A trail of evidence in a near 2-year probe into pre-sale tip-offs, the most extensive in Japan for years, had taken investigators deep inside Nomura Securities, part of the 87-year-old group (>> Nomura Holdings Inc.) at the heart of Japan's capital markets, but the firm's top executives kept stalling, say people involved in the investigation.
In late March, bankers waiting outside the office of Shozaburo Jimi, then Financial Services Minister overseeing the regulatory agency, were startled to hear him bellow to aides: "I haven't had one call from Nomura yet. What the hell's going on?"
From interviews with more than a dozen bankers, regulators and lawyers with direct knowledge of the investigation emerges a picture of a reluctant watchdog roused into action in 2010 by whistleblowers with statistical evidence that the Tokyo market was rigged against share issuers and investors.
It is also a tale of a 'too-big-to-punish' broker - Nomura - skirting around flimsy insider trading laws, and cosy ties with longstanding clients, cemented by a culture of entertaining and gift giving that set the backdrop for sharing corporate secrets.
Nomura this month acknowledged for the first time that its employees had leaked confidential information on three separate public share offerings in 2010. On Monday, it was omitted from a list of institutions chosen by the Ministry of Finance to underwrite a government sale of around $6 billion worth of shares in Japan Tobacco (>> Japan Tobacco).
Nomura declined to comment on specific issues for this article, but referred to a June 8 statement it issued after Japan's Securities and Exchange Surveillance Commission (SESC) recommended fining a U.S. company for trading on non-public information about a share offering by Tokyo Electric Power (>> Tokyo Elec. Power) - one of the three cases involving Nomura.
"Nomura takes this matter seriously and will implement improvement measures and disciplinary action in accordance with the results of the internal investigation and the Commission's inspection," the broker said then.
By the middle of 2011, the SESC had contacted the U.S. Securities and Exchange Commission, and was poring over data that showed Nomura failed to protect sensitive information on companies planning share issues, the sources say. The showdown between the SESC and Nomura developed behind the scenes for months, according to the sources, who could not speak publicly about the matter as the probe is ongoing.
Regulators are likely in the weeks ahead to order Nomura to improve its internal controls, sources say, after finding that confidential information leaked from its syndicate desk to its institutional sales team, in breach of basic banking safeguards, and then was passed on to clients. It could even be ordered to close some operations for weeks, and regulators may flex their muscles and push for a leadership shake-up at Nomura.
In past insider trading cases, Japanese regulators have tended to slap wrists rather than go for the jugular. Under weaker insider trading rules than most developed markets, the person leaking information is practically immune from prosecution unless they trade on that inside knowledge.
But Nomura has lost a third of its market value since a first insider trading case was announced, reflecting investor worries about the impact on its business. In addition to being left off government deals, some investors may stop trading with it for a certain period in line with their own compliance rules.
"If Nomura were dropped from deals there would naturally be an impact on its business. Their reputation would take a hit and its market share would fall," said Azuma Ohno, a brokerage analyst at Barclays in Tokyo. "There's nothing but risk here."
On April 25, investigators charged into Nomura's offices and set up base on the 14th floor of the Urbannet Otemachi Building, a high-rise that was once a showpiece of the financial district but had earned the nickname "bubble tower" because it was finished in 1990 right after Japan's economic bubble collapsed.
Yet even in the days after the rare escalation to an on-site investigation, SESC officials struggled to gain traction with lower-level executives who insisted there were no systemic problems. Investigators believed CEO Kenichi Watanabe and Chief Operating Officer Takumi Shibata were getting a censored version of events.
"Watanabe and Shibata are not getting straight information from the sales force, who are in their own world," one of the sources said in early May. "Once senior management understands and reveals the bad practice, Nomura can be born again."
In one case, when investigators identified a junior Nomura equity saleswoman in her 20s as the source of a leak on a $6 billion offering by energy firm Inpex (>> INPEX Corp) in 2010, they were told by the brokerage she couldn't answer further questions because the stress of the investigation had become too much.
The stonewalling became harder to defend after March when Chuo Mitsui Asset Trust and Banking, now part of Sumitomo Mitsui Trust Holdings (>> Chuo Mitsui Trust), admitted to insider trading on Inpex and privately told regulators Nomura was the source of the leak.
That kind of leak had been widespread in Tokyo after 2008, an almost sure-fire way for funds to turn an easy bet by shorting shares and a simple way for brokers to boost commissions in a weak market. A recapitalizing boom in 2009 and 2010 in the wake of the financial crisis lit a fire under such trades. In secondary offerings, existing shareholders can see their stakes diluted as more shares come on the market.
A Reuters analysis shows shares of companies in 20 of the top 25 secondary offerings in 2010 underperformed the benchmark TOPIX index <.TOPX> by an average of nearly 4 times in the three weeks prior to the deal being announced. The analysis did not account for media reports that sometimes preceded announcements. That stock performance gap nevertheless equated to $16 billion in market value, hurting shareholders and increasing the issuers' cost of capital.
