Amended, Detailed Public Comment by Nicholas Benes to JPX re: “Review of the TSE Cash Equity Market Structure”

NOTE:  This public comment supersedes and replaces the one that I, Nicholas Benes, submitted on January 12, 2019)

As the person who initially proposed the Corporate Governance Code to the LDP in 2013 and 2014, and suggested a number of principles in it, I am well aware of its limitations in various areas and the fact that Japan has not yet attained the quality level for an equity market that is expected by global investors. In this sense I am very pleased that the JPX has decided to review its equity market structure and related standards.

Challenges and Realities

This indeed an important mission, for which is it essential to recognize and discuss the impact of a number of challenges that Japan faces in improving governance, efficiency, and trustworthiness of its equity capital markets. These challenges include:

Unfamiliarity with the impact of “related-party transactions” on governance and corporate value. One of the least effective principles in the JPX’s Corporate Governance Code (CGC) is the principle requiring procedures regarding “related party transactions” and disclosure of those procedures. (1) This principle is hardly functioning at all, (a) partly because many companies do not fully understand what the term “related party transactions” includes, most firms do not already have any policies at all for the most important related party transactions; and (b) mainly because any sort of vague disclosure to the effect that “the board approves all transactions with directors that present a conflict of interest” (which merely re-iterates the board’s duty under the Company Law) is necessarily deemed to be sufficient disclosure under the CGC, because it does not define what should be included in the concept of “related party transaction”(2).

The existence of large numbers of “allegiant shareholders”, which have been calculated to account for fully 35% -50% of the shares listed on the first section of the Tokyo Stock Exchange.(3) This high percentage means that at many companies there is already a base of “related parties” in place, whose shares should logically be added to that party’s holdings and therefore excluded from the “minority” in any “majority of the minority” vote or tender calculation. The interests of such “allegiant holders” are different from those of other “minority” holders, because they have something to lose (business from the company, and possibly a “stable [cross] shareholder”), if they do not vote in agreement with management. In this sense, they are “related parties”. (4)

Multiple gaps in Japanese law, including: (a) the scarcity of significant case law regarding the duties of independent directors with regard to M&A transactions that are affected by the inherent conflicts and other issues which concern the Study Group, and how and when companies should use independent directors (via committees, etc.) to safeguard the interests of common shareholders in M&A transactions in and reduce the liability of directors or the company; (b) the legally-condoned practice of using as members of advisory committees third-party “experts” who do not bear legal fiduciary duties because they are not directors, and who often know little about the company and its long-term strategy because they have (by definition) not been attending board meetings; (c) the scarcity of case or codified law enabling shareholders to ask courts for injunctions so as to postpone proposed transactions until appropriate determinations about fairness can be made in advance of execution of the transactions; and (d) an extremely weak “discovery” system for civil litigation that often makes it impossible for prospective plaintiff shareholders to obtain enough information as evidence supporting a lawsuit or injunction request, even where unfairness seems obvious.

The absence of “safe harbor” legal rules to protect outside directors appointed to committees (and the company) from possible legal liability (e.g., “violation” of the non-executive status of that director) if such directors are involved in negotiating with counterparties and/or hiring advisors in order to fulfill their role as committee members.

Weak incentives to use “best practices” such as competitive procedures or requiring the informed approval of shareholders to ensure that the best possible terms are obtained in M&A transactions. In view of the challenges and realities faced by Japan and set forth on this page, such practices should include, at minimum, making a “market test”, using a competitive auction or other competitive process if justified by the result, and obtaining consent from neutral shareholders via a “majority of the minority” vote or tender condition. The use of such practices needs to be motivated by a fear of legal liability on the part of boards and among executives. If not, best practices will not be used in the situations in which they are most needed, or by the companies that most need to use them.

High “mandatory offer” level in securities law. Japanese securities law does not require a mandatory offer to purchase 100% of the shares of a company unless the acquiror seeks to acquire more than two-thirds of outstanding shares. This makes it easy for “listed subsidiary” or “creeping takeover with small premium” problems to persist. Moreover, except for rare cases, agreed transactions are not required to be submitted for substantive review by a regulator in advance. History has shown that for a variety of reasons, takeover defenses in Japan do not serve to increase corporate value on the part of general investors, which was their ostensible purpose. For this reason, I believe that Japan should follow the example of the UK and prohibit takeover defenses while adopting a lower level (30%) at which a mandatory offer is required.

General Recommendations

Dealing with the aforementioned challenges on a time line that meets the expectations of global investors will require integrated changes to “hard law”, “soft law”, and stock exchange listing standards.

Therefore, in view of the JPX quasi-public role as Japan’s major equity market, and its corporate social responsibility that comes with that role, I recommend that:

● The JPX advisory team’s goals and discussions should not begin and end with merely advice to update specific aspects of “market structure” at the JPX.

