Little doubt remains about how bad top management was at Olympus, the company that made Japan’s first microscope and which is now under scrutiny for financial fraud.
“The core part of management was rotten and the parts around it were contaminated,” an advisory panel of experts commissioned by the company reported on December 6.
What remains unclear is who else knew about the ¥117.7 billion (US$1.5 billion) in investment losses that date back almost 20 years, or the ¥17.1 billion Olympus paid in ‘expenses’ to brokers and bankers that were experts in engineering tobashi (‘fly away’) schemes of concealment.
Olympus avoided delisting from the Tokyo Stock Exchange (TSE) by meeting a December 14 deadline for filing five years of corrected statements, plus overdue half-year results. The earnings revision forced a US$1.08 billion cut in net assets.
Japanese prosecutors investigating the scandal have yet to make any arrests. The company’s tainted board or a meeting of shareholders must still decide on who should run it. Only then can the task of restoring Olympus’ battered reputation begin.
But already important lessons can be drawn on corporate governance in Japan.
“The whole role and function of boards needs to be addressed,” says Jaime Allen, secretary-general of the Hong Kong-based Asian Corporate Governance Association (ACGA). “There isn’t sufficient management accountability.”
The ability of Olympus’ senior managers to get away with fiddling the books for 20 years points to a corporate culture rife with cronyism and in need of reform.
The quest of ousted Olympus CEO Michael Woodford to expose wrongdoing at his former employer has elements of an American thriller.
“Flying to New York to meet the FBI, references to organised crime, boardroom conflicts, character assassination – the whole thing has been a bizarre way to live,” the Englishman said at the Foreign Correspondents’ Club of Japan on November 25.
It was Woodford’s persistent questioning of the size of a set of acquisition payments for several companies that led to his dismissal on October 14. These included the £935 million (US$1.46 billion) takeover of UK medical technology maker Gyrus in February 2008, for which Olympus paid the highest mergers & acquisitions fee in history, at US$687 million.
After being fired in October Woodford flew to London, claiming to be in fear of Japanese gangsters (see box on page 34). But he was quick to talk to the media about why he believed he was sacked and the questions surrounding payments Olympus had made.
Olympus, for its part, said – and maintains – that Woodford was fired for being a difficult manager, despite promoting him to be CEO just two weeks before. Former chairman Tsuyoshi Kikukawa led personal attacks on Woodford’s character.
The establishment was certainly slow to react to clear signs of fraud and cover-up at Olympus. The mainstream Japanese media ignored the FACTA exposés that started in July, and only began reporting the scandal after Woodford started making headlines outside Japan.
When Asiamoney met Woodford in London on November 3 he already had met with UK and US authorities, but had received no contact from their Japanese counterparts. His first meeting with Japanese prosecutors was on November 24. The first statement on the Olympus scandal by Japan’s minister for financial services was not until December 16.
Despite the apparent reticence of the government or its regulators to pursue Olympus, questions mounted over the extraordinary payments. After weeks of pressure, the company buckled, admitting that it had used the bloated fee payments to cover losses hidden from its balance sheet.
Olympus commissioned an investigation panel headed by a former judge of Japan’s Supreme Court.
Published on December 6, their report detailed how Olympus shifted the money, and criticised a corporate structure that allowed such illegal payments.
It said that Olympus used three European banks to manage a complex tobashi operation to shift depressed assets off its books.
The company would deposit money, or buy Japanese government bonds, or invest into the funds of Liechtenstein’s LGT Bank and the Singapore branches of Commerzbank and Société Générale. These banks then lent money to secret funds and shell companies set up by Olympus to buy its own depressed assets.
Years later, Olympus inflated prices and advisory fees for acquisitions to funnel money back to the funds and dummy companies it had set up. Between 1998 and 2005, ¥125 billion (US$1.6 billion) flowed through the European and Singapore routes, according to the report.
The foreign banks have been quick to promise cooperation.
