Is Mr. Ghosn’s understatement of compensation ”material”?

Mr. Ghosn and Nissan are charged with misrepresentation of securities reports.  The Financial Instruments and Exchange Act provides for civil liability as well as criminal liability for acts of misrepresentation of securities.  Nissan will face a civil lawsuit seeking damages from investors in no distant future.  One of the issues that will be argued in civil lawsuits is “materiality”. Financial Instruments and Exchange Act is concerned with untrue statement of material matters as misrepresentation, but ignores minor matters.

They said that Mr. Ghosn understated his around JPY 2 billion per year compensation to JPY 1 billion and continued to do so for 5 years from 2011 to 2015.  The remaining JPY 1 billion payment is deferred in the future, and the prosecutor’s argument is that JPY 1 billion should also be stated.  Is JPY 1 billion per year, or JPY 5 billion in 5 years material?

There were two kinds of misrepresentation in the judicial precedents in Japan so far.  The first kind is an untrue statement in the financial reports.  This pattern commonly happens, such as in Livedoor, Olympus, Toshiba, etc.  The second kind is untrue statements about fulfillment of listing prerequisites.  It happened in Seibu Railway case, but there are no other examples.  Seibu Railway understated shares held by the founder’s family by registering many name-only-shareholders, and pretended to satisfy the listing prerequisite. 

In the first kind misrepresentation in the financial reports described above, it may be said that materiality is determined by the amount of money.  Even if somebody put fictional sales, if it is only JPY 10 , it will not be a misrepresentation.  However, in Livedoor and Olympus cases, because the untrue amount was huge in comparison to the operating income and net income, it was deemed material and therefore construed as misrepresentation.  The damage amount was calculated based on the inflation in the stock price that was swelling due to untrue statements.  In thee second kind misrepresentation described above, materiality is not determined by the amount of money, and basically there is no amount in the untrue statement.  In Seibu Railway case, this untrue statement was regarded serious.  Because the Seibu Railway is a listed company, the investor has bought the stock.  No one would buy shares of non-listed family company, and even if he/she wants to buy it, it’s impossible due to non-listing status.  The court thought that investors would not have purchased shares but for misrepresentation.  Investors were awarded more generous remedy and the damage amount was calculated based on purchase price minus disposal price.

In Mr. Ghosn’s untrue statement case, it is still unknown whether financial figures of Nissan are distorted or not.  There is a compensation contract between Nissan and Mr. Ghosn, and payment term can be set freely by contracting parties.  If the accounting standards require debt recognition or provision for future payments, and if these are not done, the financial figures are surely distorted.  Here, assuming that these are not required, the financial figures are correct.  However, in the securities report there is a section to write executives’ compensation.  In the case of Nissan, it is described as follows.

(From the securities report of the fiscal year ending March 2015)

Compensation paid to the Company’s Directors consists of an amount of remuneration in cash and share appreciation rights (SARs) as resolved at the 104th annual shareholders’ meeting held on June 19, 2003. The cash remuneration is limited to a maximum of ¥2,990 million per annum as resolved at the 109th annual shareholders’ meeting held on June 25, 2008. The amount to be paid to each Director is determined in function of the Director’s contributions to Company performance and in reference to a regular benchmarking of executive pay of a peer group of large multi-national companies conducted by the Company’s compensation consultant, Towers Watson. 

Directors are eligible to earn SARs as an incentive to boost in a sustainable way the profitable growth of the Company. To earn the SARs for which they are eligible Directors must achieve objectives that are directly related to achievement of the Company’s business plan. This incentive is limited to the equivalent of up to 6 million shares of the Company’s common stock per annum as resolved at the 114th annual shareholders’ meeting held on June 25, 2013. 

The remuneration paid to the Statutory Auditors is limited to a yearly amount of ¥120 million as resolved at the 106th annual shareholders’ meeting held on June 21, 2005. This compensation is designed within this limit to promote stable and transparent auditing. 

For the current fiscal year, the amounts disbursed to the Directors and the Statutory Auditors were as follows: 

<Total remuneration by each position> (Millions of yen)

CategoryTotal Remuneration Basic Remuneration SARNumbers
(except for Outside Directors) 
Statutory Auditors
(except for Outside Statutory Auditors) 
Outside Directors and Outside Statutory Auditors 72725

<Individuals whose remuneration exceeds ¥100 million> (Millions of yen) 

NamePositionCategoryTotal Remuneration Basic Remuneration SAR
Carlos Ghosn DirectorThe Company 1,0351,035
Hiroto Saikawa DirectorThe Company 15514015

Note: The above mentioned amount of share appreciation rights (SAR) is the expense recorded based on the fair value, calculated by using the share price as of March 31, 2015. Payment is not fixed with the fair value. 

<The procedures to determine the amount of remuneration>
The chairman of the Board of the Company in consultation with the representative directors and taking into account existing contracts determined the compensation of each director after reviewing the director’s performance and the results of the benchmarking of executive pay survey conducted by the Company’s compensation consultant. 

(End of report)

The prosecutor’s argument sounds that the deferred compensation JPY 1 billion is material, and the omission of which in the field above is a misrepresentation.  Let’s first consider materiality based on the amount of money.  Looking at the consolidated net income of Nissan in 2015, JPY 457 billion, JPY 1 billion is just one 457ths and is not significant.  On the other hand, looking at the true amount of JPY 2 billion, omitted JPY 1 billion is even the half, and could be said significant.

Some may argue that it is not a quantity but a matter of quality.  Shareholders entrust running company to the directors/executives and they owe fiduciary duty to the company. Compensation contracts are an important covenant between shareholders and executives.  As shareholders usually can not read the specific contents of the compensation contract, they are solely dependent on the securities report.  Because of the high interest in executive’s expensive compensation, the form of the securities report has changed, and the degree of the compensation disclosure has been elevated.  Mr. Ghosn thought the information was so important that he wanted to avoid disclosure, risking his possible criminal liability.  In this way, the information in the compensation section is material from its nature, and the amount of money is irrelevant.

Whether material or not will be eventually judged by the courts.  However, the materiality of information should be determined based on how information-users use the information.  Will investors change investment decisions with compensation information?  For investors who do diversified investment, passive investment, algorithmic trading, executive’s compensation information seems to have little meaning.  In addition to the materiality, it may be argued as transaction causation.  I hope that the courts will sufficiently discuss whether the executive’s compensation information will affect investor’s behavior. 

End of memo

Sachiko Ichikawa; Partner lawyer at Tanabe and Partners (Tokyo), certified lawyer in Japan and NY, Certified Public Accountant in US. She has profound knowledge about the securities fraud cases from her experience as a litigator in such cases. She also gives advices to issuing companies and their directors as to the disclosure responsibilities.

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