JAPAN

JOHN PALENBERG"ALAN L. BELLER*"

1. REGULATORY FRAMEWORK 1

1.1. Principal Regulators and Regulatory Philosophy

1.1.1. Principal Regulators

The principal regulator of the Japanese securities marketsis the Japanese Ministry of Finance ("MOF").2 With regard tolisted securities, the Japanese stock exchanges play animportant regulatory role. The Japan Securities DealerAssociation ("JSDA!), a self-regulatory securities industrytrade association, has a significant function in shapingsecurities market practices, overseeing the Japanese over-the-

* Partner, Cleary, Gottlieb, Steen & Hamilton, Washington, D.C. B.A.1977, University of North Dakota; M.A.L.D. 1982, The Fletcher School ofLaw and Diplomacy; J.D. 1982, Harvard Law School. Mr. Palenberg wasbased in Cleary, Gottlieb's Tokyo office from 1987 to 1992.

"" Partner, Cleary, Gottlieb, Steen & Hamilton, Tokyo, Japan. B.A. 1971,Yale University; J.D. 1976, University of Pennsylvania.

1 The information relating to Japanese private placements in this Articlewas derived by the authors largely from a variety of non-public sources,such as discussions with Japanese bank and securities company officials,advice received from Japanese private practitioners in the context ofparticular transactions and unpublished administrative guidance. In Japan,a significant part of the learning concerning securities regulatory mattersis unpublished, and that part which has been written down is oftenavailable only in the form of Japanese-language circulars, press releases, ornewspaper articles. Furthermore, some parties familiar with marketpractices attach to their willingness to provide information concerning thosepractices the condition that their identities not be divulged. As a result, theauthors believe that it would at many turns be inappropriate, infeasible, orunhelpful to attempt to provide citations in the usual academic manner inthis Article. The authors would be very pleased to discuss with parties whoare interested in particular aspects of the Japanese private placementmarket where those parties might find additional information.

Neither Mr. Beller nor Mr. Palenberg is licensed to practice Japaneselaw. Qualified Japanese counsel should be consulted in connection with anytransaction involving Japanese legal issues.

" For general background information on the regulation of the Japanesesecurities markets, see Kunio Hamada & Keiji Matsumoto, SecuritiesTransaction Law in General, in DOING BUsINESS IN JAPAN 5 (ZentaroKitagawa ed., 1991).

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counter markets and communicating MOF's policies to theindustry. The Japanese Ministry of International Trade andIndustry and the Ministry of Agriculture have responsibilityfor certain non-financial commodities-linked products. Asoverseer and interpreter of the Japanese Commercial Code, theJapanese Ministry of Justice has influence over certainsecurities-related issues. With specific regard to private place-ments, important influences on the market are policies andpractices established, in informal consultation with MOF, bythe Japanese banks that act as trustee/placement agents inthe Japanese private placement market.

1.1.2. Regulatory Philosophy

The Japanese system of securities regulation places acomparatively strong emphasis on retail investor protection,with the result that a variety of qualitative restrictions andlimitations on the classes of eligible investors and on the typesof instruments that may be offered, as well as disclosurerequirements, are used to regulate offerings. The "disciplineof the marketplace" is supplemented by the grant of consider-able discretionary authority to regulators who tend to favor acautious, incrementalist approach to change and a substantiveevaluation of the strength and safety of issuers and theirsecurities.

Because Japan has a Glass-Steagall-like separation of thebanking and securities industries, the struggle for competitiveadvantage and the resulting friction between the banking andsecurities industries concerning the limits of their respectivespheres of activity also play an extremely important part inmolding market philosophy, rules and practices. The competi-tion between the banking and securities industries hassignificantly affected private placement rules and policies.

1.2. Principal Statutes

1.2.1. The SEL

For purposes of analyzing the legal issues relevant toprivate placements in Japan, the Japanese Securities Ex-change Law (the "SEL") and the ordinances, regulations, rules,guidelines and policy statements thereunder or relatingthereto are of central significance. In broad terms, the

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Japanese securities laws are substantially modeled on the U.S.securities laws. With regard to private placements, however,the Japanese system of regulation bears only a distantresemblance to the current U.S. system. This difference inapproach has been caused, in part, by MOF's desire to keepprivate placements of debt from undermining the developmentof Japan's heretofore small and underused public primarymarket for corporate debt securities.

1.2.2. The FECL

For non-Japanese issuers and for placements having someother international aspect, the Foreign Exchange and ForeignTrade Control Law (the "FECL")-which, like foreign exchangecontrol laws in some European countries, serves policyobjectives well beyond those of simple foreign exchangecontrol-can be important."

