Amendment to the Japanese Companies Act
The Japanese Companies Act was amended on 27 June 2014 (the Amendment) for the purpose, among others, of strengthening the corporate governance of Japanese companies. The effective date of the Amendment has yet to be determined, but it is expected to take effect around April or May 2015. The amendments relating to corporate governance include (i) strengthening the supervision of the board of directors, (ii) providing more power to statutory auditors in respect of the election and dismissal of accounting auditor(s), and (iii) strengthening corporate governance in the situation of raising funds.
Strengthening the supervision of the board of directors
Explanation of why it is not reasonable to have outside directors
Under the current Companies Act, companies which have a board of statutory auditors, which is a very common structure among listed companies in Japan, are not required to have outside directors. However, as the number of the foreign investors increases in Japan, the inclination that outside directors should be required has become strong. Based on this inclination, whether the Amendment should include this requirement in particular for listed companies was one of the most-discussed topics. In the end, the Amendment did not specifically include this requirement. Instead, under the Amendment, if certain companies (mainly, listed companies) do not have outside directors, such companies will be obliged to explain in their business reports the reasons ‘why it is not reasonable to have outside directors’. In addition, directors of these companies must explain at their annual shareholders meeting the reasons ‘why it is not reasonable to have outside directors’.
In regards to the explanation described above, it is not sufficient to simply denote that outside directors are not necessary, and it is required that an explanation be given as to why having outside directors will have a negative impact on the company.
If the directors, at the annual shareholders’ meeting, do not explain the reasons why it is not reasonable to have outside directors, a resolution of such annual shareholders’ meeting of the election of directors may be revoked. Therefore, this new requirement introduced by the Amendment is understood as a high hurdle for (listed) companies which do not intend to have outside directors, and thus it is expected that this new requirement will pressure them to elect outside directors.
The discussion on whether (listed) companies should have outside directors is not yet over. There is a note in the Amendment stating that the Government will re-visit this issue in two (2) years’ time and discuss whether the requirement of an outside director should be introduced [In relation to this point, the Tokyo Stock Exchange has amended its listing rule, and the new listing rule stipulates that listed companies must endeavor to appoint at least one ‘independent officer’ (ie, outside director who has no risk of having conflicts of interests with general shareholders or a statutory auditor). This new listing rule has already become effective.].
In addition, the criteria for outside directors have been amended. After the effective date of the Amendment, certain persons (eg, the representative director [The board of directors of a company must elect representative director(s) from among the directors. A representative director represents the company. If there is more than one (1) representative director, each representative director represents the company independently. A representative director has the authority to perform, on the company’s behalf, all acts concerning the business of the Company.] of parent company and/or fellow subsidiaries) will not satisfy the definition of an outside director.
Companies with an audit (or other) committee system which is a new corporate structure
As described above, having a board of statutory auditors is a very common structure among listed companies in Japan. Under the current Companies Act, such companies are required to have not less than two outside statutory auditors. And thus, if the amendment in relation to the explanation of why it is not reasonable to have outside directors takes effect, such companies will be pressured to have outside director(s) in addition to having outside statutory auditors. It is expected that electing both outside directors and outside statutory auditors will be a large burden on these companies.
Because of this, the Amendment established a new corporate structure, which is the company with an audit committee system (the System). Under the System, the company’s audit committee (the Committee) will conduct an audit of the performance of duties by the company’s executives, including the representative director, instead of statutory auditor(s) or a board of statutory auditors, and thus, companies having the Committee will not be required to have (outside) statutory auditor(s).
Since the Committee consists of directors (mainly outside directors), it is expected that the Committee will conduct an audit more effectively than statutory auditor(s) or a board of statutory auditors, using the voting rights of the company’s board of directors. Therefore, the Committee conducts not only an audit of a company’s business (ie securing the legality of a company’s business) but also the supervision of a company’s business (ie securing the efficiency of a company’s business), both of which are not functions of statutory auditor(s) and/or a board of statutory auditors.
The Committee should consist of not less than three directors and more than half of the members of the Committee are required to be outside directors. Furthermore, directors of a company who are the members of the Committee may not concurrently act as (i) an executive director [(i) A representative director, (ii) a director other than a representative director, who is appointed by resolution of the board of directors as the director who is to execute the business of such company with board of directors, and (iii) any other director who has executed business of such company.] of the company or the company’s subsidiary or subsidiaries, (ii) an employee including a manager of such company or such company’s subsidiary or subsidiaries, or (iii) an accounting advisor or an executive officer of such company’s subsidiary or subsidiaries. In addition, the company’s board of directors will be required to appoint the company’s representative director from director(s) other than the member of the Committee.
Under the System, the Committee conducts audit and supervision of the performance of directors’ duties using internal control systems [In detail, the Committee will conduct audit (or other) by way of (i) monitoring whether internal control systems are constructed and operated appropriately by a board of directors, (ii) obtaining necessary information for audit (or other) using this internal control systems, and (iii) making detailed instructions to the company’s internal control division.]. In addition, each member of the Committee may conduct an audit and supervise through the voting rights of the company’s board of directors. Furthermore, to secure the Committee’s functions of audit and supervision, the Committee is given the right to state their opinions relating to personnel affairs regarding the company’s directors (eg, appointment of directors and remuneration of directors) at the company’s shareholders meeting.
More power to statutory auditors regarding the election and dismissal of accounting auditor(s)
Under the Japanese Companies Act, a company’s accounting auditor(s) is or are elected or dismissed by resolutions of the company’s shareholders’ meeting and, before the Amendment, the contents of proposals at shareholders’ meetings regarding the election and dismissal of accounting auditor(s) of a company with auditors (the Content) are determined by the company’s director(s) or board of directors. However, after the amendment, the Content will be determined by statutory auditor(s) or the board of statutory auditors. The purpose of this amendment is to secure the independence of accounting auditor(s) from management.
Strengthening corporate governance in relation to raising funds
Before the Amendment was legislated, as a general rule, any company (excluding companies which require approval to transfer any shares) could determine the issuance of shares by resolution of the board of directors if it was within the authorized share capital, without shareholders’ approval, and this issuance of shares has been a useful financing method. However, this was a powerful tool for the board of directors, and the board of directors could change the major shareholder, for instance, without asking for shareholders’ approval. To weaken the power of the board of directors, the Amendment sets out that, if, as a result of the issuance of shares, a majority of all votes in the company are owned by a subscriber of the company’s new shares then (i) the company will be required to disclose information relating to such subscriber of the company’s shares to shareholders, and (ii) if shareholders that hold in total 10% or more of all votes object to such an issuance of shares, then, as a general rule, the company will be required to obtain shareholders’ approval.
Establishment of Corporate Governance Code by Tokyo Stock Exchange
In addition to the Amendment, the Tokyo Stock Exchange (the TSE) announced that it will establish the Corporate Governance Code (the CGC), which stipulates the corporate governance principles of listed companies. The purpose of this is to promote the autonomous efforts for sustainable growth of listed companies by strengthening their corporate governance. The CGC will be established based on the TSE’s existing rules of corporate governance and the OECD Principles of Corporate Governance. To establish the CGC, the TSE and the Financial Service Agency are jointly holding the Expert Committee on the CGC (the Expert Committee). The Expert Committee will put together basic thinking of the CGC. The CGC is expected to be established and take effect by June 2015.