Enforcement in the U.S. & Japan, with Lessons from the UK

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February 1, 2008

Co-organized by:
Harvard Law School’s Program on International Financial Systems

Corporate sponsorship provided by:
Mizuho Securities USA



Robert Feldman, Director of Economic Research Department & Managing Director, Morgan Stanley Japan Securities Co., Ltd.
Takatoshi Ito, Professor at Graduate School of Economics, University of Tokyo
Hideki Kanda, Professor of Law, University of Tokyo
Kazumi Okamura, Deputy Secretary-General, Securities and Exchange Surveillance Commission
Takumi Shibata, President & Chief Executive Officer, Nomura Asset Management Co., Ltd.
Yasuhisa Shiozaki, Member of the House of Representatives, former Chief Cabinet Secretary

United States

Paul Atkins, Commissioner, United States Securities and Exchange Commission
Brandon Becker, Partner, Wilmer Cutler Pickering Hale and Dorr LLP; Co-Chair, Securities Department; Chair, Broker-Dealer Compliance and Regulation
Thomas A. Russo, Vice Chairman, Lehman Brothers Inc.; Executive Vice President & Chief Legal Officer, Lehman Brothers Holdings Inc.
Linda Chatman Thomsen, Director of the Division of Enforcement, United States Securities and Exchange Commission

United Kingdom

Margaret Cole, Director of Enforcement, Financial Services Authority


Hal S. Scott, Nomura Professor of International Financial Systems, Harvard Law School

I. Introduction

Professor Scott introduced the discussion with some data about enforcement in the three countries. With respect to public civil enforcement, in FY 2007, the SEC had 655 enforcement actions, as compared with Japan with 108 and the UK’s 125. If one normalized them to the 2007 GDP of each country, the story looks different. Enforcement actions per $ trillion of GDP were: U.S., 46.5; UK, 52; Japan, 20.9. The U.S. numbers do not include state and SRO enforcement actions, e.g. FINRA, which are significant.

The composition of these actions is interesting. About one-third of the SEC cases were actions against issuers, whereas there were only a handful of such actions in the UK and Japan. Of the 80 enforcement cases brought in the first three-quarters of 2007 in Japan, 25 or 31 percent resulted in business suspension orders.

One can also compare enforcement by public monetary sanctions. The last year for which there is comparable data across the three countries is 2004. In that year, total monetary sanctions of the SEC (fines and investor recoveries) were $3.1 billion, compared to $40.48 million of the UK’s Financial Services Authority and $12 million of Japan’s Financial Services Agency. One should recognize that in 2004, civil penalties were rare in Japan, and administrative sanctions like business suspension or business improvement orders were much more prevalent.

More than 170 senior executives from U.S. and Japanese firms, as well as academics, journalists and policy makers attended the February 1 conference, Enforcement in the U.S. & Japan, with Lessons from the UK, held at Japan Society.
With respect to budget and personnel, the staffs per $ million of GDP were: U.S., 23.29; UK 19.05, and Japan 7.40, while the budgets per $ billion GDP were: U.S., 76 thousand; UK, 82 thousand; and Japan, 17 thousand. In comparing these numbers, it should be recognized that the UK and Japanese FSAs have, unlike the SEC, a wider remit than just securities enforcement.

Any comparison of civil enforcement would be incomplete without some mention of private enforcement. This is minimal in Japan and the UK. There are no securities class actions in those countries. In the U.S., private civil enforcement is very important. For example, in 2004, total monetary sanctions imposed through all public actions in the U.S. were $4.7 billion compared to recoveries of $5.5 billion in private actions. More recently, total settlement amounts in securities class actions in calendar year 2006 in the U.S. were $17 billion compared to $496 million in fines and investor recoveries by the SEC in FY 2007 (not counting Department of Justice, state or SRO recoveries). The point is that private actions are very important in the U.S.

The one crucial piece of data that is missing is the effectiveness of enforcement actions in reducing wrong doing—the major goal of enforcement. This is not because the statisticians were lazy—it is because it is devilishly difficult to measure.

II. General Enforcement Issues

The panelists from all the countries believed that enforcement plays a critical role in the integrity of the capital markets but also can affect competitiveness and efficiency. There was some concern that the U.S. had gone too far in ignoring the impact of enforcement on the efficiency and competitiveness of its markets. There was also concern that the right balance had not been struck in Japan. There, the issue was rather the type of enforcement, i.e., that overly technical enforcement against securities firms was not achieving more confidence in the market, while at the same time negatively impacting the willingness of foreign firms to operate in the Japanese market. The UK’s approach was somewhat different than both. Enforcement was regarded as one of a basket of tools—the major focus had to be on prevention. All agreed that enforcement authorities should be free of political influence in deciding how to act in a particular case.