“At all times, Commerzbank was in full compliance with all relevant laws and obligations and will assist with any possible enquiries by the regulator,” Commerzbank said in a statement sent to Asiamoney.
LGT said it had been “fully cooperating with the panel which it had contacted on its own initiative”.
“Société Générale’s policy is to fully and strictly comply with all regulations and laws in the countries where it operates, and as always Société Générale will cooperate with relevant authorities,” Elisa O’Neill, a bank spokeswoman in Paris, told Asiamoney.
The report vindicates many of Woodford’s criticisms. It concluded that Olympus lacked a system to check corrupt top managers. Presidents were arbitrarily selected. Free speech was repressed; those who voiced objections “had to be prepared to be kicked out”.
There was little sense of shareholder responsibility. “Trouble” was avoided at all costs, even if it involved “the transfer of enormous amounts of funds, as well as enormous losses”.
The board of directors included rubber-stamping “yes men”. Elected outside directors were “inappropriate and ineffective”. The board of auditors was equally useless. Due diligence was often dispensed with in corporate acquisitions. Disclosure was lacking. Human resources were mismanaged.
The report states that outsiders should have been brought in to “clean up the financial scum”. Instead, “those who shared secrets and were involved in the concealment were treated favourably”. It adds that when Woodford raised suspect transactions, “the board meeting responded by dismissing him without any investigation”.
Yet Olympus top management seem intent on clinging onto their jobs, despite being condemned in their own investigation report.
“The current directors are imperative for a solid turnaround,” president Shuichi Takayama said at a news conference on December 15. “Unfortunately, I have doubts about whether we can work together with Mr. Woodford.”
Woodford, who is attempting to rally shareholders to install a ‘clean’ slate of directors with him as CEO, reacted with fury. “Should that man be the president and custodian of one of Japan’s iconic companies?” he fumed at a rival news conference. He added: “It would scare away investors all over the world.”
Amazingly, it’s possible that Takayama, a 39-year Olympus employee and previously one of the board members who voted unanimously to sack Woodford, could stay on.
As Asiamoney went to press no current or former Olympus employee had been arrested. Meanwhile the TSE has accepted Olympus’ newly submitted accounts, preventing a delisting.
The fear is that banks, investors, and regulators move to brush the entire embarrassing episode under the carpet.
Investors’ deafening silence
The parties most notable for their silence have been Olympus’ main Japanese institutional investors, including Bank of Tokyo-Mitsubishi UFJ, Nippon Life, and Sumitomo Mitsui Banking Corp.
While foreign funds spoke out against Olympus’ treatment of Woodford and the subsequent revelations of shareholder betrayal, Japanese investors – including the ones above – have been largely mute.
“Most Japanese institutional investors are owned by banks or insurance companies, and they face conflicts of interest, so it’s very difficult for the people in the investment management division to speak out publicly,” Allen explains.
Nikko Asset Management, which has just cancelled its December IPO owing to market turmoil, is owned by Sumitomo Mitsui Trust Holdings, a major lender to Olympus.
The company was extremely reluctant to discuss Olympus. However, pressed by Asiamoney, it issued a lengthy statement:
“Ever since we restructured Nikko Asset Management back in 2004, it has been our policy not to comment on any specific companies, as it may influence the market, help manipulation of the share price, and even in some cases such acts may be regarded as spreading market rumours.
“Regulators have been quite strict in ensuring that asset management companies in Japan do not even inadvertently cause rumours on specific companies. However, we can certainly say that corporate governance is an issue that is important to us and to our fund holders, not only in Japan, but also around the world.”
Asiamoney believes that the unwillingness of major Japanese institutional investors to call Olympus to account for its behaviour is a breathtaking dereliction of duty.
Local institutional investors, especially Olympus’s shareholders, should be loudly protesting about a company that conducted fraud for years and then fired the CEO who unearthed it, resulting in huge destruction of shareholder value.
These investors should at the very least demand a complete set of untainted new managers.
Yet instead these organisations have remained largely mute. That is a betrayal of the interests of their customers, the mums and dads who invest money with them.
It also undermines the position of these investors as shareholders. Why should other Japanese companies respect the rights of these shareholders if they’re too meek to speak up for themselves when given every reason to do so?
The reluctance to speak up over Olympus is in large part cultural, a legacy of the country’s once cosy ties between companies, politicians and banks.
This chummy culture is also embodied in the reluctance of many Japanese companies to embrace international corporate practices.
Less than 3% of listed Japanese companies have audit committees. Most instead have a kansayaku (statutory auditor) system. Kansayaku, who are nominated by the president or CEO, and approved by shareholders, are meant to substitute for an audit committee and independent directors. Their main role is to ensure legal compliance. ‘Outside’ or ‘external’ kansayaku are often lawyers with no training in accounts.
Other statutory auditors are usually drawn from retired directors of the company. “They have taken part in past decisions and have no wish to criticise those decisions,” says Paul Heaton, who manages Japanese and Korean stocks at Pyrford International in London.
The staunchest defender of statutory auditors is the Keidanren, Japan’s most powerful business lobby. It believes that the present corporate governance system is in some ways superior to that in Europe or the US, and opposes mandatory outside directors.
Japan’s administration points out that other nations lack perfect track records on transparency.
“Any country has companies that don’t comply with corporate governance,” said Yukio Edano, minister of economy, trade and industry at the FCCJ on December 2. “I believe Japan is at the same level as the US, if not better, in terms of effort and results.”
Edano has a point in one area. Average pay for Japan’s top executives is way below that in the US or UK, and there has been no outcry over executive compensation at underperforming companies.
But conflicts of interest inevitably arise when a company’s management can staff its own auditors. It’s much easier for managers to conduct fraud when the people employed to prevent it owe them patronage.
Crucially, an international style of corporate governance may well have caught the fraud that occurred at Olympus.
True, Olympus had independent auditors, first KPMG and then Ernst & Young. The investigation report criticises both companies for failing to spot or report wrongdoing (see box).
But truly independent directors would have been better placed to spot Olympus’ financial shenanigans.
“If you’d had genuinely independent directors with business experience who could read accounts and had authority to ask hard questions; if you’d had an audit committee looking independently; then these issues would have come to the fore earlier and they would have been forced to deal with them,” says Allen.
Falling at the first hurdle
Moving forward, Woodford tells Asiamoney that Olympus must undertake three “really basic steps” before it can start rebuilding.
First, the current board must step down. Second, a forensic audit must be made of “every part of the company’s M&A activity”. Third, “you need to carry out an impairment test on the goodwill, because the company’s intangible assets are bigger than the fixed assets… You have to have confidence in the accounting.”
Goodwill represents the intangible brand value of an acquisition. Olympus deliberately inflated the goodwill of the companies it bought as part of its tobashi scheme. Hideo Yamada, a former Olympus auditor, and Hisashi Mori, fired as executive vice-president, intended to write down the goodwill over years.
In the latest restated accounts, goodwill was reduced from ¥168 billion (US$2.15 billion) at June 30, to ¥121.7 billion at September 30.
Unfortunately the apparent lack of desire among Olympus’ major shareholders and creditors to install leaders willing to unearth wrongdoing offers few indications that Woodford’s first step will happen, which means that the other two are most unlikely.
As things stand, Olympus offers a salutary reminder of how far corporate governance in Japan has fallen short of promises made after a deluge of scandals in the 1990s. If not for Woodford, the accounting fraud at Olympus would never have been widely known, and it remains far from clear if all those responsible will be appropriately punished.
Japan’s regulators and investors must press for a thorough investigation of any company that is implicated in fraud in Japan, followed by arrests, convictions and a purging of all tainted parties if such allegations are found to have merit. Otherwise the country’s businesses will draw a simple lesson from Olympus’ experiences: don’t appoint an outsider to a senior position.