Public Comment to the METI Fair M&A Study Group (by Nicholas Benes)

As the person who initially proposed the Corporate Governance Code to the LDP in 2013 and 2014, I am well aware of its limitations in various areas. For this reason, I am very pleased that Fair M&A Study Group have decided that its discussions should cover not only MBOs, but also ”cases which are likewise significantly affected by the issues of conflict of interest and information asymmetry”[1], including “cases of acquisition of a controlled company by its controlling shareholder.”[2]

This indeed an important mission, because these topics include virtually all types of M&A transactions and the public statements of executives and boards with regard to them. For many years in the post-war era, the failure of the government and the JPX/TSE to set forth clear bright-line rules that facilitate a fair, robust M&A market in Japan has stunted productivity, dynamism and growth in the Japanese economy.

Challenges and Realities

Japan presently faces a number of challenges in devising laws, listing standards, and guidelines to limit the negative impact of inherent conflicts of interest, self-dealing, and information asymmetry in M&A transactions. A number of these are unique to Japan.  

To execute on the Study Group’s mandate, its members and policy makers must first recognize and discuss the impact of these challenges, which 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.[3] This principle is hardly functioning at all, because: (a) many companies do not fully understand what the term “related party transactions” includes, and therefore do not already have any policies for the most important related party transactions; and (b) any sort of vague disclosure to the effect that “the board approves all transactions with directors that present a conflict of interest” (which merely reiterates the board’s duty under the Company Law) is deemed to be sufficient disclosure under the CGC, which does not define what should be included in the concept of “related party transaction”.[4]

  • 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.[5] 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”.[6]
  • 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 therefore 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; 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 obtaining 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 in this Comment, 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. In turn, these problems often set the base for low-priced MBOs and other take-private transactions. 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 these reasons, I believe that Japan should follow the example of the UK, by prohibiting takeover defenses and adopting a lower level (30%) at which a mandatory offer is required.

General Recommendations

Dealing with the aforementioned challenges on a timeline that meets the expectations of global investors will require not only clear guidelines, but also integrated changes to “hard law”, “soft law”, and stock exchange listing standards.  

Therefore, I recommend that:

  • The Study Group’s goals and discussions should not begin and end with merely the drafting of updated and wider-ranging “Guidelines” than exist at present.

  • Rather, the Study Group should also attempt to provide to the Cabinet Office, the Prime Minister’s Office, FSA, MOJ, MHLW and JPX detailed guidance and examples of proposals for the integrated, coordinated changes in hard law, listing standards, and pension governance that are needed in order to deal with the realities of Japan’s M&A market, but which cannot be adequately covered by “guidelines” issued by METI. In other words, bureaucratic and organizational “silos” should be ignored[7], in favor of identifying sufficient, fully integrated solutions and informing other policy-making arms of the government (and the JPX) about what is needed.
  • In view of the difficult challenges and realities described above, the Study Group should not assume that the same practices that seem to be sufficient in other major markets will be sufficient in Japan.

I would respectfully 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 primary reasons being given as “unbalanced focus on soft law compared to hard law” and “rules and shareholder rights [that] remain weak in many areas.”[8]

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

  1. In line with its professed purpose, the Study Group should seek to inform policymakers and the stock exchanges by identifying the types and range of transactions that can easily be “significantly affected by the issues of conflict of interest and information asymmetry”, as was set forth in METI’s solicitation for public comments. These necessarily include, but are not limited to, MBOs, third-party-allotments (TPAs), issuance of special-class or preference shares or options, TOBs, mergers, squeeze-outs, and any series of de-facto connected transactions taking place over a one-year period and combining more than one of these types (e.g., a “creeping takeover”, combining a TOB followed by a subsequent TOB and planned squeeze-out) or leading to significant change in capital structure and/or voting rights at a company.

  2. 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 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 analyze, 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.    

  3. 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 any other possible counterparties[9] 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%.[10] 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.

  4. The Charter of the committee would 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 kept 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” potential 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, and 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. 
  5. 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%, 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.[11] 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 contemplated or probable, that fact should be disclosed and these two rules should apply prior to the 18% Transaction.

    For all companies that have a ratio of “policy holding stocks” to net assets of 9% or less[12], 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 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%[13], 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 in the future) “policy holding stocks” held by the company in question. In making this calculation, the company should bear the burden of obtaining letters from any such 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, therefore, 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.”

  6. Relevant securities law and company law regulations should be changed in order to permit the aforementioned (3) (d) without risk of liability concerns regarding “execution”(執行)by an independent or outside director in the case where such a committee exists.  