The panelists also discussed the role of the market in enforcement. It was noted that reputation is a very important factor for institutions, which would be lost through the disclosure of wrongdoing. But it was also recognized that the market by itself was not enough, there was a need of an enforcement process to backstop it. It was also recognized, however, that the media and whistleblowers play a major role in shedding light on wrongdoing, so the private sector has a role in enforcement.

III. Public Enforcement

A. Agency Structure

The Japanese Securities and Exchange Surveillance Commission (SESC) was created in 1992, largely in response to the supervisory failures and wining and dining scandals involving the Ministry of Finance. The SESC, which has authority for examining the securities markets, is separate from the FSA, which was created in its present form in 2000–01. The SESC makes enforcement recommendations to the FSA and the FSA is responsible for taking action. The FSA usually defers to the SESC. The FSA itself reports to the Prime Minister’s office.

At both the SEC (created in 1934 against the backdrop of the Great Depression) and the UK FSA, enforcement (created in 2000 when the Blair Labor government came to power) is part of the agency. Reflecting the importance of enforcement at the SEC, enforcement staff is about a third of total staff. The difference is that the UK FSA, like the Japanese FSA, is responsible for the entire financial sector, while the SEC is only responsible for the securities sector. Also, the UK’s FSA is split into enforcement for retail and wholesale markets, reflecting the different approach the UK takes in the two areas.

The funding of the agencies also differs. Both the SEC and the Japanese FSA are generally funded by the government, whereas the UK FSA is funded by industry. Private sector funding is designed to make the UK FSA more responsive to industry. Neither the Japanese nor the U.S. regulators believed that government funding compromised their political independence.

The panelists discussed whether it made sense to have an SESC as part of the Japanese FSA. Two reform options would exist—to make the SESC part of the FSA, or to split
if off entirely along the lines of the SEC. This would give Japanese FSA full regulatory, not just surveillance, authority. A particular consideration in Japan is that banking dominates securities in the Japanese financial system. Perhaps proper attention to the needs of the capital market can only be achieved by creating a separate agency devoted to those concerns. There was also support for the idea of not concentrating all regulation in Japan into one super powerful agency

B. Administrative Fines

Until 2005, Japanese authorities did not have the power to impose administrative fines, a standard enforcement power in the U.S. Instead, enforcement was mainly criminal. One explanation for this approach was that lawyers thought the imposition of fines was a criminal matter, and should only be done through trials and courts, thus protecting the rights of individuals. Lawyers were less attentive to the concept of deterrence. Since the criminal law did not generally envision criminal sanctions against companies, civil sanctions against companies largely took
the form of business improvement and suspension orders. While the FSA now does have the power to impose fines, there is a maximum of $5 million, only imposed on Nikko to date, modest by U.S. standards. The maximum was to be increased in 2008. Penalty amounts in the U.S. and the UK are effectively unlimited.

Takatoshi Ito, Professor at Graduate School of Economics, University of Tokyo, comments as Robert Feldman, Director of Economic Research Department & Managing Director, Morgan Stanley Japan Securities Co., Ltd., looks on.
The UK is unique among the three countries in having the power to bring both criminal and civil enforcement actions. While the standard of proof in the two actions is different, beyond a reasonable doubt in a criminal action and the balance of probabilities in a civil action, in practice they are almost the same. This is in part due to the impact of the European Convention on Human Rights, which demands a high standard of proof for imposing serious penalties on individuals, whether fines or bans on industry employment. The UK tribunal which must pass on enforcement penalties has said there is basically no difference between the criminal and civil burden of proof. Thus, the UK, like Japan historically, has had legal problems in using administrative sanctions. Such concerns have not seemed to trouble the U.S.

C. Enforcement Against Companies

There has been a lot of controversy in the U.S. about fining companies, rather than individuals, since the incidence of such fines is on innocent shareholders or other stakeholders. The SEC obtained this power in 1990 but it was not until 2002, when a $10 million fine was imposed on Xerox, that the power was really used—after that, with the advent of the corporate frauds at the turn of the century, the use of this power substantially increased. In January 2006, the SEC issued a policy statement which said generally the imposition of fines against companies should require that the company have obtained benefit from the wrongdoing and that the wrongdoing was pervasive throughout the company. One panelist thought that an important factor in imposing corporate penalties was whether the violation was at the top of the organization, given the limits of senior management in controlling lower level individuals.

