Japanese Court Holds Daiwa Execs Liable in N.Y. Losses

In a momentous legal decision this week that sent shock waves through corporate Japan, a court found directors of a big bank financially liable for an overseas scandal.

The Osaka District Court, in response to a lawsuit brought by two shareholders, ruled Wednesday that 11 current and former Daiwa Bank directors must pay $775 million for weak management oversight.

The case followed the disclosure that a rogue employee in the bank’s New York office squandered more than $1 billion in bank funds during a decade-long unauthorized trading spree starting in 1984.

It is the largest monetary judgment ever handed down in a shareholder suit in a country where white-collar offenses lead to little more than a slap on the wrist. It is also the first time directors have been held personally responsible for lax management.

“This decision is revolutionary for shareholder rights in Japan,” said Hideaki Kubori, a partner with Hibiya Park Law Offices. “The court is saying that Japan needs to adopt global corporate standards and better internal compliance.”

The defendants, including Daiwa’s president, vowed to appeal.

Analysts said the lawsuit highlighted such Daiwa weaknesses as flabby auditing, weak internal safeguards and insular thinking that failed to unearth problems early and check their spread.

“Daiwa persisted in following informal local rules that only work in Japan, despite operating in the global arena,” the Osaka court said.

Such problems are considered rife in corporate Japan, and analysts said the first response to the ruling in many boardrooms may be a quick check to make sure their insurance coverage is adequate.

Since Japan’s Commercial Code was amended in 1993, making it easier for shareholders to sue, more than 90% of Japan’s public companies have purchased liability insurance for directors and officers, said a spokesman for Tokyo Marine & Fire Insurance. A typical policy, however, caps the coverage at around $2 million per director.

Whether it triggers fundamental new thinking within Japan’s companies is an open question, however.

“It’s a major wake-up call for corporate Japan,” said Robert Grondine in the Tokyo offices of White & Case. “This really has the potential to change the entire groundwork of corporate governance.”

But the sheer size of the award could galvanize powerful interests opposed to reform, in a country far more comfortable with incremental change than seismic shifts. It is likely to redouble efforts by business lobbies to overturn the law or cap the damages that can be brought against corporate directors.

“The size of this judgment is beyond my imagination,” said Yotaro Kobayashi, head of the Keizai Doyukai, a business group. “This case shows the need to revise the shareholder lawsuit system.”

The suit was filed against Daiwa in 1995 after Toshihide Iguchi, an employee in the bank’s New York office, admitted racking up bank losses of $1.1 billion over an 11-year period by trading off the books in U.S. Treasury bonds.

It eventually surfaced that Daiwa informed Japan’s powerful Finance Ministry about the fraud once it was discovered. But neither the bank nor the ministry bothered to tell the U.S. Federal Reserve until several weeks later despite the fact that the crimes had occurred on U.S. soil. This infuriated the U.S., which leveled a $350-million penalty in February 1996.

Japan has seen an estimated 300 shareholder suits over the last seven years as rules have made them easier and less expensive to file. But none of the earlier suits has really tackled corporate accountability.

Wednesday’s decision ordered Vice President Kenji Yasui, who was manager of the New York branch at the time, to pay $530 million and the remaining executives were hit with a combined $245 million in charges. Under Japanese law, the proceeds go to the bank, not directly to the shareholders filing the suit.

“After this, no one will want to go into bank management,” one banker told local reporters.

Although the judgment is far less than the $1.45 billion originally sought by shareholders, the numbers are seen by many as extreme and more suited to judgments against companies than individuals.

But on the principle of accountability, life in Japan’s boardrooms might never be the same.

“Wednesday’s suit suggests the days when executives could take responsibility for their actions merely by resigning are at an end,” said the Yomiuri Shimbun, Japan’s largest daily newspaper.

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Hisako Ueno in the Tokyo bureau contributed to this report.