Japan Agency Recommends Action Against Merrill Lynch : Asia: The move comes shortly after the U.S. sanctioned Daiwa Bank for bond violations.

In its first such action, Japan’s securities industry watchdog agency recommended Friday that the Finance Ministry impose sanctions against Merrill Lynch & Co. for violations of rules guarding against stock price manipulation.

While not accusing Merrill of actually trying to manipulate prices--the amounts of stock involved were too small to do that--the Securities and Exchange Surveillance Commission called the violations “quite serious.”

The commission’s recommendation came after it had already been in discussion with Merrill over the issue for months and could mark an escalation of tensions between Japan and the United States over rule-breaking by financial firms operating overseas, analysts said.

The U.S. Federal Reserve Board recently hit Japan’s Daiwa Bank Ltd. with strong sanctions after discovering 11 years of bond-trading violations at its New York branch, a major scandal that involved $1.1 billion in losses and prompted a management shake-up at Daiwa’s headquarters.

The Fed move came after Daiwa failed to immediately inform U.S. authorities when they learned of the violations. U.S. officials have also criticized Japan’s Finance Ministry for slow action in the Daiwa case.

In Tokyo, commission officials alleged at a news conference that Merrill violated rules prohibiting brokerages from trading a company’s stock while handling new securities sales for that firm. They said Merrill bought about $20 million (at current exchange rates) of stock in 40 such firms from May, 1989, through February of this year.

The commission urged only mild administrative punishment, such as a short suspension of stock trading operations at Merrill’s Tokyo branch.

The commission, formed by the Finance Ministry in 1992, has never previously recommended punishing a foreign securities firm in Japan.

Merrill issued a statement defending its trading activities. The trades in question, Merrill said, involved stocks in broad “baskets” of stocks that were traded simultaneously.

“There was no market manipulation by Merrill Lynch, nor was anyone disadvantaged by the basket trading practices, which complied with both Tokyo Stock Exchange rules and accepted international practices,” Merrill said.

The firm said Tokyo Stock Exchange rules on this issue “may be inconsistent with Ministry of Finance policies.” Merrill also said Japanese regulators may not have found out about the problem if the firm hadn’t first alerted them earlier this year to the inconsistencies in their rules and those of Tokyo’s stock market.

Basket trading, in which groups of stocks are traded in line with a broad strategy, is common in Japan and is used by most brokerages. But under Japanese regulations, underwriters may not buy existing shares of a client company’s stock from the time a new security’s price is announced to investors until the bids are accepted.

The rule exists to prevent underwriters from boosting stock prices to get an artificially high price for new securities. To comply with this rule when handling new stock issues for a client, a brokerage should remove that company’s stock from any baskets of stock it is trading.

Merrill said it “looks forward to discussing this matter with the Ministry of Finance and resolving it in a mutually acceptable fashion.”

“There was no unfair production of profit or manipulative intent or harmful effect on the market,” said Masahito Amano, Merrill’s senior counsel in Tokyo. “These were technical violations of ministry rules. Our traders failed to eliminate from the baskets of shares particular trades that should have been removed.”

The firm has already taken steps to ensure that such violations do not recur, Amano said.

Commission officials said at the news conference that the violations were serious because a Merrill trader continued to ignore the rule even though he had been warned to comply with it.