Given the procedural obstacles to imposing sanctions on individuals, the standard enforcement technique in Japan has been sanctions against companies, in the form of business suspension orders. There was some disagreement among the Japanese panelists as to whether business suspension orders should be retained, now that Japan has the power to impose administrative sanctions on companies as well as individuals. Fines would be more tailored to a particular company and have less impact on customers. The case of the two-month business suspension order against Chuo Aoyama, the Japanese affiliate of PricewaterhouseCoopers, was cited as an example. The auditing operations for over 2,800 public companies were disrupted. In addition, 450 partners and 3,500 employees were seriously affected.

D. Enforcement Style

The U.S. is criticized by some of making enforcement a public spectacle, summed up by the word “Gotcha.” This is a system, some say, focused on disciplining violations more than creating a culture of compliance. Focus on the latter is often called the prudential approach. Is the high level of civil fines in the U.S. a sign of the strength of enforcement or its failure to avoid violations? There was also concern that enforcement decisions, such as the criminal indictment of Arthur Andersen, needed to consider the broader public policy context.

In Japan, the enforcement style issue was whether the authorities were too bureaucratic and technical in their approach. Some believe officials are unable to exercise discretion because excessive discretion in the past by the Ministry of Finance led to its demise as a regulator and that they are unwilling to communicate with firms due to the legacy of the wining and dining scandals. The current FSA Commissioner Sato has indicated that he wants to change this style by encouraging focus on real problems and encouraging communication between the agency and financial institutions.

The UK is the epitome of the prudential style of enforcement with focus on compliance ex ante rather than enforcement ex post. Some, however, believe UK enforcement is too lax, and that one cannot be sure whether the low level of public enforcement is a result of a good compliance culture, or the failure to uncover and discipline wrongdoing. It appears the FSA believes it needs to bring more insider trading cases in the future. Indeed in January 2008, shortly before this conference, the FSA brought a criminal insider trading case against a general counsel of a telecommunications firm. One panelist observed that the private funding of the UK FSA made it less prone to use public enforcement splashes as a technique of increasing its funding.

IV. Private Enforcement

Neither Japan nor the UK has securities class actions, a major enforcement technique in the U.S. As discussed in the introduction, securities class action settlements dwarf publicly imposed fines.

Kazumi Okamura, Deputy Secretary-General, Securities and Exchange
Surveillance Commission (left) considers remarks by Yasuhisa Shiozaki, Member of the House of Representatives and former Chief Cabinet Secretary.
Given Japan’s low level of public enforcement, should it consider introducing U.S. style securities class actions?

The answer was generally no. Given that U.S. class actions do not seem to compensate shareholders (institutions sue themselves, in effect) but mainly lawyers, and given the Japanese predilection against litigation, adoption of such a new procedure seems unlikely. Japan does have derivative actions, where the company can recover money from directors and management, but that is different than cases in which companies pay funds out to investors. There was also concern with the judicial system in Japan, as to whether judges were really equipped to handle such cases.

Nor did the UK seem interested in the possibility of introducing securities class actions. One consideration there was how the existence of such actions could affect public enforcement. Companies, with the prospect of private actions, would be less willing to admit wrongdoing, or even to disclose such wrongdoing to the authorities. This seemed one effect of class actions in the U.S.

In considering the case for class actions in the U.S., the major justification seems to be deterrence but we have little empirical research on whether such actions do deter. Do crooks really care whether shareholders will sue their companies for damages? But the question was raised as to why, if class actions were undesirable, investors were not more active in opposing them. On the other hand, the point was made that most class actions were “piggyback” coming on the back of SEC enforcement actions, or whistleblowers, so there was little evidence that they were truly an engine of uncovering wrongdoing.

V. Criminal Enforcement

As already noted, the UK’s FSA has both civil and criminal authority, although its criminal authority overlaps with that of the Serious Fraud Office, a government department whose head is appointed by the Attorney General. In some sense, this is not surprising given the closeness of the legal standards for civil and criminal actions. Moreover, the criminal sentences are significantly shorter in the UK than the U.S.

There was little interest in uniting these authorities in the U.S. There was a view that use of the criminal power should result in more direct political accountability. Indeed, the uniting of the civil and criminal power, as in New York, raised issues of abuse of power that could flow from the concentration of power.

Authorities from both the U.S. and Japan made the point that they referred cases to criminal authorities and continued to work with criminal enforcement after the referrals—so the separation between the two powers was not absolute. In Japan, referrals almost always result in prosecution, so it seems the power to refer is almost the power to prosecute. Further, it is rare in Japan for prosecutors to initiate prosecutions on their own. In the U.S. this often happens.

VI. Conclusion

In a subject as complicated as enforcement, it is hard to come up with any unifying theme except that the history and circumstances of each country have a profound impact on their systems. While convergence is proceeding apace in the general area of regulation, enforcement is probably the most difficult area to converge.

—Hal S. Scott
Topics:  Business, Policy

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