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On October 4, 2006, the Financial Services Agency of Japan (the "FSA") adopted a new rule requiring securities companies to take certain measures to reduce the risk of insider trading that may arise from "market surveys" that securities companies often conduct prior to a proposed securities offering by a publicly traded issuer.  This new rule will become part of the Ordinance of Cabinet Office concerning Regulations, Etc., of the Conduct of a Securities Company (the "Ordinance"), and is scheduled to take effect on November 1, 2006.

Background

When acting as lead manager in a proposed securities offering by a publicly traded issuer, a Japanese securities company will often conduct a "market survey" to gauge the potential demand of domestic and offshore institutional investors for the proposed offering.  Japanese authorities are concerned that investors may engage in insider trading based on information received from securities companies during their pre-offering market surveys, prior to public disclosure of the information. 

In response, the Securities and Exchange Surveillance Commission of Japan (the "SESC") is taking a tougher stance against suspected insider trading based on informational disclosures made during pre-offering market surveys.  In February 2003, insider trading was alleged in connection with the ¥300 billion preferred stock offering by Sumitomo Mitsui Financial Group, Inc.  The SESC requested the cooperation of authorities responsible for regulating securities in the UK and Singapore, leading to the imposition of civil penalties on certain offshore investors under the laws of their respective jurisdictions.  On April 14, 2006, the SESC issued an official recommendation that the FSA should take appropriate measures to prevent insider trading in connection with the disclosure of non-public information by securities companies through their pre-offering market surveys.  The amendment to the Ordinance promulgated by the FSA is a direct response to the SESC’s recommendation.

Overview of New Rule

The FSA’s new rule requires securities companies to take certain preventative measures when they provide non-public corporate information involving any planned issuances of equity or equity-linked securities by publicly traded companies.  Specifically, a securities company is required to:

• obtain the approval of the securities company’s compliance department for (i) conducting a pre-offering market survey, (ii) the persons to be surveyed, and (iii) the nature, timing and method of providing such non-public corporate information;
• obtain the written agreement of each participant in a pre-offering market survey not to (i) trade [1] in the securities of the issuer that is the focus of such pre-offering market survey until the applicable non-public corporate information or the issuer’s decision to go forward with the planned offering is made public, or until the securities company notifies the survey participant that the proposed securities issuance will not take place, [2] or (ii) disclose any non-public corporate information obtained in a pre-offering market survey to any other persons [3] ; and
• prepare and maintain records of the persons responsible for and the persons who actually conduct pre-offering market surveys, the names and addresses of persons surveyed, and the dates and the nature and methods of providing such non-public corporate information.

In addition, when a securities company uses a third party to conduct a pre-offering market survey, the securities company must require the third party to take the same preventative measures in conducting a pre-offering market survey.

Conforming amendments will concurrently be made to the Ordinance of the Cabinet Office concerning the Securities Business of Financial Institutions and the Ordinance of Cabinet Office Foreign Securities Firms, which govern, respectively, pre-offering market surveys of financial institutions in the securities business and of foreign securities firms.

In addition, the Japan Securities Dealers Association, the self-regulating authority of securities companies and registered financial institutions in Japan, is currently in the process of amending its Regulations concerning the Underwriting of Securities (Fair Business Practice Regulations No. 14) in order to incorporate similar obligations in its rules that govern pre-offering market surveys by its members.

Final Notes on New Rule regarding Pre-Offering Market Surveys 

The purpose of this new rule is to prevent insider trading by requiring securities companies to take certain preventative measures in connection with their pre-offering market surveys.  The existing substantive regulation of insider trading under the Securities and Exchange Law (the "SEL") will not be changed by this new rule.  It is important to note that if a participant in a pre-offering market survey trades securities of a publicly traded company with knowledge of a possible offering, the investor may have liability for insider trading under the SEL’s substantive regulations (and may be subject to investigation for such liability) regardless of whether the securities company has complied with its obligations under the new rule with respect to the pre-offering market survey.

It is also important to note that the new rule is not intended to promote pre-offering market surveys by securities companies, or to provide a safe-harbor for non-violation of the gun-jumping rule under the SEL.  As the FSA emphasized in its response to public comments for the new pre-offering market survey rule, even after the adoption of this rule, the question of whether certain conduct in the course of a pre-offering market survey constitutes a "solicitation" under the SEL will continue to be analyzed in light of the specific facts under which such survey is made.

This new rule only applies to pre-offering market surveys conducted by securities companies (and financial institutions and foreign securities firms).  A publicly traded issuer that conducts its own pre-offering market survey for a prospective offering of its securities is not subject to this new regulation.