United States: J-REIT Reform – Finance And Insider Trading Regulations

On December 7, 2012, the working group of the finance committee of the Financial Services Agency of Japan (the "Working Group") issued its final report (the "Final Report") with respect to the reform of the legal regime of Japanese real estate investment trusts1 ("J-REITs"). The Japanese government plans to submit a bill to effect the reform of J-REITs in the current Diet session.

A. PURPOSE OF J-REIT REFORM

The main purpose of the Working Group was to review the current J-REIT system, which started in 2001, and to propose reforms for improvements. In order to increase the attractiveness of J-REITs to investors around the globe and lead to greater assets and better management efficiency, an urgent priority was to make the J-REIT system comparable to the global standard. The Working Group was particularly focused on (i) improvements to financial stability and (ii) the implementation of mechanisms to attain more trust from investors.

In this client alert, among the various reforms proposed, we would like to introduce the following aspects: (i) increased means for fund raising and capital management and (ii) application of the insider trading regulations.

B. INCREASED MEANS FOR FUND RAISING AND CAPITAL MANAGEMENT FOR J-REITS

1. New Measures to be Implemented

While the J-REIT market has shown trends of recovery in recent months, the global financial crisis following the turmoil in the subprime market has revealed vulnerability and the lack of adequate means of financing J-REITs during financially challenging times.2 The Working Group intends to respond to this issue by implementing the following three measures:

(a) Rights Issues

In the Final Report, the Working Group concluded that it recommends the introduction of a system that would allow J-REITs to conduct rights issues (the "Rights Issues"), as this would contribute to the operational stability of J-REITs. In essence, the Rights Issues enable J-REITs to raise funds in financially challenging environments, while protecting the existing investors from dilution. Expansion of financing alternatives by J-REITs would contribute to raising the credibility of the J-REIT system by providing a contingency plan to respond to other possible financial crises.

Specifically, it is likely that the Investment Trust and Investment Corporation Law (the "ITICL") will be amended to permit J-REITs to issue warrant-type securities3 to unitholders for the purposes of conducting Rights Issues. These warrant-type securities would allow the unitholders to acquire investment units4 in J-REITs (the "Rights").

Before the Japanese government submits a proposed amendment to the ITICL, certain issues must be considered, for example, when the Rights can be issued and how the listing of the Rights may be established on a stock exchange. Additionally, despite a series of reforms to Japanese law and rules of stock exchanges and clearing institutions removing many obstacles for Japanese issuers to conduct Rights Issues, there have been only a few cases where ordinary business corporations (i.e. Kabushiki Kaisha) have conducted Rights Issues in Japan.5 Further legal reforms and efforts by Japanese market participants may be necessary in order to make Rights Issues a more popular and established financing method in Japan.

(b) Acquisition of Treasury Investment Units

In the current J-REIT system, except in certain limited circumstances,6 a J-REIT is prohibited from acquiring its own investment units. The Final Report states that the acquisition of its own investment units (the "Treasury Investment Units") should be allowed, as it contributes to the operational stability of the J-REITs. Through the permitted acquisition of Treasury Investment Units, J-REITs will have broader tools to structure and effect their capital strategies.

However, it is still unclear to what extent the acquisition of Treasury Investment Units will be permitted. For a Kabushiki Kaisha, the acquisition of its own shares is only allowed, as with the declaration of dividends, to the extent there are retained earnings and other distributable amounts within the company as defined in the Company Law. On the other hand, under the current provisions of the ITICL, J-REITs can make distributions without being subject to the requirement of having a 'distributable amount',7 and therefore by analogy, acquisition of Treasury Investment Units may also be permissible without any such restriction, unless the ITICL provides otherwise. The maximum amounts available for acquisition, acquisition procedures and the governing body that would authorize the acquisition, tax treatment and the after-treatment of acquired Treasury Investment Units are all outstanding issues that need to be considered.

(c) Capital Reduction

The Final Report also proposed to allow J-REITs to conduct capital reduction without returning capital to unitholders ("Capital Reduction without Consideration").

Capital Reduction without Consideration has been advocated by the J-REIT industry for some time. The issue arises, for example, when the market value of managed real estate substantially drops and requires the J-REIT to book an impairment loss. Due to the difference in the loss recognition rules under Japanese GAAP and tax laws, impairment losses may cause high corporate taxes to be imposed on J-REITs. Capital Reduction without Consideration is said to provide a straightforward method for a J-REIT to avoid this corporate tax consequence.

2. Other Measures Discussed

The Working Group also explored the feasibility of convertible investment corporation bonds8 and different classes of investment units (e.g. non-voting preferred units). However, with the simple governance structure used in J-REITs, it is difficult to balance the interests of different investors. The implementation of these measures was concluded to be premature and will not be permitted for J-REITs at this time.

C. APPLICATION OF INSIDER TRADING REGULATIONS TO INVESTMENT UNITS OF J-REITS

The investment units of J-REITs are currently not subject to the insider trading regulations (the "Insider Trading Regulations")[9] under the Financial Instruments and Exchange Law of Japan (the "FIEL"). This is mainly due to the fact that investment units of J-REITs were believed to have little risk of insider trading because the prices were thought to be determined based on the net asset value of managed real estate.

