Tokyo Stock Market Rocked by Madoff-Style Fraud and Chinese Backdoor Listing

Two scandals exposed over the last week have been damaging to Japan's stock market which, up to this point, has been doing well this year. News came in that AIJ Investment Advisors was being shut down due to the company's inability to account for 90% of the JPY 200 billion of corporate pensions assets under its management.

Stephen Harner
2/27/2012 @ 1:09PM
Forbes

Just when things have begun to look up in the Japanese stock market, two scandals exposed during the past week are roiling financial institutions and investor sentiment.

Japanese stocks have rebounded, buoyed by yen weakening to 80.55 and QE from the BOJ. The Nikkei average closed at 9,634 yen on February 27, up some 10 percent in one month, regaining a level last reached in August 2011. Long suffering Japanese stock investors, like the early blooming plum trees, have been showing signs of new life, with Nikkei volume averaging around JPY 1.5 trillion over the past week, up 20-30 percent from earlier weeks.

So much less welcome, then, were the headlines in the Nihon Keizai Shimbun beginning February 24 announcing that a Tokyo pension fund investment advisory company, AIJ Investment Advisors, was being closed down by the Financial Services Agency (FSA) because AIJ could not account for some 90 percent of the JPY 200 billion (USD 2.5 billion) of corporate pension assets under its management.

We do not expect innovation from Japan’s financial market, and in AIJ we do not get any. The fraud is of a type with Madoff, Sanford and so many others: a “black box” formula–in this case using Cayman-registered private placement trusts–producing amazingly consistent and stable high returns even when the overall market, and industry, is making losses. The biggest disparity and boost to AIJ’s market reputation came post-”Lehman shock” in 2008 when Japan’s broad market TOPIX index dropped some 35 percent and the company reported earning a 7.45 percent return. AIJ boasted that its premier product, AIM Millennium Fund, never had a down year from its establishment in June 2002 until November 2011, and totally appreciated 245 percent over the period.

The truth seems very different. The typically cautious and more than usually chagrinned FSA has still not revealed, if indeed it has found out, what happened to the money. Most speculation is that AIJ and its management vehicle, ITM Securities, gambled and lost big in derivatives and unlisted foreign stocks. FSA is clearly terrified that AIJ’s bad practice might have been copied by the 262 other licensed investment advisors in the Japan market, and has launch an emergency audit of all of them. Because success–even fraudulent success–invites imitation, the FSA’s fear is justified.

Finally, the man now being called to account is the AIJ president, Asakawa Kazuhiko, a former Nomura Securities regional sales office manager. Other officers are also from Nomura. All Asakawa is saying, we are told, is that he cannot explain what happened. The truth will come out soon, of course. What we already know is that Nomura’s culture over the years has incubated many scandals. This, sadly, seems another.

To me, news an even more interesting securities scandal was broken by, of all places, NHK on February 26. It is that a JASDAQ listed software company, Celartem (JASDAQ: 4330), which 3 years ago announced it was buying a Beijing-based Chinese company, is being investigated for securities fraud.

The 2009 cross-border acquisition announcement propelled Celartem stock to a 10 fold price rise, as Japanese investors saw rapid growth in China’s booming market, in contrast to theretofore stagnation in Japan.

The deal was announced as follows: Celartem issued new shares to and in exchange received JPY 1.5 billion (USD18.8 million) in funds from a Chinese investment fund. The funds were used to acquire an environmental technology firm in Beijing.

Turns out that no money was raised. Rather, Celartem simply handed over about half of its entire shares to the Beijing company in what became a reverse takeover by the Chinese side. Subsequently, the Beijing company dispatched officers to Celartem, effectively bringing the Japanese company under Beijing’s control.

In short, this transaction looks like a “back door listing” by a Chinese company on the Japanese market, similar to what has been seen in the U.S. markets. The gambit enables Chinese firms to avoid approvals and red tape from Chinese authorities–the biggest hurdle, particularly when, as is often the case, black money is involved–but can also illegally circumvent rules listing and disclosure requirements in the listing market.

Japan’s SEC is investigating Celartem for stock price manipulation and false reporting. It has requested the cooperation of the Chinese securities regulator. We’ll keep watching how this plays out.

Readers know my belief that Japan is increasingly integrating with China. Celartem is an interesting vignette within the broad moving picture of intertwining relationships, financial, economic, social, and even political. As with the AIJ scandal, it is likely not an isolated case, nor one of which we will not see more in the future.

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