Japan: Introduction Of Fair Disclosure Rules In Japan

1. Introduction

A bill amending the Financial Instruments and Exchange Act, the main statute codifying securities laws and regulating securities companies in Japan, including new rules requiring fair information disclosure by listed companies, etc. to investors (the "Fair Disclosure Rules"), was passed and enacted at the plenary session of the Upper House on May 17, 2017 (the "Amendment"). The Amendment will go into force on the day set forth by Cabinet Order not to exceed one year from the promulgation date (May 24, 2017). This newsletter offers commentary on the background of the Amendment, key points of the Fair Disclosure Rules, and anticipated moves by the authorities going forward.

2. What are the Fair Disclosure Rules?

Generally, the fair disclosure rules are referred to as the rules which ensure that when a listed company provides inside information to a third party before disclosing it to the public, such information must also be equally disclosed to other investors.

As its Japanese version, the Amendment has established the following system as the Fair Disclosure Rules: "When a listed company, etc. provides undisclosed material information in the course of its business to a certain recipient such as a securities company or an investor, such listed company, etc.must disclose such information via the internet, etc. at the same time if such provision is intentional or promptly thereafter if such provision is unintentional."

3. Background of the Amendment

Before the Amendment, rules in Japan requiring timely information disclosure by issuers had been limited to (i) extraordinary reports under the Financial Instruments and Exchange Act and (ii) the timely disclosure system under the securities exchange rules. The Fair Disclosure Rules were put on the backburner on the basis that issues warranting such rules had not explicitly surfaced.

In recent years, however, multiple cases have come to light where major securities companies have obtained "Corporate Information" (hojin kankei joho, meaning certain undisclosed information including material information about operations, business, or assets of the listed company, etc. that would have an impact on investors' investment decisions) through their analysts from listed companies, and provided it directly to customers or indirectly through sales representatives to lure customers to trade shares in such listed company, resulting in administrative sanctions against such securities companies.

Further, overseas investors had begun pointing out that fair disclosure rules have already been introduced in the U.S. and major jurisdictions in Europe and Asia, and similar rules should also be established in Japan to ensure credibility of the Japanese market.

With this as a backdrop, the Fair Disclosure Rules were introduced in Japan to ensure fair and timely information disclosure to investors, including individual investors and overseas investors, so that all investors can engage in trading with a sense of security.

4. Intent

In addition to the purposes outlined above, introduction of the Fair Disclosure Rules is also considered to have the following intent. While the design of such rules will be left in many instances to relevant government ordinances, the rules should be established and enforced without losing sight of such intent.

1. To encourage early information disclosure by issuers and dialogue with investors
   (By establishing and clarifying issuer-side disclosure rules, the Fair Disclosure Rules encourage prompt disclosure of information by issuers and eventually promote dialogue between issuers and investors.)
2. To create an environment that allows objective analysis by analysts
   (The Fair Disclosure Rules create an environment for more objective and accurate analyses and recommendations by analysts.)
3. To change the mindset of investors toward making investments from a mid- to long-term perspective
   (By ensuring fairness in the timing of information disclosure by issuers, the Fair Disclosure Rules promote a change in the mindset of investors toward making investments from a mid- to long-term perspective rather than short-term trading based on so-called "information tips.")

The specifics of the Fair Disclosure Rules introduced in the Amendment are described below. (See the table for a summary.)

5. Point (1): Scope of information that triggers the Fair Disclosure Rules

The Fair Disclosure Rules of the Amendment newly define "Material Information" (juyo joho) as "material information about operations, business, or assets of the listed company, etc. that would have a material impact on investors' investment decisions," with the obligation to disclose to be imposed on listed companies, etc. only when such Material Information is communicated.

The following discussion took place at the Task Force on Fair Disclosure Rules (the Working Group on Financial Markets of the Financial System Council) regarding the scope of such Material Information.

1. The scope of Material Information should in principle correspond with the scope of information which triggers Japan's insider trading regulations (the "Material Facts," juyo jijitsu).
2. Material Information should also include the following: "non-public information of a precise nature concerning an issuer or its financial instruments which would likely have a material effect on the price of the issuers' securities if made public."
3. Meanwhile, Material Information does not include information that may have an effect on an investment decision when combined with other information, but would not have an immediate effect on an investment decision by itself (so-called "mosaic information") (e.g., information provided to visitors on factory tours or at business briefings).