However, it has become clear that the prices of the investment units are volatile and greatly affected by the market forces. Therefore, in order to preserve the trust of the investors and the integrity of the market, the application of the Insider Trading Regulations is now seen as necessary with respect to the J-REIT investment units.

1. Final Report

In the Final Report, it has been concluded that the investment units of J-REITs should be subject to the Insider Trading Regulations. In addition, the Final Report especially pointed out that (i) in light of the fact that the asset managers (the "Asset Managers") of J-REITs acquire, hold and manage the material information of the acquiring assets, the officers, employees and other related persons of the Asset Managers shall be treated in the same way as those of the J-REITs themselves and (ii) given that the parent company of the Asset Manager (the "Sponsor") plays an important role in the provision of personnel, know-how and potential investment assets, the Sponsor should be subject to the Insider Trading Regulations as well.10

The Final Report also indicated that due to the distinct nature of J-REITs, the events that influence market prices of investment units differ from those of shares of Kabushiki Kaisha and also tend to not be clearly evident. Based on historical data of the events that have led to investment unit price changes, the Final Report provided examples of those changes as follows:

o Changes in the content and conditions of the investment units (e.g. announcements of public offerings);

o Changes in the J-REIT assets (e.g. announcements of major tenant departures; announcements of changes in financial forecasts);

o Changes in the operations or business of the J-REITs (e.g. announcements of bankruptcy); and

o Changes in the operations or business of the Asset Manager or Sponsor changes (e.g. announcements of changes of Sponsors).

In the proposed amendment to the ITICL, the details of material information subject to insider trading restrictions will likely be structured around these events.11

2. Other Developments in Insider Trading Regulations

In response to recent violations of the Insider Trading Regulations in equity offerings by Japanese issuers, the Financial Services Agency has announced a separate plan of further general amendments to the Insider Trading Regulations. Under the proposed amendments, transmitting non-public material information for the purpose of insider trading or encouraging trading while withholding such information will be included in the categories of illegal actions. Also, the penalties to be imposed on investment managers or financial intermediaries (such as securities companies) for violation of the Insider Trading Regulations will be revamped to achieve effective enforcement. These amendments, once introduced, would equally apply to J-REIT issuers, Asset Managers, Sponsors and investors.

Footnotes

1 In Japan, in practice, REITs take the legal form of an investment corporation (toshi hojin), as opposed to the form of investment trusts. In this newsletter, a J-REIT refers to an investment corporation that is listed on a Japanese stock exchange and invests primarily in real estate assets.

2 The serious impact even led to one J-REIT, New City Residence Investment Corp., filing for bankruptcy in October 2008.

3 The ordinary business companies (i.e. Kabushiki Kaisha) under the Companies Law of Japan (the "Company Law") can issue stock acquisition rights (shinkabu yoyaku ken) that represent rights to acquire shares at pre-determined purchase price and are transferrable to other investors. In Japanese Rights Issues, the issuer allots stock acquisition rights to all existing shareholders on a pro rata basis, free of consideration, and such stock acquisition rights are listed on a stock exchange.

4 These are the equity shares of J-REITs (i.e. equivalent to shares in Kabushiki Kaisha).

5 Issuers of these Rights Issues were Japanese small or mid-sized listed companies, all of which were "non-commitment type" Rights Issues where no securities company was involved as underwriter in the offering (i.e. these rights have adopted a mechanism where all unexercised rights lapse).

6 For instance, in the context of mergers of J-REITs, the assumption of the Treasury Investment Units (as defined herein) from the dissolving J-REIT and the purchase of the Treasury Investment Units from objecting investors are permitted (e.g. Articles 80, 149-8 and 149-13 of the ITICL).

7 However, in addition to the minimum net asset requirement under the ITICL, the rules of the Investment Trust Association of Japan provide for certain restrictions on distributions by a J-REIT in excess of its retained earnings (i.e. return of capital). Specifically, such distributions must be made with (i) 60% of the depreciation expenses for the relevant fiscal period or (ii) if the amount of the income prescribed under the same rules is less than the taxable income, the amount of such taxable income.

8 Convertible investment corporation bonds are bonds that could be converted into investment units with a predetermined conversion price.

9 To be precise, investment units of J-REITs are not subject to the general prohibition of insider trading provided for in Article 166 of the FIEL, but are subject to Article 167 of the FIEL (the prohibition of trading of target company's securities, when one is aware of a decision to conduct a tender offer or certain accumulation of shares of a listed (or traded in the over-the-counter market) target company).

10 Under the Insider Trading Regulations, certain corporate insiders (e.g. directors, employees, parties who conduct transactions with the listed company) as specifically enumerated in the FIEL, and any person who directly receives non-public material information from such corporate insiders, are prohibited from trading securities of a listed company before such material information is made public.

11 It is also likely that there will be a basket provision that picks up unremunerated items of information to be included in the categories of material information in the same way the current Insider Trading Regulations do with respect to shares of Kabushiki Kaisha.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Shusaku Iwasaki
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions