Overview of ''Financial Instruments and Exchange Law'' (Part 3)

The law for amending the Securities and Exchange Law and other financial laws (2006 Law No.65) and the law for abolishing and amending the related laws to implement the law for amending the Securities and Exchange Law and other financial laws (2006 Law No.66) were promulgated on June 14, following the approval and passage of the respective bills at the 164th Diet session held on June 7, 2006.
More specifically, the legislations can broadly be divided into the following four basic elements:
  (1) Development of a cross-sectoral legal system to protect investors regarding financial instruments with strong investment characteristics (legal system based on so-called ''Investment Services Law'');
(2) Enhancement of the disclosure system;
(3) Reinforcement of self-regulatory functions of stock exchanges; and
(4) Strict approach to unfair trading, etc.

Parts 1 and 2 reviewed ''1. Building a cross-sectoral legal system to protect investors regarding financial instruments with strong investment characteristics (legislation ''Investment Services Law'')''. This part reviews ''other revised provisions''.
* The Securities and Exchange Law and the Financial Instruments and Exchange Law are hereinafter referred to as ''SEL'' and ''FIEL'', respectively.


 Enhancement of Disclosure System
  1) Enhancing of Disclosure by Listed Companies, etc.
The latest legislations involve the following revisions of the disclosure requirements of corporate information for the purpose of ensuring the timely, speedy and proper disclosure of financial and corporate information.
a) Statutory Quarterly Reporting System
The system of quarterly disclosure-which is currently based on self regulations of stock exchanges-will become a statutory system, and listed companies, etc. will be obliged to submit a ''quarterly report''. The quality report will be subject to audits conducted by Certified Public Accountants (CPAs) and auditing firms (Article 24-4-7 and Article 193-2 of FIEL). Submission of the false quarterly reports will be subject to criminal or civil money penalties.
b) Enhancing Internal Control over Financial Reporting
- In order to ensure appropriate disclosure of financial and corporate information, ''internal control reports'' which provide an evaluation of the validity of internal control of financial reporting for each fiscal year will become a mandatory requirement for listed companies and will be subject to audits by certified public accountants or auditing firms (Article 24-4-4 and Article 193-2).
- Listed companies, etc. will be obliged to submit ''certification'' by management stating that descriptions in the securities report, quarterly reports, etc. are appropriate and in compliance with the FIEL and related regulations (Article 24-4-2 and Article 24-4-8, etc.).

2) Reviewing the Tender Offer System
The ''tender offer (TOB) system'' is a system that ensures transparency and fairness in stock transactions that may affect the management rights of a company. Specifically, by imposing duties to disclose information including offer periods, volume and prices to companies intending to conduct large volume off-exchange purchases of stock, a fair opportunity for shareholders of the target company to sell such stock is ensured.
In conjunction with the dramatic increase in corporate mergers and acquisitions (M&A) and the diversification of M&A methods in recent years, the number of cases of TOB-which is one of the means of M&A-is rising. Under these circumstances, the TOB system has been reviewed in this legislative revision as exemplified below.

a) Taking Measures against Law-evading Transactions and Ensuring Fairness amongst Bidders
Even if the number of buyers is extremely small (no more than 10 bidders within 60 days), TOB must be performed in cases where the shareholding accounts for more than one- third of all outstanding shares purchased outside of the stock exchange

- It will be made clear that aggressive buying involving transactions executed on and/or off the market that will result in shareholdings of one third or more will be subject to regulations on tender offers.
- If a party with shareholding of more than one third of the target company's shares begins a rapid buy-up while a tender offer of another party is in place, the former is obliged to make a tender offer also.
(paragraphs 1-4 and 1-5 of Article 27-2 of FIEL (amended SEL))


 Partial Introduction of Obligation to Buy All Stocks
-  In order to protect shareholders in cases where the shares are delisted, etc. after TOB, if a purchase will result in shareholdings of two thirds or more, offering companies are obliged to buy all of the tender offered shares. (paragraph 4 of Article 27-13 (matters of government ordinance))


 Enhancing Provision of Information to Investors
-  The targeted company will be obliged to submit a ''position statement report''. The targeted company may ask questions to the bidder in the ''position statement report''.
-  If the targeted company asks a question to the bidder in the ''position statement report'', the bidder is obliged to submit a ''response to questions''. (paragraphs 1, 2 and 11 of Article 27-10)
d) Extending the TOB Period
The period for tender offers is set between 20 and 60 days (on a calendar date basis) by the offering company.