With respect to the information described in ii above, in cases of administrative disposition against major securities companies, it was found that six-month or quarterly earnings information (generally speaking, information on earnings for a period other than for a full fiscal year is not considered to constitute a Material Fact under insider trading regulations) was provided to certain customers.  According to the Task Force, "as long as it is accounting settlement information soon-to-be-announced, even if such information has not been officially approved by management or is within the scope of the immateriality standards [or does not meet the materiality standards of insider trading regulations], it could be material information which would affect investors' decisions." Based on the awareness that all such information should not be exempt from the rules, such information should also be treated as Material Information that triggers the Fair Disclosure Rules.

Further, when considering the scope of information described in (ii) above, it is worth noting that the language in the original draft of the Task Force report was amended at the final stage from "may have a material effect on the price of the issuers' securities if made public" to "would likely," thereby limiting the scope of such information.

Based on the above, we can see that the scope of Material Information that triggers the Fair Disclosure Rules is in principle wider than the scope of Material Facts referred to in the insider trading regulations under the Financial Instruments and Exchange Act, but is narrower than the scope of Corporate Information referred to in the Cabinet Office Ordinance on Financial Instruments Business, etc. (see the following illustration for a simplified image of the scope of these concepts).

6. Point (2): Scope of information providers that trigger the Fair Disclosure Rules

The Fair Disclosure Rules of the Amendment only apply when listed companies, etc. (or asset management companies of listed investment corporations), or the "officers, agents, employees, or other personnel" thereof, communicate information "in the course of their business."

This is because, since the Fair Disclosure Rules require fair and timely information disclosure by issuers, it is appropriate to limit the scope of the information providers that trigger the rules to those that fulfill roles and are responsible for information provision in the execution of business of a listed company, etc.

Accordingly, under the Fair Disclosure Rules, listed companies, etc. would not be forced to disclose Material Information even in a case where, for example, an employee with no involvement in the communication of business information divulges Material Information to a relative or friend as idle chatter.

7. Point (3): Scope of information recipients that trigger the Fair Disclosure Rules

The scope of information recipients that trigger the Fair Disclosure Rules of the Amendment is limited to those who are likely to be involved in the trading of securities. Specifically, a listed company, etc. is obligated to disclose under the Fair Disclosure Rules only when it provides Material Information to any of the parties listed below.

1. Securities companies, investment managers, investment advisors, investment corporations, credit rating agencies, or other parties whose business is to trade securities or provide financial analysis to third parties, including officers or employees of all these parties.
   (The official provision sets forth as follows: "Financial instruments business operators, registered financial institutions, credit rating agencies, or investment corporations, or other parties to be specified by Cabinet Office Ordinance, or their Personnel.")
2. Parties that are expected to trade securities of the issuer based on information obtained from such issuer.
   (The official provision sets forth as follows: "Any party so specified by Cabinet Office Ordinance as highly likely to engage in trading of securities of a listed company, etc. on the basis of investment decisions based on Material Information received by such person in connection with the investor relations activities of such listed company, etc.")

In this regard, the structural design is in contrast with the fair disclosure rules in Europe, where disclosure is enforced when material information is provided to any "third parties."

8. Point (4): Information provision that does not trigger the Fair Disclosure Rules

Even when a listed company, etc. provides Material Information to an information recipient that would trigger the Fair Disclosure Rules, disclosure is not required if the information recipient bears both of the following obligations:

• The obligation not to divulge secrets regarding non-public Material Information (confidentiality obligation); and
• The obligation not to trade listed securities (obligation not to engage in trading).

However, if a listed company, etc. becomes aware that such information recipient has divulged Material Information to a party described in the "scope of information recipients that trigger the Fair Disclosure Rules" (Section 7 above) which bears no confidentiality obligation, or has engaged in a transaction in violation of the confidentiality obligation or the obligation not to engage in trading, such listed company, etc. would be required to promptly disclose such Material Information.  

Notwithstanding the foregoing, even if a listed company, etc. becomes aware of a violation of the confidentiality obligation or the obligation not to engage in trading on the part of the information recipient, such company would be exceptionally exempt from the obligation to disclose when it is unable to disclose such Material Information due to "unavoidable reasons." This exemption has been established to avoid overly harsh consequences such as, for example, in a case where a concerned party not employed by a listed company divulges Material Information to a third party in violation of the confidentiality obligation regarding an M&A or equity finance matter that is being considered by such listed company, and such violation would force such company to disclose such Material Information despite it is rather a victim of an information leak.  The specific "unavoidable reasons" under which the obligation to disclose would be exempt are to be set forth by Cabinet Office Ordinance.