1.2.3. The Commercial Code

The Japanese Commercial Code is significant in that itdetermines what instruments Japanese issuers are permittedto issue, and taken in conjunction with the definition of a"security" in the SEL, often indirectly affects what foreigninstruments may be introduced into Japan.4

1.2.4. Other Statutes

There are other statutes that may have a bearing onprivate placements (such as the law concerning the recordationof bonds and the tax laws), but it is unnecessary to go intothem for purposes of this Article. Offerings of interests inopen-end investment funds are governed by a special regulato-ry regime. Market practices and perceptions of MOF policiescan be relevant in the legal analysis of instruments that do notfit within established regulatory niches.

'See infra sections 3.1.3., 3.1.4. and 4.2.4 See infra section 5.2.

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2. PUBLIC OFFERINGS

2.1. Registration Requirement for Public Offerings

The SEL, which as suggested above was modeled to asubstantial degree on U.S. securities statutes, provides that:

No one shall make public offerings of new or outstand-ing securities without the issuer of such securities filingwith the Minister of Finance a registration statementof such public offering of new or outstanding securities[subject to certain disclosure exceptions, "qualifiedinstitutional investors" exceptions, and de minimisexceptions]."

The required registration statement is a lengthy documentwhich, in terms of its contents, resembles a U.S. securitiesregistration statement, although some of the disclosure itemsdiffer.

2.2. 'Public Offerings" Defined

As amended in the summer of 1992, the SEL defines a"public offering of new securities" to be "the solicitation topurchase newly issued securities (including conduct deter-mined as equivalent by MOF ordinance), of many and unspe-cific persons (but not including the solicitation of 'qualifiedinstitutional investors' as determined by ordinance) [subject toexceptions where by ordinance it is determined that thesecurities are unlikely to be transferred to entities other than"qualified institutional investors" or the securities are unlikelyto be transferred to many entities]." A "public offering ofoutstanding securities" is defined as "the offer to many andunspecific persons [as determined by ordinance] to sell, or thesolicitation to many and unspecific persons [as determined byordinance] for subscription to buy, any already issued securi-ties."' Unlike in the United States, therefore, secondaryofferings by non-affiliates that come within this definitionrequire registration under the SEL.

Securities and Exchange Law of Japan (USELP), art. 4(1).* Id art. 2(3).7 Id art. 2(4).

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2.3. 'Many and Unspecified Persons"

A 1971 internal MOF circular suggested that an offering to"many and unspecified persons" shall be considered to haveoccurred when the relevant solicitation or offer is made to"approximately fifty or more" persons." A 1989 JSDA releaseconcerning the offering within Japan of securities originallyissued in foreign markets stated that the JSDA had receiveda MOF directive instructing that public offering disclosurerequirements will not apply:

(a) [in] the case where the same security is sold on thesame day and the number of persons solicited is lessthan fifty and (b) [in] the case where the same securityis sold over a period of several days, the number ofpersons solicited on any single day is less than fifty, thesecurities are sold at prices which [are] based onmarket conditions that from day to day are not uniform,and the settlement dates for sales on different dates arenot the same.'

These guidelines are now often expressed by market partici-pants in terms of there being a private placement exemptionfrom the SEL registration requirements for offerings ofsecurities made to no more than forty-nine offerees on liketerms and conditions in a single day. Because the market forprivately placed securities tends to consist of a limited numberof institutional investors, there seem to be few problems withcoming well within the scope of the "rule." It should be noted,however, that an offering exclusively to "qualified institutionalinvestors" is excluded from the "public offering" definition setforth above independently of whether the "many and unspeci-fied persons" test is satisfied.

s See Internal Circular concerning Disclosure of Corporate Information

(Sept. 6, 1971 Kura Sho 2272).sGaikoku Shij5 Hakk45 Shaken no Waga Kuni ni Okeru BoshZt5 no

Toriatsukai ni Tsuite (Concerning Procedures for the Placement withinJapan of Securities Offered in Foreign Markets), JSDA Circular, Vol. 1989,No. 14, issued June 30, 1989. MOP is expected to formalize the fifty-offereerule in a ministerial ordinance that is scheduled to be issued in April 1993.

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2.4. Attraction of Offshore Offerings for Japanese Issuers

High transaction costs and various regulatory hindranceshave for some time stunted the domestic Japanese market forpublic offerings of Japanese issuers, particularly corporatedebt securities. For example, with corporate debt securities,the so-called commission bank system, which requires that aJapanese bank be appointed to perform certain functions inconnection with an offering and be paid a commission, is a costdeterrent to offerings in the Japanese market; this systemdoes not obtain in the Euromarket. Over the past decade,Japanese issuers have often tended to turn to the Euromarketsfor debt and equity-linked financings, where transaction costsare smaller and securities can be quickly brought to marketwith a relatively modest amount of paperwork, and whereJapanese investors have been active purchasers. This flight byissuers to London has threatened to result in a "hollowing out"of the Japanese primary securities market (particularly withrespect to debt and debt/equity warrant offerings), which hasbeen of concern to proponents of a strong Japanese domesticcapital market.

