The Nut of the Problem: Olympus, Kyushu Electric, and the “Third Party Committee” Problem

To say the obvious: Japanese companies need truly independent oversight, – by actual board members who can vote, and fit a legal definition of independence. Here, the words actual, vote, and legal definition need to be stressed, because presently in Japan:

There's no legal definition of independence, and the TSE's watery version is brand new – so the concept and benefitsof independence from management are not well understood;

Third party committees have no legal validity because the Company Law creates no framework for them. Hence, they are usually not composed of actual directors or anyone with legal duties or liability who can be sued, their decisions are not binding on the board, and there are no required rules of order such as the taking of minutes. In fact,still anotherreason they are formed isbecause there are not enough independent external directors on boards. (One problem begets and continues another problem.) Moreover, unlike statutory auditors, directors do not have independent authority to investigate, so even if such third party committees do include one or two directors, they do not have the legal right to demand information and get all of it.

Most importantly, even if a board had truly independent board members on it, under present Japanese law there is no good way to use them in this type of situation. Per the Company Law directors can only make decisions and act as a group. This means the board cannot create a committee of three of their independent and un-conflicted members and delegate investigation and decision-making to those three members only. The board can appear or claim todo this, but it cannot do so under the law. If it sets up such a committee, under lawthat groupis just a meeting of certain directors, no different than if those personsmet at Starbuck's to gab. And such get-togthers, again, will be under no legally required rules of order, -such a taking minutes or keeping records – and would have no bindingforce.If such groups come back with a report (as Kyushu Electric's third-party committee did) concluding X,Y, and Z, but thenthe majority decision of the board is to delete Z, then Z can be deleted….just as Kyushu Electric is doing.

Since outsiders (who are usually not independent) on Japanese boards are usually not the majority, what would you guess is the probability that suchthird-party committeeswill conclude Z if they know in advance it is likely to be struck down and they will then all be warned by the Chairman that of course, everything we discuss on this board is confidential?

In short, the legal framework in Japan needs to not only require independent directors in meaningful numbers, but also set up the infrastructure so that they can be useful: (1) the ability to for the board flexibly set up committees and delegate to them key decisions and actions (including the right to demand information), and (2) incentives to do so in cases where managerial self-interest or involvement is an issue.

This may all sound like legalese, but if one has ever been on a Japanese board in a sensitive situation, who has exactly what legal rights determines whetherone can sort things out in a manner that is anything close to smoothly and discreetly. In the absence of good infrastructure and larger numbers of independent directors, it iscommonplace here that the options of someone who really wants to do the right thing and live by his duties are very limited. He/she can fight internally (a futile effort, unless many others are not already complicit); (b) hope for anonymous leaks, whereupon one's reputation will be tainted for not having appeared to correct the situation oneself (since no one will ever know how hard he/she fought on the board); and/or (c) just inexplicablyresign soon… which of course, is exactly what the other board members want.

Personally I would alwaysseek to fight the good fight internally and put it all in the minutes, but I sympathize with the dilemma faced by a Mr. Woodford, especially if it seemed that majormistakes (or worse)had been covered up or not fully explained (including by statutory auditors, who are seemingly complicit). And option (c) obviously does not ensure that the right thing happens. It just ensures that one irresponsibly distances himself from a mess ASAP, and leaves it in someone else's lap. But because the system doesn't give one any better alternatives, that is what most outside directors here do.

And then as a result, everyone here asks what are outside directors good for? When they are most needed they never seem to correct the situation. Whatthe hell werethey doing? Answer: they were not independent of mind, and even if they were, the system gave them no good alternatives.

But since most Japanese people do not know all this arcane stuff and prefer to keep their heads as politically low as possible, it is much more satisfying to avoid discussions about how to actually improve the system, and focus on just bashing the personal ethics of the managers and board members at Tepco, Kyushu Electric, and Olympus. Bashing like that is something everyone can agree on over a cold beer.But even if one is a lawyer and (in his heart) knows what is wrong with the law, uttering that opinion in polite company might mean that large companies (and small) viewyou as overly outspoken, and give you less business. Or if you are an academic, you might miss a chance at promotion and you certainly never would be considered to sit on an government (e.g., MOJ) council or study group.

So life goes on, and no meaningful improvements in the laware made.

Anyway, for what is worth, at leastthe optimists at the American Chamber of Commerce in Japan have made this constructive proposal:

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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