With respect to confidentiality obligations, if, for example, a bank or a securities company conducting investment banking bears a confidentiality obligation to the issuer by law, ordinance, or separate agreement, re-execution of a written confidentiality agreement is not considered to be necessary.

9. Point (5): Permitted methods of information disclosure under the Fair Disclosure Rules

Disclosure of Material Information under the Fair Disclosure Rules of the Amendment must be "through use of the internet or any other method set forth by Cabinet Office Ordinance."

Here, "use of the internet or any other method" is assumed to mean statutory disclosure (EDINET) and timely disclosure under the rules of Japan's stock exchanges (TDnet), as well as disclosure on the website of such listed company, etc.

Meanwhile, according to the Task Force, social networking sites are considered to be inferior to company websites in terms of reaching the general public, and are therefore unlikely to be recognized as a means of disclosing material information.

10. Point (6): Enforcement under the Fair Disclosure Rules

Under the Amendment, when it is found that Material Information has not been disclosed despite being required under the Fair Disclosure Rules, a listed company, etc. may be instructed to take measures to disclose such Material Information, and if it fails to comply with such instructions without good reason, it may be ordered to disclose. An individual who violates an order (e.g. a representative and/or a person in charge of disclosure of such company) will face criminal penalties (imprisonment up to six months; fines up to 500,000 yen).

According to statements from representatives of the Financial Services Agency in the Task Force, however, it is difficult to think of situations in which such penalties would in fact be levied. They note that it is listed companies that are subject to the Fair Disclosure Rules and, in terms of enforcement, disclosure would first be encouraged through administrative dialogue before instructions and orders are issued, and it is difficult to imagine companies violating those orders and penalties being imposed.

With respect to the introduction of the Fair Disclosure Rules in Japan, it has been observed that companies may become passive in providing information, and, in fact, a report has found that information disclosure by companies initially decreased after the introduction of such rules in the U.S. (it is said that companies became reassured and information disclosure returned to previous levels only after the SEC exhibited an unassertive stance in terms of enforcement).

Similarly, the passive enforcement posture taken by authorities in Japan should contribute to proactive information disclosure by companies to investors.

11. Anticipated moves by the authorities

The Task Force observed that in introducing the Fair Disclosure Rules in Japan, it is important to improve the market environment by, for example, educating concerned parties about the purpose of the rules so the goals of encouraging early information disclosure by listed companies, etc. and eventually promoting constructive dialogue between issuers and investors can be achieved.

The Financial Services Agency's policy is to establish guidelines which identify the scope of Material Information as part of the improvement process.

12. Conclusion

Major jurisdictions have already introduced fair disclosure rules for fairness and transparency in information disclosure. Meanwhile, Japan has seen multiple cases of administrative sanctions against securities companies that have solicited customers by providing insider corporate information. If Japan left this issue unaddressed and continued to be the only country without some sort of rules, investors (particularly individual investors and overseas investors) would most likely lose confidence in the Japanese market.

The introduction of the Fair Disclosure Rules by the Amendment should dispel doubt among investors that certain market participants are using whisper numbers (unofficial earnings forecasts of listed companies) for their investment decisions, and should be praised as a step toward ensuring market confidence.

One issue for the Fair Disclosure Rules going forward is how to prevent listed companies, etc. from becoming passive toward information disclosure as such rules are administered.

In this regard, the unassertive posture taken by the Financial Services Agency regarding enforcement is commendable. However, further clarification on what constitutes Material Information as the trigger for the rules is necessary. Even if Material Information is simply defined as "information about operations, business, or assets of the listed company, etc. that would have a material impact on investors' investment decisions," whether or not that information affects investors' investment decisions depends on the type of business or size of the listed company as well as the timing when or context in which the information emerged. Accordingly, even when referencing discussion by the aforementioned Task Force, determining what is included in Material Information and what is not is not necessarily an easy task.

We hope that the formulation of appropriate guidelines by market participants—including the authorities and self-regulatory organizations—will encourage early information disclosure by issuers and dialogue with investors.

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