2.5. Japanese Public Offerings of Foreign Securities

2.5.1. Listed Public Equity Offerings

Generally, only large, well-established foreign corporationswill qualify to list their shares on the Tokyo Stock Exchange(the "TSE").1" As a threshold matter, a foreign companymust meet the minimum eligibility requirements for listing,which include: (i) total shareholders' equity of Y10 billion(approximately $75 million); (ii) earnings before income tax ofat least Y2 billion (approximately $15 million) for each of thefiscal years ending within three calendar years immediatelypreceding the listing application; and (iii) "good prospects" thatthe company will have at least 1,000 shareholders resident inJapan." An eligible company will spend substantial amountsof time and money preparing for a listing, as well as thereafter

" At present, foreign shares cannot be listed on other Japanese stockexchanges.

n See A LISTING GUIDE FOR FOREIGN COMPANIES (2d ed., Tokyo StockExchange 1991).

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preparing Japanese language annual reports and periodicreporting materials. Because the retail market for foreignsecurities in Japan is still relatively small, and since thelimited liquidity for foreign securities and fixed tradingcommissions in Japan tend to lead to flowback (the return ofsecurities to their home market), some critics have questionedwhether a listing in Japan is worth the trouble for foreigncompanies.12 Still, many foreign companies (more than 100)have chosen to list their shares on the TSE. To the presenttime, this listing has always been accomplished without aconcurrent public offering.

2.5.2. Public Debt Offerings

Foreign sovereign and high-grade corporate issuers havelong been able to issue straight bonds in Japan, and foreigncompanies that are listed on the Tokyo Stock Exchange havealso been permitted to issue convertible bonds since May 1989.Relatively few non-sovereign foreign issuers have chosen toenter the debt market. Although Japan-licensed securitiesfirms have the exclusive right under the SEL to underwritethe public issuance of corporate debt, issuers are required toretain a bank to act as a commission agent, which requires thepayment of commission agent fees.S Moreover, public offeringdisclosure requirements apply.14 In addition, unless qualityand rating standards are satisfied, publicly issued bonds mustbe collateralized, adding additional expense and restrictions.MOF has taken steps to attract foreign issuers, such aslowering ratings standards, approving the issuance of bondswith maturities of less than four years and introducing avariant of a shelf registration system. For private issuers,however, these measures generally have not overcome the costand other disadvantages of launching a public debt issue inJapan.

" See, e.g., Robert Grondine, East Asian Executive Reports, Vol. 11, No.2, at 9 (Feb. 15, 1989).

" These fees can be in the area of approximately 0.135% of principal atissuance and 0.05% annually thereafter. Fee rates vary considerably basedon a variety of circumstances. Bankers with whom the authors spoke wouldnot disclose the full rate schedule, perhaps because it may be too complexto follow without lengthy study.

14 See SEL, art. 4(1).

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2.5.3. Unlisted Registered Public Equity Offerings

Since June 1989, when new rules eliminated the listingrequirement for publicly offered foreign stock, foreign issuersof common stock have had a relatively efficient means ofachieving a wide distribution in Japan, particularly inconnection with a global offering. To qualify for an unlistedpublic offering, the company's stock must be listed on a"designated exchange" (a group that includes most of theprominent international exchanges) and the company'searnings per share must be 20% of the share's nominal valueprior to the offering. Different standards apply to newlyprivatized companies. Issuers that engage in unlistedregistered offerings must file a Japanese-language securitiesregistration statement with MOF. The registration statementmust be declared effective pursuant to the SEL before theoffering. Thereafter, issuers become subject to the SEL'scontinuous reporting requirements. Certain FECL-relatedrequirements must also be satisfied in connection with aprimary offering of shares in Japan.15

3. PRIVATE PLACEMENTS UPON INITIAL ISSUANCE

The rules governing the private placement of securities inJapan upon initial issuance (as opposed to private placementsof outstanding securities) tend to be restrictive and rathercomplex. In examining the Japanese regulatory regime forprivate placements, this discussion focuses on its applicationto non-Japanese issuers, because this is the area in which thereaders of this survey are likely to have a practical interest.This section, however, also addresses the restrictions onJapanese issuers of debt, because this market has becomerather active over the past three years.