● Bureaucratic “silos” should be ignored (5), in favor of attempting to identify sufficient, integrated solutions, delineate how JPX itself can maximally contribute to those solutions, and informing other policy-making arms of the government about what else is needed.

I would note that the Asian Corporate Governance Association’s most recent analysis of corporate governance system in Asia’s major markets, Japan’s ranking in Asia fell from four in 2016 to seven in 2018, with one primary reason being given as “rules and shareholder rights [that] remain weak in many areas.” (6)

Specific Recommendations

From this perspective and based on the challenges and realities outlined above, I would like to make the following specific recommendations:

  1. The rules of the JPX for all “sections” and types of companies should:

(a) Prohibit third-party allotments (as opposed open public offerings or the use of rights) to a “controlling” shareholder owning greater than 30% interest in a company, unless the company is in financial distress as defined in JPX rules.

(b) Require prior shareholder approval for the issuance of stock of any type that is not offered on a pro-rata basis and results in dilution greater than 20% “pre-money”, similar to the rule used by NYSE and Nasdaq.

(c) Define in detail the minimum scope of what constitutes a “related party” and “related party transaction” for purposes of the Corporate Governance Code, and require full disclosure of all related party dealings in corporate governance reports (or better still, yuho securities reports, following coordination with FSA).

(d) Require disclosure of the names of all former directors or kansayaku which now serve as “sodanyau”,”komon” or other types of advisor, or who have received compensation or payments with respect to a position of any type during the past year. Such disclosure should include the amount of the compensation, and the type(s) of work provided.

(e) Define “independence” more stringently than at present in the listing standards and for purposes of the Corporate Governance Code. For instance, persons affiliated (in the past or present) with suppliers, customers, or business or trading partners of any significance whatever should not be considered “independent”, nor should persons who are or have been affiliated with companies in a cross-shareholding relationship with the company.

2. There should be only two sections of the JPX: (1) a TSE Premium Section and (2) an Emerging Companies Section.

Premium Section

3. Companies listed on the Premium Section must fulfill the following requirements in addition to the existing standards and governance principles that apply to TSE1 companies:

(a) A five-year average market capitalization exceeding 50 Billion yen. 

(b) The ratio of total “policy holding stocks” (seisakuhoyukabu, 政策保有株) to net assets(純資産)as of the most recent FYE “yuho” financial report (or the one submitted just after any AGM) must not be more than 9%(6% in 2022, 3% in 2024, 2% in 2026).

(c) Convocation notices must be sent out by both post and electronic methods at least four weeks before each AGM, and the electronic voting platform must be used.

(d) Companies must distribute financial reports, kessan tanshin, corporate governance reports, convocation notices, and jigyou hokokusho business reports in both Japanese and English, and the English reports must use the same XBRL format tags as those used for the respective Japanese materials. (Note: Japan will need to create standardized, detailed XBRL formats for business reports and convocation notices. This should be phased in over the next three years. At the same time, the legal changes to the Company Law and securities laws that are needed to combine jigyou houkokuho with yuho into a single integrated document should be made as soon as possible, as should shifting to a smooth system for filing/distributing that single report together with the convocation notice. This will be more convenient and less burdensome for both investors and company managers.

(e) Corporate governance reports in both languages must stratify and separate out the “disclosure items” using separate XBRL tags, which (counter-intuitively) is not the case at present.

(f) The Articles of Incorporation must explicitly permit an AGM to held within four (not three) months of the FYE or cutoff date (基準日), whichever is later. Starting in 2024, the AGM must be held in July.

(g) More than least one-third of the board (one-half starting in 2024) consists of independent directors as defined more stringently than at present, including the exclusion of persons with affiliations to business partners and suppliers. More than one-half of the board consists of non-executive directors as of 2022, and there is a nominations and compensation committee (or two separate committees) with a majority of independent directors and having no CEO (代表取締役) as a member and no executive officer as the chair.

(h) In order to be ready to immediately advise the board with regard to the fairness to shareholders and the optimization of terms for any of the above-identified transactions (a “Transaction”), a standing committee of three independent directors must exist at all times, with its members identified and disclosed in advance on the company’s web site, “yuho” securities report, and corporate governance report. If in the initial years a company does not have three independent directors to staff the committee, it must staff it with disinterested outside directors and outside expert advisors as necessary, and explain in advance why it believes this composition is sufficient and the degree of legal liability (if any) that each member bears, setting forth the names of directors who voted for the composition of the committee and the date of that board resolution. In general, the role of the committee is to stand ready to negotiate and recommend (or recommend against) Transactions where the committee itself deems that its independent judgment is required. In the case of TOBs, the committee must advise on the public statement(s) that the board makes in disclosure and elsewhere regarding its opinion of the sufficiency of the terms and whether or not the board should recommend that shareholders accept the offer.

