Compliance programmes for financial services firms in Japan

Compliance programmes

What requirements exist concerning the nature and content of compliance and supervisory programmes for each type of regulated entity?

Every FIBO is required to establish internal compliance programmes that are in line with the Supervisory Guidelines and Inspection Manual. Such compliance programmes involve the following (among others):

• establishment of a concrete plan for the implementation of a legal compliance system;
• development and implementation of a compliance manual on the applicable code of conduct;
• provision of compliance training for staff;
• periodical review of the effectiveness of the compliance programme; and
• periodical assessment of the compliance programme by way of internal audit.

Further, a FIBO is required to put a corporate governance framework in place that enables its chief and other compliance officers to perform their compliance functions independently from the influence of departments handling business operations. Typically, legal and compliance risks will be subject to the review of the legal and compliance department.

How important are gatekeepers in the regulatory structure?

Every FIBO is required to establish a system of proper checks and balances. As the effectiveness of such a system rests with the gatekeepers, their independence from the influence of departments handling business operations is essential to their ability to perform their gatekeeping functions effectively.

An independent internal audit department will usually also be established to audit the business activities of the FIBO, and to assess the effectiveness of the FIBO’s internal control functions. An internal audit department would usually report directly to the FIBO’s board of directors.

What are the duties of directors, and what standard of care applies to the boards of directors of financial services firms?

The board of directors of a stock corporation is given authority under the Companies Act of Japan to make decisions on all matters related the corporation’s business, other than matters that are expressly subject to shareholders’ approval. Every director on the board assumes duties of a fiduciary nature with regard to the corporation. The following are some of the main duties assumed by a director in a stock corporation:

• duty of loyalty, which requires the director to comply with applicable laws, the corporation’s constitutional documents, and board and shareholder resolutions, and to perform his or her duties faithfully for the benefit of the corporation;
• duty of care of a good manager, which requires the director to abide by the terms of his or her mandate and to perform his or her duties with the care of a good manager;
• duty of monitoring and supervision, applicable to the board of directors as a whole, which requires the board to monitor and supervise directors in the performance of their duties. As part of such duty, the board will make suggestions and take action to prevent any director from engaging any illegal or other activity that may be detrimental to the corporation; and
• duty of reporting, which requires a director to report to the board of directors upon discovery of any fact that may be detrimental to the corporation.

A director who breaches of any of his or her duties is liable to the corporation for the resulting damages sustained by the corporation. Directors who are deemed jointly in breach will be jointly and severally liable.

The Companies Act of Japan provides for criminal fines of up to ¥10 million or penal servitude for periods of up to 10 years in cases of serious and deliberate breaches of trust against the corporation and causing damages to the corporation. Further, non-penal, administrative fines in amounts not exceeding ¥1 million are in principle assessable for failure by directors to discharge certain obligations stipulated in the Companies Act.

When are directors typically held individually accountable for the activities of financial services firms?

A director would typically be held individually accountable if any violation of applicable laws and regulation is attributable to such director, such as where the director has authorised any falsification of accounts or entry into fraudulent transactions.

Japanese courts are generally understood to have demonstrated in judicial precedents to date that directors are recognised to be vested with broad discretion in the performance of their duties and, accordingly, that judicial post-factum intervention should not be excessive. As a result, Japanese courts tend not to hold directors individually liable for business decisions made in accordance with the following principles:

• when making decisions, the board has used efforts to avoid mistakes through adequate preliminary investigations and consultation with professionals, as necessary;
• the relevant decision made by the director was not materially unreasonable in light of the standard of care of a good manager typically expected of managers in the same industry; and
• the board has sought to avoid violation of applicable laws and the corporation’s constitutional documents and internal rules through consultation with legal counsel or others.

Do private rights of action apply to violations of national financial services authority rules and regulations?

Whether a person is permitted to institute legal action against a FIBO for violation of applicable JFSA rules depends on the circumstances of each case. In this regard, the Supreme Court held in a decision dated 14 July 2005 that a breach of the principle of suitability under the FIEA does not automatically lead to tort liability under private law, but added that tort liability may result where securities transactions deviating significantly from such principle are solicited and entered into. Accordingly, a FIBO may be subject to private rights of action in limited circumstances.