15A number of non-Japanese issuers have taken advantage of theunlisted public offering option, including PolyGram N.V., Coastal Corp.,U.K. Water, U.S. West and Telmex, but to this time, to the authors'knowledge, unlisted public offerings have only been used in connection withinternational offerings for which offering documents were otherwise beingprepared.

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3.1. The Direct Private Placement of Newly Issued EquitySecurities by an Issuer Not Resident in Japan

3.1.1. General

With respect to private placements of equity by foreignissuers with Japanese investors, only the most credit-worthycompanies receive the required MOF approval, which, ifforthcoming, takes approximately one month to obtain. Thecriteria that MOF uses in evaluating whether an issuer is fitto offer securities in Japan are not publicly available, althoughit appears that having a listing on a stock exchange in anOECD country and a record of paying dividends for at least thepast three years is helpful, as is having some form of businessoperations in Japan. Privately-placed securities are generallysubject to a two-year bar on resales and may only be pur-chased by institutional investors.

3.1.2. SEL Requirements

Once a foreign issuer has received approval for a proposedprivate placement, the issuer is required to file a SecuritiesNotification with MOF or, if the issuer is already subject tocontinuing reporting requirements under the SEL, a CurrentReport is required."6 These SEL filings must be submittedonly in the case of a placement of newly-issued shares, andonly where the aggregate issue price is Y500 million ormore.' The filing of a Securities Notification does nottrigger the application of the SEL's continuous disclosurerequirements. In the course of a private placement, it is acommon practice in Japan for a foreign issuer to prepare anddistribute a placement memorandum in the same manner aswould an issuer in the United States or the Euromarket.

3.1.3. FECL Requirements

Under the FECL, when an issuer not having its main officein Japan contemplates the issuance or offering of equity sharesin Japan, it must within two months and no later than twentydays before the issuance or offering of shares fie a notification

1, SEL, art. 24-5(2).1. Id. art. 4(1).

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with MOF through the Bank of Japan describing the nature ofthe shares, the proposed issue date, and certain other mattersrelating to the transaction."' A prospective issuer that hasfiled the required notification may not carry out the issuanceor offering plan, unless otherwise permitted by MOF, for aperiod of twenty days after the receipt of the notification byMOF. 9 Within the twenty-day waiting period, MOF mayrecommend revision or suspension of the plan if MOF per-ceives that it would have an unfavorable effect on Japan."After the closing, the issuer is required to file a brief reportconcerning the closing with MOP.

3.1.4. Informal Pre-Clearance

To the authors' knowledge, MOF has not made any formalrecommendations or orders with respect to private placementsor equity by non-Japanese residents because in practice thereexists an informal system of consultation and pre-clearance byMOF. This customarily takes place at least one week beforethe filing of the requisite formal notification under the FECL.Based on this review, MOF may informally suggest modifica-tions to or the suspension of the offering plan, or may advisethe issuer to proceed with the filing of the requisite notifica-tion under the FECL. As a result of this process, the offeringis, in effect, "pre-cleared" and the actual filing under the FECLis a mere formality. The statutory waiting period under theFECL, therefore, is often shortened by MOF to as little as oneweek. It is important to note that if securities come intoJapan through a secondary market transaction,21 a FECLfiling by the purchasers may be required in lieu of a filing bythe issuer.2 With regard to voting securities, there arecertain other FECL limitations intended to prohibit or restrictJapanese equity investment overseas in certain sensitiveindustries (e.g., armaments or narcotics) and there are anti-monopoly limitations on the ability of banks and insurancecompanies to acquire holdings of an issuer's voting securities

Is FECL, arts. 22, 23.Is Id art. 23(1).20 Id. art. 23(2).2' See infra section 4.22 FECL, art. 22.

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in excess of certain percentage limitations."3

3.2. Procedures for a Direct Private Placement of Newly IssuedStraight Debt Securities by an Issuer Not Resident in Japan

3.2.1. Non-Sovereign Issuers

Japanese counsel and participants in the private placementmarket have advised that MOF's policy, at least until August1992, had been to "discourage" non-Japanese private issuersfrom making direct private placements within Japan of debtsecurities upon initial issuance. In practical terms, except inunusual circumstances, direct private placements of debtappear to have been limited to sovereigns, sovereign-relatedentities, and international organizations.2 ' Starting onAugust 1, 1992, qualifications for both non-sovereign issuersand sovereign issuers to make direct private placements were,at least formally, relaxed. It has yet to be seen whether thisformal change indicates a shift in MOF's attitudes towardprivate placements of debt by foreign non-sovereign issuers, orwhether MOF intends to continue "discouraging" such issuesin spite of the formal changes.

