JPRI Critique Vol. VI No. 8 (August 1999)

The Big Bang and the Sokaiya

by Henry Laurence

"As long as companies want to rig their shareholders meetings, they'll need sokaiya . . . ." Kaoru Ogawa, "Dean of the Sokaiya," interviewed in Tokyo Journal, March 1998. In November 1996, Prime Minister Hashimoto announced that he intended to make Japan's financial markets "Free, Fair and Global." Yet within a year, Tokyo was gripped by a financial scandal that glaringly revealed the extent to which Japan's financial system is penetrated by the sokaiya corporate extortionists. Many of Japan's largest and most prestigious financial institutions, including all of the "Big Four" securities houses as well as Dai-Ichi Kangyo Bank, admitted paying protection money to Ryuichi Koike, one of an estimated 1,000 sokaiya gangsters who demand cash in return for silence at annual company shareholder meetings. The scandal claimed the life of at least one financial industry executive, and the jobs of dozens of company presidents and other senior officials. A poll revealed that around 70% of big companies have recently received demands or threats from sokaiya. And for the past few years, over 90% of the companies listed on the Tokyo Stock Exchange have held their annual shareholder meetings on the same day and at the same time in order to minimize the threat of sokaiya disruption. In 1996, over 60% of such meetings lasted less than 25 minutes. Since the sokaiya are still alive and well in Japan, I would propose that this is because deep-rooted structural problems within the financial system have not been resolved during the past two decades of gradual liberalization. These problems include: an inadequate system of financial disclosure; a poorly developed notion of shareholder rights, including a fundamental lack of accountability of senior managers to shareholders; and a weak and disorganized regulatory and legal structure to police markets against fraud. As a result, an often collusive and secretive corporate culture exists in which management "insiders" do whatever it takes, legal or illegal, to keep "outsiders," including individual shareholders and foreign investors, from exerting influence over company decision-making. In other words, so long as sokaiya are as active and deeply entrenched as they are now, it will not be possible to describe Japan's financial markets as truly free, fair, or global. Thus, we can use the presence or absence of sokaiya as an "indicator" of the success or failure of the Big Bang program. If the reforms are carried out in the spirit in which they were intended, and markets are characterized by genuine competition and real disclosure, then by the year 2001 there should be no home for the sokaiya in Japan. Company presidents will be--and should be--more afraid of their shareholders and the regulators than of the sokaiya. If, on the other hand, vested interests in the financial services industry, the bureaucracy, and the Diet, succeed in disrupting the reform process, then we can expect to hear about sokaiya for years to come. It is tempting to dismiss the sokaiya as an unpleasant but essentially irrelevant blemish on the underside of the Japanese economic system. The lack of scholarly attention to their activities is a striking testament to this attitude. But such a view is mistaken. Their existence is not so much a cause of problems as a symptom of them. Just as woodworms are an indication that a house is suffering from dryrot, the sokaiya are important less for themselves than for what they signify about the basic structure in which they operate. It is true that in terms of numbers and influence, the sokaiya have been declining from their heyday in the 1960s. Estimates put their numbers at around 7,000 in the late 1970s, to 1,700 in 1984 after the Commercial Code had been amended making pay-offs to sokaiya a criminal offense, to around 1,000 today. Since the Koike scandal broke, sokaiya have been subdued and there have been no reports of disruptive activity at shareholder meetings in either 1998 or 1999. But it is too early to tell if this calm is a sign that the sokaiya are truly finished, or whether, as some reports suggest, they are lying low until the fuss and the media attention die down. These days, relationships between sokaiya and companies are often described as kusareen--undesirable, but unseverable. Yet ironically, sokaiya were originally encouraged by Japanese companies as a means to cement the system of friendly cross-shareholdings which became the hallmark of Japanese corporate governance. In the postwar period, Japanese companies and bureaucrats alike were united in preferring a system in which managers and bankers, rather than shareholders, held decision-making power. As the system developed, sokaiya were helpful in controlling meetings and discouraging