-  The TOB period is due to be changed to business day basis, i.e., between 20 and 60 business days. (matters of government ordinance)
-  Bearing in mind that it may be necessary to make a counterproposal and give shareholders enough time to carefully think about it, the TOB period will be extended to 30 business days (matters of government ordinance) upon the targeted company's request if the original TOB period is short. (paragraphs 2 and 3 of Article 27-10)
e) Flexible Approach to Withdrawal of TOB, etc.
If target companies take countermeasures against the takeover, offering companies may withdraw tender offers or reduce offering prices. (paragraph 1-1 of Article 27-6 and paragraph 1 of Article 27-11 (matters of government ordinance))

3) Reviewing the reporting system for Large Shareholdings
''The reporting system for large shareholdings'' is a system to promptly disclose the status of large shareholdings to investors. Specifically, for example, if total shareholdings in a listed company reach above 5%, the shareholder must submit a ''report on large shareholdings'' within 5 business days from the date of the purchase. However, a special reporting system with a lower frequency of reporting is applied to institutional investors who are engaged in trading large volumes of shares, etc. in their daily business activities, considering the administrative workload associated with it and other such factors.
The latest legislations involve the revision of the reporting system for large shareholders as exemplified below, in response to the increasing number of cases in which purchases of shares in large volumes do not lead to M&A in recent years.
a) Reviewing Special Reporting System
In order to enhance transparency for investors, the reporting deadline, frequency, etc. will be reviewed.
If holding of listed shares, etc. reach above 5% of all outstanding shares
A report must be provided ''once every three months by the 15th of the following month''

A report must be provided ''roughly every two weeks (on every base date at least twice a month) within 5 business days''. (paragraphs 1 through 3 of Article 27-26 of FIEL (amended SEL))
b) Obligation to Submit Electrical Reports on Large Shareholdings
Submission of electrical reports on large shareholdings will become mandatory, aimed at making the information available to the public promptly via EDINET (Electronic Disclosure for Investors' NETwork). (Paragraph 30-2 of Article 27 of FIEL)

(3) Enhancement of Self-regulatory Functions of Stock Exchanges
Stock exchanges are allowed to be demutualized pursuant to the revision of the Securities and Exchange Law in 2000. There have been suggestions that an incorporated stock exchange is required to ensure the independence of the organization in charge of self-regulatory functions from other operations, due to the risk of conflict of interest arising between its ''profitability'' as a joint stock company and its ''self-regulatory operation'' aimed at ensuring fairness and transparency of transactions on the exchange. On the other hand, in discussions about the concrete organizational structure, there have been suggestions that attention needs to be paid to take finely-tuned action in accordance with the market circumstances.
The latest legislations develop the following systems in consideration of such discussions.
a) Self-regulatory Operations
Financial instruments exchanges will be required to properly engage in ''self-regulatory operations'' (such as operations concerning listing or delisting, and examination on the compliance of market participants) to enhance the quality of services provided by the exchanges (Article 84 of FIEL).

b) Self-regulatory Corporations and Self-regulatory Committees
- Financial instruments exchanges will be able to outsource all or part of their self-regulatory operations to a ''self-regulatory corporation'' (Article 102-2) with the Prime Minister's approval (Article 85). The majority of board members of the self-regulatory corporation must be outside board members (paragraph 3 of Article 102-23).
- An incorporated exchange will be able to establish a ''self-regulatory committee'' that determines matters relating to its self-regulatory operations (Article 105-4). The majority of members of the self-regulatory committee must be outside directors (paragraph 1 of Article 105-5).
   (Note)   Whether to adopt such organizational structures or not is at the discretion of each exchange. However, if an financial instruments exchange wishes to be listed on its own exchange or another exchange, it must obtain the Prime Minister's approval (Articles 122 and 124), in which case the framework to properly run the self-regulatory operations is also deemed to be subject to screening.