3.2.2. Sovereigns, Sovereign-Related Entities and Interna-tional Organizations

The private placement of non-yen-denominated foreignbonds was formerly restricted to the World Bank, but thereappears to have been a relaxation of this restriction in recenttimes, at least with respect to convertible bonds.

For both yen-denominated foreign bonds and foreigncurrency-denominated bonds, limits are set on the size of anissue based on the credit rating of the issuer."' The pricesand coupons of the bonds are determined in accordance witha schedule calculated with reference to a so-called "base rate."The "base rate" is the lower of the long-term prime lendingrate and the yield to maturity (by simple computation) of themost recent issue of ten-year Japanese Government Bonds

' See, e.g., FECL, art. 22; Antimonopoly Law, art. 11(1).24 But see discussion of secondary market transactions infra section 4.2 MOF Press Release (July 16, 1992).

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plus a certain number of basis points. In general, as anissuer's credit rating increases, the number of basis points, ifany, that are tacked on to the base rate decreases. Unratedinstitutions may qualify if they have issued or guaranteed abond, or have borrowed under or guaranteed a syndicated loan,in a major financial market within the past five years, or ifthey are the public agencies of a country that has "anyrating."

2 6

Japanese financial institutions that are qualified toarrange private placements (such as banks and securitiescompanies) generally arrange for the requisite Japaneseregulatory clearances and filings in conjunction with counsel.It is customary to prepare a private placement memorandumin conjunction with the placement. The SEL and the FECLfiling requirements discussed above with respect to the private

.placement of foreign equity securities also apply to foreigndebt securities. 7

The privately placed bonds are subject to a two-yearprohibition on resale (which obviously creates some foreignexchange risk for the Japanese purchasers of non-yen-denomi-nated bonds). They may be sold only to and among sophisti-cated institutional investors, and any resale must be to onepurchaser and in one full lot. MOF has in the past indicatedthat the number of purchasers of yen-denominated foreignbonds should be kept to as few as possible (e.g., ten to fifteenpurchasers). Japanese purchasers must submit to MOF a"Confirmation of Investment Intent""8 confirming acceptanceof these restrictions. Participants in the private placementmarket have advised the authors that MOF is expected toissue an ordinance in late 1992 or early 1993 to relax theformal restrictions on privately placed bonds irrespective ofthe nature of the issuer. In particular, either the two-yearprohibition on resale will be eliminated or the "sophisticatedinstitutional investors" requirement will be relaxed. A thirdpossibility is that the ordinance will call for two classes ofprivate placements: one that eliminates the two-year prohibi-tion on resale but maintains a strict definition of eligible

2 It seems likely that the ratings must be from a major ratingsinstitution in Japan or the United States.

27 See supra sections 3.1.2. and 3.1.3.28 See infra section 3.3.

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investors and one that maintains the two-year holding periodbut relaxes the "sophisticated institutional investors" stan-dard.

3.2.3. Zero Coupon Debt, Etc.

Certain tax and additional regulatory issues may berelevant to the introduction into Japan (whether upon initialissuance or in secondary market transactions) of zero couponnotes, indexed bonds, and other debt instruments that are notfixed-coupon straight debt securities.

3.3. Procedures for a Direct Private Placement of Newly IssuedStraight Debt (shibosai) by a Japanese Resident Issuer

To qualify to issue bonds in a private placement, a Japa-nese non-governmental issuer must, as a practical matter,meet certain strict eligibility requirements that vary with thesize of the issuer (basically, the higher the level ofshareholders' equity, the more liberal the standards). Amongthe tests used in the eligibility matrix are the issuer's amountof shareholders' equity; the issuer's ratio of dividends tocapital; the issuer's ratio of capital to shareholders' equity; theissuer's ratio of shareholders' equity to total assets; theissuer's ratio of operating income, interest income, anddividend income to total assets; and the issuer's interestcoverage ratio. An issue's size (no more than two times netassets, and no less than 100 million yen but less than 10billion yen), its price and coupon (determined by reference tothe yield on newly issued Japanese Government Bonds), andits term and structure (amortizing versus bullet principalpayments) are all prescribed. The bonds must be fullycollateralized by a first mortgage on immovable assets of theissuer, unless the issuer satisfies the eligibility standards fora public offering of uncollateralized bonds. The lead bank inthe placement will usually act as the recording agent (whosefunction is to provide formal notification to the Government ofthe placement) and as the paying agent. It will also act as oneof the commissioned banks (possibly the only one) and possiblyas a purchaser. For each type of service provided, the leadbank will collect fees that are established percentages of theissue amount, some upon initial issuance and some over time.For so-called large-lot placements (not less than 2 billion yen

