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A Heaven for Insider TradingThe dark side of Japan's stock markets

August 06, 2012  Hideo Aiba

 This article first appeared in Japanese on JBpress on July 23. You can read it here.

A series of insider trading scandals involving Nomura Securities and others have cast a dark cloud over Japan's capital markets. But this is just the tip of the iceberg, says financial journalist Hideo Aiba.

Major Japanese media have recently been reporting on the economic and social aspects of insider trading scandals relating to planned capital increases by listed companies. Japan's securities watchdog, the Securities and Exchange Surveillance Commission (SESC), plans to recommend an administrative penalty against a securities company on suspicion of violating securities law by leaking information to a trust bank.

But insider trading runs far deeper than what you read in the news. Let's take a look into the dark side of Japan's capital markets.

Securities company salesman "disappeared"

"My salesman suddenly disappeared…."
The other day I was eating lunch with an Asian hedge fund manager when he blurted this out.

The salesman had worked for a major Japanese securities firm. "He had handled my trades for a long time and we had developed a friendship, so I wasn't satisfied when I heard he had quit 'for personal reasons' without a word to me."

Of course, he couldn't get though on the salesman's company mobile phone. He called his home phone and personal mobile just in case, but couldn't make contact on those either. He even went to the salesman's house so he could talk to him about planning a farewell party, but the salesman had already moved house. In fact, he hadn't just moved: he'd disappeared.

野村HD、10-12月期は赤字3000億円 日経

Nomura Securities HQ in Nihonbashi, Tokyo〔AFPBB News

Today, insider trading scandals like those at Nomura Holdings and the former Chuo Mitsui Asset Trust and Banking are rocking Japan's markets.

The SESC is investigating two instances where Nomura salesmen leaked information to the trust bank, and is expected to recommend that the Financial Services Agency hits Nomura with an administrative penalty.

When a listed company increases its capital through a public offering, the total number of outstanding shares increases. As this dilutes the value of existing shares, the market generally tends to sell the stock (although there are cases where investors take the long view and buy).

If market players know in advance that a company will conduct a public offering of new shares, they can generate a quick and easy profit by short selling the stock, as the share price will most likely fall once the offer is announced. If a broker preferentially leaks this information to certain clients, it is clearly unfair. The SESC's hard line on Nomura is good and proper.

Insider info on offerings "tip of the iceberg"

Let us return to the hedge fund whose securities company salesman disappeared.

I suggested to the manager that perhaps the hedge fund had received some proprietary information and made a killing. Maybe the salesman disappeared to preempt possible action against his company by the SESC.

The manager smiled mysteriously. He put forward his view that the salesman's company was watching the insider trading scandal very closely to see how far it went.

I tilted my head, questioningly, and he spoke in a hushed voice.

"Insider information on stock offerings in the Japanese market is only the tip of the iceberg..."

Here's one example: the manager opened his laptop and showed me a file. It was a report in which a well-known analyst from a major foreign securities firm upgraded his investment recommendation for a big Japanese manufacturer that he covered.

"Getting these reports to clients as quickly as possible is an important part of a salesman's job," the manager said.

Reports passing through firewalls

Securities companies are supposed to have firewalls between analysts from the research division or the underwriting division in charge of market financing and the sales division targeting institutional investors such as hedge funds and trust banks. To prevent conflicts of interest people working in these different divisions at the same firm are not supposed to exchange information.

But the reality is somewhat different, says the manager. Salesmen regularly leak analyst reports to institutional investors to enable them to trade before other investors.

Of course, many analysts resist this unfairness. But according to one analyst at a foreign securities firm, in securities companies where the sales division has a lot of influence it's the norm to leak reports and recommendations.

Just look at reports on individual stocks by online brokerages or articles by the business press or newswires. There are many examples of articles indicating that share prices moved significantly in response to upgrades or downgrades of investment recommendations by top-ranked analysts.

In other words, before this information reaches individual investors it has already been conveyed, secretly and without leaving evidence, to hedge funds and other institutional investors. Equity salesmen at brokers are preferentially giving this information to certain institutional investors in return for large commissions.

"Small meetings" for huge info leaks

Not long ago someone at a different hedge fund told me another way brokers facilitate insider trading.

He recently received an email from a big Japanese securities firm. It explained that the firm would be hosting a conference about a major transport-related company for which his company served as lead manager. The invitation also went out to several other big institutional investors. It was for what's known in the industry as a "small meeting."

This major transport-related company had just announced plans to increase its capital through a public offering of new shares. The person leading the meeting was the analyst covering the company at his securities firm.

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