, in the case where the company has appointed the chief financial officer as a person with responsibilities equivalent to those of the representative person with regard to financial reporting, said chief financial officer (Article 17-5(1)(i) and Points to Note in Preparing Statements (3) and (4) of Form 4-2 of the Cabinet Office Ordinance on Disclosure of Corporate Affairs, etc.). The inclusion of the title and name of the chief financial officer also applies to Internal Control Reports (Article 24-4-4(1) of the FIEA; Article 4(i) and Points to Note in Preparing Statements (4) of Form 1 of the Internal Control Ordinance).

Q28.

How does a Confirmation Letter differ from a written oath of the management submitted under self-regulation of a Financial Instruments Exchange?

A1.

Under self-regulation of a Financial Instruments Exchange, listed companies are required to submit the following (e.g., Article 418 and Article 421 of the Securities Listing Regulations of the Tokyo Stock Exchange):

(i)

a document stating matters including the fact that the company recognizes that the Annual Securities Reports, etc. contain no false statements (a “confirmation document on the adequacy of Annual Securities Reports, etc.”); and

(ii)

a “written oath pertaining to proper disclosure” in which the company makes an oath that it will take a sincere attitude in the appropriate and timely provision of corporate information to investors, etc.

2.

Of these, the “confirmation document on the adequacy of Annual Securities Reports, etc.” in (i) above resembles the Confirmation Letter system introduced under the FIEA. While the effectiveness of the Confirmation Letter system under the FIEA is ensured by such measures as an order by the administration to submit an amendment Confirmation Letter (Article 24-4-3(1) of the FIEA), the effectiveness of the confirmation document of the Exchange is ensured by such methods as a request by the Exchange for the company to submit an improvement report (e.g., Article 502 of the Securities Listing Regulations of the Tokyo Stock Exchange).

Q29.

Are there penal provisions concerning Confirmation Letters?

A1.

A person who fails to submit a Confirmation Letter is punished by a non-criminal fine of not more than 300,000 yen (Article 208(ii) of the FIEA).

2.

If penal provisions were imposed in the case of having submitted a Confirmation Letter stating that contents of the Annual Securities Reports, etc. are proper while knowing that they contain false statements, the requirement for constitution of the crime would basically overlap with those of penal provisions in the case of having submitted Annual Securities Reports, etc. containing false statements on important matters. Therefore, in the case of having submitted a Confirmation Letter containing false statements, the penal provisions for the case of having submitted Annual Securities Reports, etc. containing false statements (Article 197(1)(i), Article 197-2(vi) and Article 207(1)(i) and (ii) of the FIEA) are applied, instead of providing for individual penal provisions for such a case.