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but less than 10 billion yen), an arranger or arrangers (whichmay be a bank, a securities company or a life insurancecompany) must also be involved. Purchasers of privatelyplaced bonds are limited to institutional investors. MOFinformally requires that such purchasers submit to MOF a"Confirmation of Investment Intent" in which (1) the purchas-ers confirm that they know that the offering does not providethem with the protection of the disclosure filings required fora public offering; (2) the purchasers confirm that they arepurchasing with no intent to resell, and that they win not,without MOF's permission, resell the bonds unless (i) twoyears have lapsed since the time of the initial purchase, (ii)the subsequent purchaser is a single institutional investor,and (iii) all of the bonds acquired will be resold in a single lot;and (3) the purchasers agree to deliver to MOF within oneweek of resale a "Confirmation of Investment Intent" in likeform from the subsequent purchaser. The strict two-yearprohibition on resale and the limited class of eligible purchas-ers make it clear that the domestic Japanese private place-ment market is in substance an extension of the syndicatedlending market. Japanese banks have not been permitted tosell loans from their loan portfolios. Therefore, putting a loanin the form of a private placement of debt securities has hadthe advantage of making the debt transferable to a limiteddegree once two years have lapsed. There are percentagelimitations on how much of an issue a single arranger/purch-aser may buy, and there are limitations on how much and howoften debt may be issued in private placements by an issu-er.2

9

3.4. The Role of Banks in Promoting the Boom in the JapaneseDomestic Private Placement Market

With (i) the Bank for International Settlements capitaladequacy standards putting pressure on Japanese banks toshrink the asset side of their balance sheets, (ii) the witheringof the market for equity-linked Japanese bonds, and (iii) recent

11 Recent press reports indicate that the Ministry of Justice plans toscrap the Commercial Code limits on the maximum amount of bonds thatJapanese corporations are permitted to issue. See, e.g.,."Government Plansto Scrap Curbs on Corporate Issues," Japan Economic Newswire (Jan. 22,1993).

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amendments to the Japanese Commercial Code liberalizing thestatutory limit on bond issues by Japanese corporate issuers,private placements of bonds within Japan by domesticJapanese issuers have occurred in increasing volume. Bankseager to establish a track record in advance of securitiesmarket deregulation and searching for fee income haveencouraged their clients to replace bank loans with privatelyplaced bonds.

Private placements have been an area of competitiveadvantage for the Japanese banks vis-a-vis securities compa-nies. Prior to the summer of 1992, Japanese banks had beenprohibited from underwriting debt securities in Japanesepublic offerings (an activity reserved to securities companies),but they had been permitted to act as "arrangers" for privateplacements. Typically, a bank acted as both the arranger andthe commission bank for a privately placed issue. Amend-ments to the SEL in the summer of 1992 have loosenedlimitations on banks acting directly in private placements andnow permit banks to establish securities dealer subsidiariesthat are expected to be able to underwrite debt securities inthe public markets.3 0 Implementing regulations with respectto these amendments will be adopted by MOF. Even beforethe 1992 changes to the SEL, banks tended to dominate theJapanese market for private placements because of their closeties to issuers and because of their placement power withsmall issues (banks often being the buyers of the privatelyplaced debt for their own portfolios). The SEL changes can beexpected to increase the banks' dominance in the area ofprivate placements. A particular attraction of going forwardwith a domestic private placement for debt securities, ratherthan an offering in the Euromarkets, is the ability to placeyen-denominated bonds directly with Japanese institutionalinvestors at initial issuance. Under current MOF policies, yen-denominated Eurobonds must be "seasoned" offshore for ninetydays before they may be sold into Japan in secondary markettransactions; "dual currency" Eurobonds (generally withprincipal payable in yen and interest payable in some othercurrency) must be "seasoned" offshore for 180 days, whichtheoretically exposes underwriters and others who intend to

30 SEL, art. 65-3.

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sell the bonds into Japan to a certain degree of risk.

