CFA Institute Report Highlights Related-Party Transaction Risks in Japan

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CFA Institute, the global association for the investment profession, suggests that institutional investors should pay closer attention to inherent risks in related-party transactions while investing in Japanese companies.

Hong Kong, March 9, 2010– CFA Institute, the global association for the investment profession, suggests that institutional investors should pay closer attention to inherent risks in related-party transactions while investing in Japanese companies.

In a newly published report, co-authored with CFA Society of Japan"Inter-Corporate Network Dealings and Minority Shareholder Protection – Cases in Japan" (PDF), CFA Institute has found that Japan has much room for improvement in corporate governance, particularly in relation to the different forms of related-party transactions that may disadvantage minority shareholders. The report said investors would benefit from improvements in corporate governance, better disclosure of corporate network dealings, and increase in the level of investor protection and ethical standards in the Japanese market.

The study reveals a number of cases where corporate management in Japanese companies has not sufficiently considered the position of its minority shareholders. Currently, most significant transactions require only board, and not shareholder, approval and disclosure of related-party transactions is basically mandatory only once a year. CFA Institute believes all material transactions should be subject to shareholder approval, disclosure should be on a continuous basis, and adequate thresholds should be established to determine the size of transactions that need approval and reporting.

The report raises concerns over the practice of parent and subsidiary listings in Japan, where almost 11 percent of listed companies also have a listed subsidiary. CFA Institute believes the significant influence of the parent to appoint the directors of the subsidiary can put shareholders of the subsidiary at risk, but remedies are available to reduce parent and subsidiary listings.

Alex Flatscher, CFA, advocacy chair, CFA Society of Japan said, “We have found cases where related-party transactions undertaken by listed and unlisted entities withinKeiretsubusiness groups have resulted in improper cash shifting, profit inflation, shareholding dilution, and other conflict of interest issues.

“There is an abundance of research on related-party transactions in Hong Kong, China, and Korea. However, in Japan, related-party transactions are not well documented, and despite many Japanese companies operating on an international level, board accountability and disclosure requirements are low in comparison to international standards. There is a real risk that the adverse impact of related-party transactions may go unnoticed in the investment decision-making process.”

Lee Kha Loon, CFA, head, Asia Pacific, Standards and Financial Market Integrity Division of CFA Institute, added, “For Japan to compete with global markets and attract investment, corporate governance standards and best practices must be improved. There needs to be tighter regulation around related-party transactions and important steps will have to be taken to protect minority shareholders.  We hope our recommendations lead to significant change; the results of which would be positively reflected in the effectiveness and quality of the market in Japan.”

The report included several case studies to highlight the many forms that related-party transactions may take place in Japan, all involving high profile companies:

• Case 1: Listed subsidiaries shifting cash to unlisted group financing firms
• Case 2: Inflating profits by using unlisted subsidiary of listed subsidiary
• Case 3: Issuing shares to companies of the sameKeiretsu, thereby diluting holdings of minority shareholders
• Case 4: Issuing shares to friendly companies not related toKeiretsu, thereby diluting holdings of other minority shareholders
• Case 5: Tax savings, transfer pricing, and inter-corporate dealings

About CFA Institute

CFA Institute is the global association for the investment profession. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has nearly 100,000 members, who include the world’s more than 89,000 CFA charterholders, in 134 countries and territories, as well as 136 affiliated professional societies in 57 countries and territories. More information may be found atwww.cfainstitute.org. 

About CFA Society of Japan

CFA Society of Japan (CFA Japan) was established in 1999. In partnership with CFA Institute, CFA Japan conducts educational programs and disseminates information and ideas related to the investment profession. The society is an association of local investment professionals in Japan. As a member society of CFA Institute, it connects members to a global network of investment professionals. In addition, it provides a networking forum for CFA charterholders in Japan. More information may be found atwww.cfaj.org.

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