The Charter of the standing committee must be publicly disclosed in advance and should state that: (a) the CEO and other executives must inform the committee when they first seriously consider a Transaction; (b) each committee member has the authority to request any and all information regarding a Transaction or alternatives to it, at any time; (c) the committee will be required to submit, and the board will be required to receive, a detailed report to the board (including as relevant a fairness opinion from a qualified independent advisor selected by the committee) prior to the final agreement regarding a significant Transaction or a significant agreement related to it (or disclosure of an opinion related to it); and (d) a chair of the committee elected by its members will be authorized to represent the committee’s views and negotiate the Transaction and contact other possible counterparties (7) when the committee deems it to be necessary, and always in the case of any proposed Transaction involving as principal counterparty a shareholder holding 10% or more of the company’s stock or in any case in which the ratio of total “policy holding stocks” (政策保有株) to net assets 純資産)as of the most recent FYE “yuho” financial report is greater than 9%.(8) This last practice is necessary because if a company in Japan has such a large percentage of its net assets invested in “allegiant shareholder” companies, there is almost always a large pre-existing base of “related parties” in place which have interests which are different from those of other “minority” holders and are almost certain to abide by the wishes of management regardless of the terms.

The Charter of the committee must require it to do the following in any Transaction, except where independent advisors agree in writing that it not relevant or that the size and impact of a Transaction is not significant: (a) ensure that it is fully informed by the board and executives (who will have a duty to inform it); (b) hire an independent financial advisor of its own choosing and receive advice; (c) obtain a fairness opinion from an independent expert of its own choosing and publish it well in advance of the Transaction; (d) fully consider and attempt to negotiate a similar or alternative transaction with those other counterparties that have shown interest in the past; (d) using independent advisors, at minimum conduct a “market test” by contacting logical “new” other counterparties, and if justified by the result, conducting a competitive auction or other competitive process; (e) write a report including its full analysis (and that of advisors) about the proposed Transaction, possible alternatives, its clear recommendations for or against the Transaction (or suggesting changes), and in the case of approval, an explanation of why doing the proposed Transaction in this case is better than all other possible alternatives (also describing the extent to which each of those has been considered and discussed with possible counterparties); and (f) require that the committee’s full report and minutes (including the votes by each director) be attached to the minutes of the next board meeting, at which the committee’s advice must be discussed in advance of any decision.

(i) In the case of any Transaction (other than a merger) involving a shareholder already holding 10% or more of the company’s stock, or in any case in which the ratio of total “policy holding stocks” (政策保有株) to net assets 純資産)as of the most recent FYE “yuho” financial report is greater than 9% (9), either (a) all terms of the Transaction shall be offered to all shareholders on an equal basis, pro-rata, providing an “exit” option at any time on the same terms, including at the time of any subsequent “squeeze-outs”; or (b) a “majority of the minority” vote (or tender condition) should be required by the board prior to agreeing to the Transactions in any way or making public statements or disclosures to recommend it. These rules (a) and (b) should be applied on a look-back basis, combining all Transactions that are planned to occur within a 12-month period, or discussed between the parties on that basis. For instance, if a two-step transaction involving an initial 18% third-party-allotment followed by a TOB is considered probable, that fact should be disclosed and these two rules should apply prior to the initial 18% Transaction.

For all companies that have a ratio of “policy holding stocks” to net assets of 9% or less(10) , the “majority of the minority” condition shall be presumed to be met based on published voting results that explicitly exclude the number of votes that are controlled by the explicit Transaction counterparty or parties that are controlled by it or working in concert with it. For all companies for which the ratio is greater than 9% or other applicable level (11), the condition shall be considered to be met only if the company discloses clear records of voting results that explicitly exclude not only the votes of the aforementioned related party holders, but also the votes of any holders the names of which appear on the yuho securities report list of the largest 30 (scheduled to be raised to 60) “policy holding stocks” held by the company in question. In making this calculation, the company should bear the burden of obtaining letters from any cross-shareholders appearing on those lists and confirming whether or not they voted or tendered in the transaction, and if they did vote, how they voted.

Once again, the latter is necessary because if a company has such a large percentage of its net assets invested in “allegiant shareholders”, there is almost always a large pre-existing base of “related parties” in place which have interests which are different from those of other “minority” holders and are almost certain to abide by the wishes of management regardless of the terms. Logically, in the “majority of a minority” vote or tender condition, the “minority” should be defined as excluding the votes of not only (a) the counterparty in the prospective transaction, but also (b) all shareholders in which the company owns shares for purposes “other than pure investment”.

Emerging Companies Section.