4. SECONDARY MARKET TRANSACTIONS

4.1. Secondary Market Route

Because of the rigidities of the system for direct privateplacements upon initial issuance, many non-Japanese securi-ties that find their way into Japan are issued and held for acertain period (a "seasoning period") outside of Japan and thentransferred into Japan by means of secondary market transac-tions. Similarly, the securities of Japanese issuers (particular-ly equity warrants) issued in the Euromarkets often find theirway back to Japan in secondary market trades. Some partici-pants in the market take the view that the seasoning periodfor securities that are neither denominated nor settled in yencan be as short as one day (overnight). Accordingly, manyissuers have found it comparatively advantageous to reachJapanese investors through the Euromarkets, even though informal terms this selling structure limits the marketing withinJapan (e.g., the distribution of offering documents, roadshows)that may take place in advance of the issuance, since theprinciple is that no offering or sale of the relevant securities issupposed to occur in Japan until they have been issuedoverseas. Issues brought into Japan by means of secondarymarket transactions are not exempt from the SEL registrationrequirements for public offerings. Therefore, care is usuallytaken to avoid actions that might cause the secondary markettrades to be characterized as a secondary public offering.FECL complications can arise for the purchaser if the acquisi-tion of foreign securities is not considered a portfolio invest-ment. In general, the FECL treatment of foreign securities iscomplex, with different participants in the market havingdifferent views on the accepted regulatory treatments anddifferent appetites for novelty and risk. Therefore, it isdesirable to obtain expert advice before introducing unconven-tional instruments into Japan through secondary markettransactions.

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4.2. Yen-Denominated and Dual-Currency-DenominatedSecurities

As mentioned above, the seasoning period for yen-denomi-nated or -settled securities is ninety days and the seasoningperiod for dual currency securities (yen and some othercurrency) is 180 days.3 ' In each case, an FECL license withrespect to the issuance must be obtained from MOF and theterm sheet for the transaction must specify that no placementin Japan is permitted during the relevant seasoning period.MOF takes the view that any offering of securities denominat-ed or settled in yen by a non-Japanese issuer requires alicense from MOF, irrespective of where the securities areissued. 2

4.3. The Relevance of Listing Outside of Japan

4.3.1. Ordinary Investors

Japan-licensed securities firms may generally only deal ininstruments that fit into one of the categories stipulated in theSEL definition of a "security." 8 In addition, under JSDArules, such firms may not sell to ordinary investors foreignsecurities that have been issued by an issuer that does nothave a class of debt or equity securities listed on an approvedforeign stock exchange or trading system.3 ' In practice, sincemost Japanese investors have been required under the FECLto deal exclusively with Japan-licensed securities dealers, theyhave been limited to acquiring securities of foreign issuerswith a security listed on a designated exchange. In November1990, a change in the rules that permits Japanese residents toplace unsolicited orders for securities with offshore securitiesdealers without prior MOF approval was announced. Thepractical effects of this change, which by its literal terms israther limited, are still being gauged, but they do not seem tobe very significant.

1 See supra section 3.4.

32 See FECL, arts. 20(7), 21(1)(2).33 SEL, arts. 20(8), 43. See discussion infra section 5.1.34 Most major exchanges and the NASDAQ trading system are on the list

of approved exchanges.

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4.3.2. Designated Financial Institutions, Etc.

"Designated Financial Institutions" (sometimes called"Designated Institutional Investors" or "Qualified InstitutionalInvestors") are a group that includes most major Japaneseinstitutional investors, with the exception of trading compa-nies and leasing companies. Designated Financial Institutionsmay acquire foreign securities from Japan-licensed securitiescompanies in secondary market transactions unencumbered bythe aforementioned rule concerning listing on a designatedexchange. Some categories of such investors may also dealdirectly with foreign securities firms. Licensed foreignexchange banks, 5 most Japanese life insurance companies,and most trust accounts maintained by Japanese trust bankshave acquired a regulatory exemption either by virtue of theirstatus or by their approved application that permits them toacquire foreign securities offshore for their own investmentportfolios without filing prior notifications with MOF. Onoccasion, the licensed foreign exchange banks, at least, mayacquire foreign securities upon initial issuance overseas.

5. NARROW DEFINITION OF "SECURITIES"

5.1. The SEL Definition

The SEL defines the instruments that are considered"securities" for Japanese regulatory purposes." The defini-tion lists a number of instruments, such as common stock anddebentures. With regard to foreign securities, the SELcategorizes as "securities" for purposes of the SEL those"securities or certificates issued by foreign countries or foreignjuridical persons which are of the same nature as the securi-ties or certificates [identified in Article 2].""T The SELdefinition of "securities" does not include a "catch-all" basketthat encompasses other instruments with the characteristicsof a security. Even obvious investment-like instruments, suchas limited partnership interests, are not treated as securities

" These include banks and trust banks authorized by MOF to engage ina foreign exchange business and to carry out correspondent arrangementswith foreign financial institutions.