Additionally, a FIBO that breaches its duty to explain the nature of the relevant financial product to its customers pursuant to the Act Concerning the Sale of Financial Products (ACSFP), as discussed in further detail in question 19 below, is subject to private causes of action. In such cases, the burden of disproving causality between violation of the duty of explanation and the loss incurred by the customer will be sustained by the FIBO pursuant to the ACSFP.

What is the standard of care that applies to each type of financial services firm and authorised person when dealing with retail customers?

FIBOs and their staff are required to provide financial services to their customers in good faith, in accordance with the principle of fairness. The ACSFP also requires a FIBO, before selling a financial product to a customer, to explain the nature of the product, the risks involved in purchasing such product, and key aspects of the structure of the transaction.

Does the standard of care differ based on the sophistication of the customer or counterparty?

Yes, FIBOs are exempt from compliance with some of the key provisions on conduct in the FIEA (such as the principle of suitability, the requirement to deliver written statutory disclosures to customers, and advertising regulations) where the counterparties are professional investors. ‘Professional investors’ include QIIs, listed stock corporations, stock corporations with stated capital of at least ¥500 million, special purpose companies established pursuant to the Act on Securitization of Assets of Japan (TMKs) and foreign corporations. Individuals with trading experience of at least one year and net and invested assets of at least ¥300 million, as well as other corporations, may apply to change their status from general investors to professional investors.

On the other hand, FIBOs have to follow the principle of suitability when marketing financial instruments to non-professional investors. The principle of suitability requires FIBOs to adjust their manner of solicitation as appropriate in light of the customer’s sophistication (as determined from the customer’s knowledge, experience, assets and purpose for purchasing the product, among other factors).

Further, the degree of a FIBO’s duty to explain the nature of a financial product under the FIEA is generally understood to vary, depending on the level of sophistication of the relevant customer or counterparty. For example, the FIEA prohibits a FIBO from selling financial products or otherwise providing financial services to a customer without first providing sufficient explanation through delivery of a statutory pre-contract disclosure document in such manner and to such extent necessary for the customer to understand the nature of the relevant product, in light of the customer’s sophistication (as determined from the factors mentioned above).

Finally, the duty of a FIBO under the ACSFP to explain the nature of a financial product and the other information described in question 18 does not apply where the customer is a professional investor.

How are rules that affect the financial services industry adopted? Is there a consultation process?

National law

Bills affecting the financial services industry are usually prepared by the Strategy Development and Management Bureau and the Policy and Markets Bureau of the JFSA. In preparing a major bill, the JFSA customarily seeks the advice of the Financial System Council, a statutory advisory body. The final bill is often consistent with the advice of, and supported by a report issued by, the Financial System Council. A bill that is approved by the Diet will become national law.

Subordinate regulation

Under certain laws, such as the FIEA, responsibility for preparing subsidiary legislation (such as cabinet orders and ordinances) that affects the financial services industry is delegated to the JFSA. When preparing subsidiary legislation, the JFSA will, in most cases, commence a public consultation process requesting members of the public to provide feedback on the JFSA’s proposals. Upon finalising the relevant subsidiary legislation, the JFSA will usually also publish its response to the public feedback it has received.

Guidelines

The JFSA and SESC are also tasked with establishing supervisory guidelines, inspection manuals, and questions and answers (collectively, guidelines) that affect the financial services industry. These guidelines are not statutes and accordingly have no force of law. Instead, they seek to clarify the JFSA’s interpretation of the relevant statutes and the manner in which regulators will exercise their supervisory and inspection powers under the law. When the JFSA proposes to amend any supervisory guidelines, it will usually also commence a public consultation process to obtain public feedback on the JFSA’s proposals.

Self-regulatory rules

The JSDA and other self-regulatory organisations sometimes also initiate public consultations when proposing to amend their own rules.