"The market fell apart in 2008 and almost from that moment you could see the trend emerge. The companies doing the lead underwriting were suddenly under big pressure and started to cut corners," said Nicholas Smith, Japan strategist at CLSA.
A handful of global funds, upset at the damage being done to their portfolios, visited the regulator in late 2010 and urged it to take action. Indus Capital, for one, had seen its holding in Inpex decimated by the leak and ensuing sell-off.
Smith, then at MF Global, was a spark in the debate. At the request of his fund clients, he gathered data on stock underperformance ahead of offerings and published a report that for the first time revealed the scale of the problem.
The flurry of media coverage that followed was crucial in prodding the financial regulator into action, people close to its thinking say. The SESC is now under pressure to prove itself to the global financial community, and how it deals with Japan's top underwriter will be closely watched.
Nomura isn't the only broker ensnared in the investigation.
Nikko SMBC Securities was punished for priming its retail clients with non-public information about the share sale of its parent bank, and JPMorgan (>> JPMorgan Chase & Co.) was found to have leaked news of a stock offering by Nippon Sheet Glass (>> Nippon Sheet Glas) to a Japanese hedge fund. Nikko has since apologized and announced steps to bolster compliance. JP Morgan, a U.S. bank, said it had not been accused of any "organizational" involvement in insider trading.
In late May and early June it emerged that investigators were looking into insider trading in two other share offerings underwritten by Nomura - by Mizuho Financial Group (>> Mizuho Financial Gr.) and Tokyo Electric - dashing any hopes Nomura had of ringfencing the problem around the isolated Inpex case.
"Tell me the truth!" Watanabe boomed to staff on the equity sales floor soon after the Mizuho case was announced, according to a person present. It was a key turning point: Nomura's approach to the regulator was about to change.
The probe shone a light on a hard-charging culture at Nomura that harked back to its checkered past. In 1991, Nomura and other brokers were caught compensating top clients for post-bubble investment losses, and a 2008 insider trading ring centered around a Nomura employee in Hong Kong prompted Watanabe to promise tougher internal controls.
A report by an investigative panel set up by Sumitomo Mitsui Trust to look into its compliance issues offers a window into how Nomura sales executives went about forging extremely close ties with their clients. The report, which refers to "Securities Company X" - which sources say is Nomura - contends those relationships were too close, clouding the judgment of the fund managers implicated in the probe.
The unnamed Chuo Mitsui fund manager found to have traded on inside information ahead of the Mizuho Financial offering was entertained by a sales executive of Securities Company X 39 times over a nine-month period at a total cost of 890,000 yen ($11,200) and received 320,000 yen in gifts, the report says.
In the Inpex case, the bond between broker salesperson and fund manager was so tight the two often exchanged e-mails on their personal mobile phones, and the fund manager attended the salesperson's wedding, the report said. While the report didn't name the brokerage employee, sources have identified her as the young woman in Nomura's institutional sales department. Nomura has not disclosed her name.
Sources say she met the fund manager at a cafe near Chuo Mitsui's office on June 30, where regulators believe she relayed news of the impending Inpex offering. The fund manager unloaded Inpex shares the next day. The offering was officially announced a week later.
Her knowing of the offering ahead of time would constitute a breach of the "Chinese Wall" that exists in investment banks as a safeguard against information on stock offerings and other material facts from leaking out.
The SESC has zeroed in on Nomura's syndicate desk - which sits between sales and equity capital markets and is brought "over the wall" on deals to help gauge investor demand - as the origin of the leak to institutional sales, sources say.
In the face of mounting evidence, Nomura has moved quickly in recent weeks to minimize the risk of a tough penalty.
Watanabe, upset by how his compliance team had dealt with the problem, has tasked two trusted executives - Chie Toriumi and Shoichi Nagamatsu - with breaking the impasse with the Financial Services Agency (FSA), the top banking regulator which oversees the SESC, sources said.
Toriumi is known as a communicator and reports directly to Watanabe. Nagamatsu, a senior investment banking executive, was drafted in part due to his experience dealing with a scandal in the 1990s when he was a liaison to the finance ministry.
The SESC, waiting for Nomura to announce this month the findings of that internal investigation by outside lawyers, faces a balancing act between wanting to send out a tough message against insider trading and the potential consequences of sidelining a bank vital to Japan's capital markets.
"This is a serious problem, but I'm not so sure that translates into a serious punishment," said Yuri Yoshida, a director at Standard & Poor's. "Besides, it would be hard to get underwriting and other deals done without going through Nomura."
(Additional reporting by Emi Emoto, Noriyuki Hirata and Theresa Barraclough; Editing by Kevin Krolicki and Ian Geoghegan)
By Nathan Layne and Taro Fuse