36 SEL, art. 2(1).37Id. art. 2(8).

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under the SEL. Investment instruments that are consideredsecurities in other jurisdictions but that do not fit within thelist of instruments designated in the SEL as "securities" tendto be subject to regulatory uncertainty that can be difficult toresolve because of the clash between the Japanese banks andthe Japanese securities companies over the scope of theirbusinesses. If an instrument is not a "security," (i) Japan-licensed securities dealers may not be able to trade theproduct; (ii) the internal regulations of certain regulatedJapanese investors may restrict the purchase of the non-security, except for certain limited purposes; (iii) the Japanesetax treatment may be difficult to predict; (iv) differentexchange control rules may apply; and (v) other uncertaintiesmay arise. There was widespread expectation that theamendments to the SEL adopted in the summer of 1992 wouldinclude significant revisions to the definition of "securities"under the Japanese securities laws. 8 The expected revisionswould have lengthened the current "positive list" by adding anumber of instruments and, more importantly, would haveadded a "catch-all" provision under which instruments with"security-like" characteristics would have been treated assecurities under the SEL. A principal objective of the catch-allprovision would have been to stimulate in Japan the develop-ment of an asset-backed securities market by bringing suchinstruments within the definition of "securities" under theSEL. However, as a result of an apparent jurisdictional battleamong MOF, the Ministry of International Trade and Industry("MITI") and the other ministries, MOF's proposals weredramatically cut back. MITI is responsible for the regulationof many of the entities that generate assets likely to besecuritized, such as trading companies, as well as othercompanies, such as non-bank financial institutions, that arepotential participants in a possible asset-backed market. TheMinistry of Construction also sought jurisdiction in respect tocertain mortgage-backed vehicles. The amendments to theSEL that were adopted include only a modestly increased"positive list," which adds to the definition of "securities"commercial paper, foreign certificates of deposit, foreign-

38 In fact, in deliberations within the government, MOF proposed suchrevisions.

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originated credit card receivable-backed securities, andforeign-government-backed mortgage pass-throughs3 9 Nobroad catch-all provision was added. Securities could be addedto the definition, either by MOF or by MOF in combinationwith other ministries, depending on the nature of the issuer,the instrument, and the targeted investors. This potentialinvolvement by other ministries in what has been to date theprovince of MOF might even be viewed as a step backwards,since the bureaucratic consensus to approve most new productswould have to be reached not only among the different bureausof MOF, but also among the various other interested minis-tries. In addition, only instruments with elements of transfer-ability or negotiability under Japanese law will be classifiableas securities. The failure to adopt a broad comprehensivedefinition of securities raises questions about the nature andpace of the development of securitization in Japan. Requiringeach new product to be added to the positive list by MOF orinter-ministerial action leaves the situation much the same asit was before. The failure to change the definition of securitiesalso leaves legal investment restrictions in place on certainJapanese institutional investors.

5.2. The Japanese Commercial Code-Restrictions on JapaneseIssuers

Although MOF may on occasion bend definitional guide-lines to allow an innovative foreign product into the Japanesemarket on a secondary market transaction basis, ' Japaneseissuers face an additional hurdle to issuing novel productseither in or outside Japan. The Japanese Commercial Code,which provides the authority for Japanese corporations toissue securities, authorizes only a narrow list of permissibleinstruments."' For example, a Japanese issuer may issuewarrants for its own new stock, because the Commercial Codepermits the issuance of "subscription warrants."' TheJapanese issuer has no power, however, to issue a warrant onany other company's stock or a stock index-linked warrant,

39 SEL, art. 2(1), 2(2).4o See discussion supra section 5.1.41 Commercial Code of Japan, arts. 296, 341-2(1), 341-8(1).4 Id. art. 341-8(1).

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because these instruments are not identified as "securities" inthe Commercial Code. This disability can have an effect onthe range of foreign securities that may be introduced intoJapan because of the way "securities" are defined in section2(8) of the SEL.43 Even certain products that MOF might forSEL/FECL purposes view as a security or as an instrumentthat may be introduced into Japan might be off limits toissuance by Japanese corporations because of the limitationsof the Commercial Code, which is administered by the Minis-try of Justice.

6. REFORM

Many observers agree that the irrational and obscuretangle of rules and guidelines concerning the private offeringof securities in Japan is in need of reform, but because theissue is wrapped up in the debate over the structure of theJapanese financial system, it will likely take some time beforereform can be accomplished. As indicated above, MOF may bemoving toward loosening the effective prohibition on privateplacements of debt securities by non-Japanese issuers,permitting private placements to be made to a broader class ofinvestors, and toward replacing the two-year lock-up with lessdraconian resale restrictions. In the meantime, for foreignnon-sovereign issuers, the unlisted public offering procedurecan be of utility in planning global securities offerings ofequity, and it appears that participants in the market willcontinue to find secondary market transactions to be a usefulmethod of introducing securities issued outside of Japan toJapanese investors.

See supra section 5.1.

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