The arrest early last year of Takafumi Horie, the publicity-hungry maverick who ran livedoor, an internet company, gripped a media-obsessed nation. It became the fizziest scandal in Japanese corporate history. His indictment on charges of falsifying profits and creating a false market in livedoor’s shares brought his $6 billion company crashing down. The collapse caused chaos on the Tokyo Stock Exchange (TSE) and much fuss and chatter on the evening talk shows. Mr Horie continues to attract attention: on March 16th he was found guilty of securities fraud and sentenced to two and a half years in prison. On March 22nd a fellow executive, Ryoji Miyauchi, who turned prosecution witness, was also found guilty and given a two-year jail term.
These sentences are unusually harsh for Japan, where white-collar crime typically carries a suspended term. But then the typical establishment crook is quick to express remorse. Mr Horie on the other hand has protested his innocence to the end and will appeal against his conviction.
Even without Mr Horie’s talent for publicity, the spotlight would remain on auditing irregularities and the policing of securities laws in Japan. Another company that has rapidly fallen from grace is Misuzu Audit, formerly ChuoAoyama PricewaterhouseCoopers. Once Japan’s third-biggest audit firm, it used to count Sony, Toyota and Softbank among its clients. Late last month, Misuzu asked other leading auditors to take on its remaining clients as a prelude to its liquidation.
ChuoAoyama’s problems began in earnest in 2005 when several of its accountants were arrested for allegedly conspiring with executives at Kanebo, a cosmetics company, to falsify the firm’s accounts. ChuoAoyama had also audited Ashikaga Bank, a big regional bank in trouble with Japan’s Financial Services Agency (FSA) for cooking its books to conceal its insolvency. As punishment, the FSA last summer barred ChuoAoyama from doing business for two months with almost all of its corporate clients.
That put its fate in the balance. The balance tipped late last year when it became clear the auditing firm had failed to notice that Nikko Cordial, Japan’s third-biggest broker, had inflated its profits in the year to March 2005. Late last month another of its former clients — Sanyo, a big electronics company — admitted its accounting practices were under investigation. By then PricewaterhouseCoopers had lost faith in its Japanese affiliate. Its reputation in tatters, Misuzu has imploded just as Arthur Andersen did in America after the Enron scandal in 2001.
As for Nikko Cordial, it has also swayed on its feet of late. The TSE was considering its delisting, at which point America’s Citigroup made advances. Perhaps thinking the prospect of foreign control was humiliation enough for the broker, the TSE on March 12th ruled that a delisting would be too harsh a punishment. That led to a bounce in Nikko’s shares and Citigroup had to raise its offer, valuing the firm at $13.4 billion. The American giant has long looked for a way to expand into Japan’s securities business. If its bid is successful — Citigroup’s tender offer runs until the end of April — it would be the biggest-ever foreign acquisition of a Japanese securities firm.
With so many scandals, regulators are under pressure, despite earlier attempts at better supervision. One regulator complains that the FSA lacks a range of appropriate sanctions in cases like ChuoAoyama’s, where auditors have clear management shortcomings. The authority can issue what the regulator calls the “popgun” of a public warning, or it can use the “cannon” of a suspension, from which the firm’s reputation may never recover. It has little in-between.
Earlier this month the FSA submitted a draft bill revising Japan’s law dealing with auditors. The revision would impose fines on auditing firms when employees are found to have overlooked clients’ falsified accounts. The FSA is also seeking powers to impose business-improvement orders on auditors, in the hope that problems can be picked up at an earlier stage.
Clearer roles as well as new tools may be what the regulators need now. The FSA and the Securities and Exchange Surveillance Commission that sits under it lack resources and independence. The Certified Public Accountants and Auditing Oversight Board, which also sits under the FSA, is both the accountants’ watchdog and their representative. Crucially, Japanese companies are not obliged, as are American ones, to have oversight boards, independent of management, to select auditors and negotiate their fees. The relationship between auditors and their clients is dangerously cosy. What else might they be hiding between them?