(4) Strict Approach to Unfair Trading, etc.
  1) Increase in maximum criminal penalty
In response to the series of scandals involving some listed companies recently, the statutory penalties under penal provisions of the Securities and Exchange Law have been strengthened as exemplified below, in order to enhance user protection, secure fairness and transparency in transactions and establish public confidence in the markets.
2) Countermeasures against ''misegyoku''
''Misegyoku'', a means of market manipulation, is a trading order with intention of canceling immediately.
Among the acts corresponding to ''misegyoku'', the act of applying to buy/sell shares by a customer is currently subject to criminal punishment on the grounds of being an act of market manipulation. The latest legislations involve the following revision aimed at ensuring the effectiveness of regulations on unfair trading, in consideration of the proposal made by the Securities and Exchange Surveillance Commission (SESC) dated November 29, 2005.
- The act of applying to buy/sell shares by a customer is subject to fines on the grounds of being an act of market manipulation (paragraph 1 of Article 174 of FIEL (revised SEL)).
- The act of applying to buy/sell shares by a securities company as a part of self-dealing activities is also subject to criminal punishment and fines on the grounds of being an act of market manipulation (paragraphs 2-1 and 3 of Article 159 and paragraph 1 of Article 174).

   ●Effective dates of legislation
  The effective dates of the amendments are as follows.

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Amendments of the Enforcement Ordinances and Orders of the Customer Identification Law


 Customer Identification Law

   The Customer Identification Law1 is a law that requires financial institutions to conduct an identification procedure etc. of a customer upon the opening of a deposit account or in the case of a transaction of a large sum, i.e., exceeding 2 million yen. It was legislated in April 2002 and came into force as of January 2003.
   Against the backdrop of these amendments were demands from the international community to address the growing need to combat money laundering in the wake of the 2001 9-11 terrorist attacks in the United States and the increasing number of drug- and gun-related crimes etc.


 Purposes of the Amendments

   The FATF (Financial Action Task Force on Money Laundering), an intergovernmental body whose mission is to fight money laundering and terrorism financing, developed a set of "Special Recommendations on Terrorist Financing" in 2001, one of whose recommendations was the Special Recommendation VII on "Wire transfers," which recommends FATF member countries to strengthen, by the end of 2006, customer identification measures in wire transfers exceeding 1,000 U.S. dollars or 1,000 Euros.
   As part of Japan's actions to implement the Recommendation above, necessary amendments were made recently to the Enforcement Ordinance of the Customer Identification Law and the Enforcement Regulation of the Customer Identification Law (promulgated on September 22 of this year with a view to being enacted on January 4, 2007).
   As a result of these amendments, financial institutions will, on and after January 4, 2007, be required to conduct identification procedures, etc. for any customer who makes a cash transfer exceeding 100,000 yen etc.


 Procedures in the Case of Transfer Exceeding 100,000 Yen

   On and after January 4, 2007, when the amendments take effect, customers will need to present a piece of ID, such as a driver's license, health insurance certificate or passport, at the teller's counter of a financial institution to transfer funds initiated with cash exceeding 100,000 yen. It should be noted that transferring funds initiated with cash exceeding 100,000 yen will no longer be allowed at ATMs.
   On the other hand, non-cash transfers from one deposit account to another will still be permitted in the same fashion as in the past, whether at an ATM or a teller's counter (if, however, customer identification procedures at the time of account opening have not been completed, transfers may not be allowed without the presentation of ID).

* To transfer funds from the remitter's own deposit account, customer identification is, as a general rule, not required.
○IDs to be requested for presentation:
For individuals : Driver's license, Health Insurance Certificate, National Pension Handbook, passport, Maternal and Child Health Handbook, Physically Disabled Persons' Certificate, Foreign Resident Registration Card, Basic Resident Register Card (indicating the name, address and date of birth) etc.
For corporations : Certificate on Registered Matter, etc.
4.  Conclusion
   The FSA is determined to make steady efforts in publicity and outreach activities, such as poster distribution and publication in newspapers and magazines, so that the new scheme should work smoothly. We have also advised financial institutions to develop a structure necessary to, among other actions, prevent any confusion at service counters and we will also thoroughly monitor its implementation progress in the future.

   While the new scheme may cause some inconvenience for users, the establishment of this scheme will make it possible to prevent illegitimate funds transfers via financial institutions and, even if such illegitimate funds transfers are conducted, to subsequently monitor them through checking and tracking.

   We would like to ask our citizens for their understanding and cooperation in regards to the recent amendments, which we have made to address international demands, to the cause of combating money laundering and terrorist financing.

1Law on Customer Identification and Retention of Records by Financial Institutions, and Prevention of Fraudulent Use of Deposit Accounts

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