4. All companies not listed on the Premium Sections shall be listed in the Emerging Companies Section. After an initial “moratorium” transition period of two years, existing TSE1 and TSE2 companies still not meeting the requirements set forth above should be automatically moved to the Emerging Companies Section.

Listing on the Emerging Companies Section should require:

(a) Annual submission and timely revision of full comply/explain corporate governance reports to the JPX, as is presently required for TSE1 and TSE2 companies, separating out the “disclosure” items using discrete XBRL tags for each item as described above in (2)(e).

(b) Production of convocation notices, and jigyou hokokusho (and later, a combined yuho/jigyouhoukousho) using the same XBRL format as used by Premium listing companies for their Japanese reports. Likewise, corporate governance reports in Japanese must stratify and separate out the “disclosure items” using separate XBRL tags, which (counter-intuitively(12) ) is not the case at present.

(c) By 2024, a ratio of total “policy holding stocks” (政策保有株) to net assets 純資産)as of the most recent FYE “yuho” financial report that is less than 6%.

Additional Comments

This JPX “market structure” public comment process should not be used as means to create a listing section where standards that are lower than those currently applied to TSE1/2 companies are tolerated for firms that wish to “flee” to it. If that is what it results in, the process will have been a step backwards.

With respect, I cannot help but note that over the past 15 years, the JPX has not been very particularly proactive in proposing and adopting listing standards and policies with an eye to improving corporate governance and market efficiency, and has not been very active in policing its own Corporate Governance Code. Encouraged by the current public comment process, which I applaud, I would like to encourage the JPX to make greater efforts, so that it can retain a position as a world-class stock exchange.

I will give a few examples from the recent past. Although some 80 companies in the world had corporate governance codes as of 2010, the JPX did not promulgate one until 2015, when it was encouraged to do so by the LDP and the FSA(13). Whereas the governance code of Pakistan requires 40 hours of substantive training for each and every director, the JPX’s Corporate Governance Code only requires each company to disclose its “policy” for director training, which is commonly interpreted by many companies as merely requiring “orientation” of new outside directors, or a vague policy of “training when skills are needed”. After almost five years the JPX still has not identified with separate XBRL tags the 11+ “disclosure items“ in corporate governance reports that companies submit to it as required by the JPX’s own code, even though this would be easy and low-cost to do, and would make analysis of the reports much easier.

Such lapses by the JPX, a private corporation with a public role, in adhering to higher standards for corporate social responsibility with regard to improving its own market and making a greater contribution to Japan’s economy, have been disappointing. But this public comment process is encouraging.

I am very thankful to the JPX for this opportunity to share my views on these important topics. Please feel free to ask me about any aspects of this letter that may be unclear.

Nicholas Benes

(Submitted as an individual, and not representing the views of any organization.)


(1) Principle 1.7.

(2) Similarly, JPX does not provide any or guidance filters for what constitutes sufficient disclosure for any of its CGC-required “disclosure items”.

(3) See: “How Many Shares are Actually Held by “Allegiant Shareholders”?”, by Ken Hokugo,
Director, Head of Corporate Governance, Pension Fund Association. .

(4) The concept of cross-shareholdings, which were promoted by METI in the early 1960s as a de-facto takeover defense, makes a mockery of the legal concepts of “equal treatment of shareholders” and “prohibition of vote-buying”, and was in fact opposed by Konosuke Matsushita, the venerated founder of Panasonic, in a 1967 article in which he stated his fear that it would lead to a “maldistribution of capital.“ See: .

(5) FSA, MOJ, METI, and JPX may have differing “jurisdictions” and responsibilities, but that is no reason disclosure and policies cannot be coordinated in order to dovetail with one another in smooth manner that is more convenient for investors and corporations alike.

(6) CG Watch 2018: Hard Decisions, CLSA and Asian Corporate Governance Association, December 5, 2018

(7) This should not be equivalent to the right to represent the company as CEO, and any “negotiated” terms should always be explicitly subject to approval by the full board of directors.

(8) At present, this “greater than 9%” criteria would affect approximately 40% of the companies listed on the first section of the TSE. This 9% criteria should be reduced over time to 2% by 2026.

(9) At present, this “greater than 9%” criteria would affect approximately 40% of the companies listed on the first section of the TSE. The 9% criteria should be reduced over time to 2% by 2026.

(10) See above. This level should be reduced from 9% to 2% by 2026.

(11) See above. This level should be reduced from 9% to 2% by 2026.

(12) “Counter-intuitively”, because the whole purpose of using XBRL is to separate out different items of information.

(13) At any time over the past few decades, under its own authority the JPX (or the TSE) could have created a corporate governance code with detailed, meaningful provisions such as those in the 2015 CGC, but it did not. See also: .

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