Driving a car requires a license. And so does selling or trading securities, or supervising brokerage employees. While U.S. securities firms usually go to great lengths to ensure that their employees are properly licensed, the same can't be said for the U.S. subsidiaries of three of the four largest Japanese firms. According to a Feb. 25 Securities & Exchange Commission order, those firms routinely flout National Association of Securities Dealers (NASD) licensing rules and many other regulatory requirements.
Take Yamaichi International (America) Inc., a subsidiary of Japan's fourth-largest broker. According to the SEC and the individuals' NASD records, Yamaichi's Kentaro Watanabe, who headed institutional sales, research, and mergers and acquisitions, is not registered as a general securities principal, a requirement for supervisors. Nor is Hiroyuki Tahara, who headed three departments from 1989 to late 1991. As of mid-1991, Tahara had not passed any sales or supervisory exam. Masao Yamashita, who ran Japanese institutional equity sales, passed the basic exam for sales representatives only on his seventh attempt, in October, 1991, four years after he joined the firm. He never took the supervisory exam. Yamaichi Chairman Scott E. Pardee confirms the licensing violations and says all three executives had been reassigned outside the U.S.
The SEC has also accused U.S. subsidiaries of Yamaichi, Daiwa, Nomura, and Nikko of additional offenses, from illegal purchases of Treasury bills to concealing trading losses to reimbursing customers for trading losses.
SYSTEMIC FLOUTING. The SEC's investigation was sparked by 1991 revelations that several Japanese brokerage firms had engaged in widespread and improper covering of client losses in Japan. Three of the firms settled the SEC charges without admitting or denying any guilt. They were censured and had to pay $841,000 in fines and penalties. Nikko Securities Co., the third-largest Japanese firm, is contesting charges that its top officials concealed an $18 million trading loss in the firm's 1991 fiscal year. The SEC's investigation of Nikko, which includes its record-keeping practices, is continuing.
While some of these other misdeeds seem more serious than breaking licensing rules, the license violations raise serious questions about the pervasiveness of the wrongdoing and the extent to which it was condoned by top executives. The NASD licensing rules are designed to make sure that securities professionals understand the securities laws and to help monitor their adherence to those laws. Although the most widely publicized of the alleged actions were isolated incidents by individuals, the licensing violations, according to SEC officials and Americans familiar with the U.S. operations of Japanese firms, were systemic and involved senior executives, at least at Yamaichi and Daiwa Securities America Inc. One of the improperly licensed executives was actually responsible for his firm's compliance with regulations. "Japanese firms have complete and utter contempt for American regulations," says John E. Fitzgibbon, a former executive at Nomura Securities International Inc. and author of Deceitful Practices: Nomura Securities and the Japanese Invasion of Wall Street.
Nomura's U.S. unit does not break licensing rules, says Gary Lynch, Nomura's attorney. He points out that the SEC order found only two employees who were not fully registered. A Daiwa spokesman says the licensing deficiencies stem partly from the constant rotation of employees from Japan and from their difficulties taking the exam in English. In addition, the spokesman says Daiwa has "strengthened and revised its compliance procedures."
`DID NOTHING.' The cost to the firms from the violations could extend beyond mere embarrassment. Firms that hawk securities can be held liable by their customers for losses on transactions that were executed by unregistered brokers. Since such cases tend to be clear-cut, "firms won't fight," says Robert I. Kleinberg, general counsel of Oppenheimer & Co. "Usually the matter is settled [out of court]."
Why were officials at the Japanese firms able to operate so long without licenses? The reason was apparently lax enforcement by the NASD. One source close to the NASD suggests that it may not have been an aggressive cop for political reasons. The association "knew about this years ago and did nothing," says a former member of the group's qualifications committee. "You didn't do anything to upset the relationships between the U.S. and Japan." The reason: Until Japan's recent economic slowdown, Tokyo firms were flooding U.S. markets with capital. John E. Pinto, the NASD's head of compliance, denies there is a double standard. "Nothing at all would cause us to hesitate to do something if we knew of Japanese firms' violations," he says.
NASD officials point out that some Japanese officials can legally run their businesses without taking the qualifying exams and getting U.S. licenses. Takuro Isoda, the former chairman of Daiwa's U.S. unit, for instance, never took the two basic tests for brokers and principals, because the NASD issued him a waiver. The NASD can waive the rules for senior officials, including U.S. executives, if it decides they already have extensive experience in the business. Daiwa says that getting a waiver in no way diminishes Isoda's qualifications.
But most lower-level Japanese employees don't get waivers--and a significant number don't bother to take the tests. One reason is that Japanese firms often transfer employees to the U.S. for three- to six-year stints. Japanese officials, who don't have to be licensed in Japan, contend that it would be too much of a burden for their employees to take the American tests because of language problems--even though the exams now can be given in Japanese.
Despite the NASD's denials and explanations, it seems clear that the association hasn't been very strict about policing its rules. As of September, 1991, when the SEC conducted its investigation, 20 of about 50 Daiwa traders and investment bankers who are regularly rotated from Tokyo to the U.S. had not gotten sales licenses, according to the SEC. In addition, at least three of Daiwa's U.S. directors were not properly licensed for between two and five years. The directors included three Americans, according to an affidavit filed in an unrelated wrongful-discharge suit brought by an American former Daiwa vice-president.
One of the directors was bond trader William Brachfeld, an executive vice-president, who was fined $31,000 and suspended for three months for his role in the illegal Treasury bond trades. According to NASD records, Brachfeld wasn't fully licensed until August, 1990--five years after he assumed his post. Brachfeld's lawyer says the delay was due to a misunderstanding.
LAWSUITS? Even Daiwa's chief legal and compliance officer, Lawrence Jacob, appears to have violated rules, according to NASD records and the affidavit in the lawsuit. Jacob failed to get a supervisory license until early 1988--which was more than two years after he joined Daiwa, according to the records. Daiwa declined comment.
The licensing problems led to more serious violations, the SEC alleged. The commission charged Daiwa with repeatedly assigning legitimate brokers' registration numbers to trades conducted by many unlicensed Japanese. False record-keeping is a serious violation of securities laws.
SEC Enforcement Director William R. McLucas says he's confident the firms will soon put procedures in place to assure complete compliance with U.S. laws. Yamaichi launched a policy two years ago that requires Japanese brokers to pass the basic U.S. test before setting foot here. But that may not protect the firms from disgruntled customers, who may try to recoup losses, citing trades done by unlicensed personnel. For Japanese firms, this lesson in American regulation could be expensive as well as embarrassing.