  7. Along the lines of my 2011 proposal (attached as Appendix 1), as soon as possible the Company Law should be amended so as to: (a) shift the burden of proof from shareholder plaintiffs to defendant directors in the case of shareholder derivative lawsuits alleging breach of the duty of due care where executive directors have inherent conflicts or self-interest at stake, or there is risk of such; unless (b) the decision was made by a “Special Board” (特別取締役会) set up along the lines of Article 373 of the Company law but composed solely by independent directors. (See also the ACCJ’s Viewpoint reflecting this same proposal, published in July of 2017.[14])

    This change would provide a strong incentive for companies to appoint sufficient independent directors to adequately “police” Transactions, while providing stronger protections to shareholders because the Special Board could choose to not only advise on the transaction but also determine its terms if necessary.

    The Special Board should have a Charter similar to that set forth in (3) above. The Study Group should also consider recommending to change the standard for judging whether there has been a violation of the duty of due care in the case of decisions regarding Transactions, to a stricter standard.

  8. Japan needs clear rules similar to the “Revlon duties” and “Unocal” doctrines, first in guidelines, and as soon as possible, hard law. There needs to be a strong motivation for the board to consider (and if feasible, attempt to negotiate) any and all other transactions with alternative counterparties which might provide better terms to shareholders, whenever a transaction will result in the sale of the company or a change of control, or is likely to set the base for subsequent Transactions leading to a change of control. Clear minimum standards and required practices regarding: (a) the use of completely independent committees to advise the board, or Special Boards; (b) requirements to consider any and all alternative transactions; and (c) procedures for the adoption and use of takeover defenses or de-facto defenses, and enhanced standards and procedures for judicial review when their misuse is asserted, are needed under such “change of control” circumstances.

    In its meetings and materials for METI’s “Corporate Value Study Group” culminating in its May 2005 report and justifying the use of takeover defenses in Japan, there were lengthy descriptions of the logic of U.S. law, “Revlon duties”, and the “Unocal Standard” [15] . Although the final report clearly stated in its conclusion that “in order to prevent self-serving decisions by the board, structures to reflect the judgement of [independent] outsiders will be necessary” [16], over the past 14 years sufficiently concrete structures and rules for that purpose were never put in place, notwithstanding the fact that recommendations by an active and informed special committee of independent, disinterested directors are the bedrock of those and other doctrines in Delaware law related to M&A transactions. This is surprising when one considers that not only METI, but also MOJ’s name appears as the author of the May 2005 report.

  9. To the extent possible, listing standards and rules of the JPX and other exchanges should be amended in order to require and support as many of the aforementioned practices as possible, such as (1), (2), (3), (4), (5) and (8).  This should include a prohibition of third-party allotments (as opposed open public offerings or rights offerings) to a “controlling” shareholder owning greater than 30% interest in a company, unless the company is in financial distress. The rules should also 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. At the same time, the minimum scope of what constitutes a “related party” and “related party transaction” should be defined in detail in the Corporate Governance Code, and full disclosure of all related party dealings should be required in yuho securities reports, which should be released at the time when convocation notices are sent.

    With respect, I cannot help but note that over the past 15 years, the JPX has not been 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.

    I will give a few pertinent 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[17] . 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 misinterpreted 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 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 the JPX’s recent public comment process was a step forward, and it would be my hope that encouragement by METI and FSA (and others) will continue to improve the stance of the JPX

I am very grateful to the METI and the Study Group for providing 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.)

Download a copy of the full public comment to METI, including the Appendix.

[1] “Solicitation of opinions/information on fair M&A”, METI Corporate System Division, December 28th 2018, page 1.

[2] “Solicitation of opinions/information on fair M&A”, METI Corporate System Division, December 28th 2018, page 1.

[3] Principle 1.7.

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

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

[6] The accumulation 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”. The practice was 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: .

[7]  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.

[8] CG Watch 2018: Hard Decisions, CLSA and Asian Corporate Governance Association, December 5, 2018.

[9] 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.

[10] 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 – e.g., to 6% in 2022, 3% in 2024, 2% in 2026.

[11] 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 – e.g., to 6% in 2022, 3% in 2024, 2% in 2026.

[12] This 9% criteria should be reduced over time to 2% by 2026 – e.g., to 6% in 2022, 3% in 2024, 2% in 2026.

[13] Ibid.

[14] 「コーポレート・ガバナンス改革の強化を促進するための会社法改正案」”Proposed Amendments to the Companies Act to Further Strengthen Corporate Governance Reform”, American Chamber of Commerce in Japan, July 2017.

[15] 敵対的買収防衛策(企業価値防衛策)の整備」「企業価値研究会の論点公開の骨子と企業価値防衛指針策定に向けた対応」 (資料2)、企業価値研究会(経済産業省)、「平成17年3月。

[16] 「企業価値・株主共同の利益の確保又は向上のための買収防衛策に関する指針」13頁 、企業価値研究会(経済産業省、法務省)、2005年5月27日。 引用します:「このため、買収防衛策は、消却条件の客観性の度合いに応じて、社外者あるいは独立社外者の関与の度合いを高める工夫が必要となる。特に、客観的な消却条項を設けない場合には、原則として、取締役会の恣意的判断を排除するために、独立社外者の判断を重視する仕組みが必要となる。」

[17] 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. 


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