shareholder activism. For example, during the Minamata scandal in the 1960s, the Chisso Petrochemical Corporation employed sokaiya thugs to battle (quite literally) victims of mercury poisoning who attempted to use Chisso's annual shareholders meeting to air their grievances. In a similar fashion, in 1971, Mitsubishi Heavy Industries employed Ryuichi Koike and his gang to beat up students protesting Mitsubishi's involvement in the arms industry. Unfortunately, not enough people in Japan were concerned about the negative aspects of the sokaiya and what they signified. These corporate gangsters even developed the sort of "Samurai Chic" that their yakuza cousins often enjoy. In Saburo Shiroyama's 1963 novel Sokaiya Kinjo, for example, the aging protagonist--who legend had it once killed a man with a sword at a shareholder meeting--is sympathetically portrayed as dignified, proud, professional and morally upright. He disowns his only daughter when she has an affair with a married man. He shows special concern for a beggar boy, giving him money and asking about him in the winter. And he leaves his deathbed in order to help his old friend, the bank chairman, fight off a challenge from a rival sokaiya. (See Tamae Prindle's translation of Shiroyama's novel, New York, Weatherhill, 1989.) By the early 1980s many sokaiya had figured out that it was easier and more lucrative to become shareholders themselves and intimidate management than simply to act as bodyguards. They soon became more of a problem than a solution for corporate Japan. Yet, most corporations routinely elect to pay them off rather than calling their bluff. Hiroshi Ogino tells the story of a young financial journalist on his first visit to a major company. On his arrival at the head office, he was told to join a line of other smart young men in suits. When his turn came to see the general manager, he was handed an envelope stuffed with cash, thanked, and told to leave! (See "The Sokaiya's Grip on Corporate Japan," Japan Quarterly, July-September 1997, p. 19.) Why do companies pay up? Sokaiya have four weapons: violence, sex, inside information, and the simple ability to make a company president lose face by shouting and heckling at the annual general meeting. The first, and most troubling, is the threat of violence. Since 1994 there have been at least three murders of corporate executives attributed to sokaiya. In June 1998, when Nomura Securities announced it was cutting all ties with the sokaiya, an executive promptly received a note reading "Your grandson is very cute" and a map showing the route the boy walked to school (The Daily Yomiuri, June 24, 1998). Yet while such threats are potent, they cannot by themselves explain the willingness of so many companies to indulge the sokaiya protection racket. They do, however, highlight the general weakness of police protection against gangsters. The second threat, that of revealing the sexual indiscretions of company officials, is also probably not a major reason why companies pay up. Extramarital affairs seem to be less taboo among the Japanese elite than among the more puritanical Americans--compare the general lack of interest in former Prime Minister Hashimoto's dalliance with a Chinese spy to the Clinton matter. It is also hard to believe that more than a small number of chief executives have any real sexual scandals to be exploited. Which leaves the last two reasons: fear of losing face, and fear that a company's dirty linen will be aired. Here we come to the heart of the problem. Disclosure rules are poor in Japan, and the role of securities research analysts is accordingly circumscribed. Thus, for 364 days a year, shareholders do not really know what management is doing. By contrast, U.S. investors have an abundance of information available minute on their companies. The result is, in the words of one Japanese CEO: "A Japanese CEO faces only one 'exam' per year--an annual general meeting which usually lasts less than an hour--while an American CEO is under scrutiny 24 hours a day." Accordingly, the Japanese manager has both the means and the incentive to try to rig his annual 'exam.' Moreover, thanks to the cross-shareholding system, it is highly unlikely that disgruntled shareholders could ever fire a Japanese CEO, so he need not fear retaliation (as a U.S. manager would) if it became know that he had been engaging in payoffs. Enter the sokaiya. For a few million yen the managers can guarantee a shan shan sokai ("handclapping meeting") with no nasty questions for another year. Sokaiya extortion became so rampant that in 1982 the Commercial law was changed to make it illegal to pay them off. While this had the effect of making things slightly more complicated for the sokaiya (who now had to insist that, for example, the company subscribe to their overpriced "research" journals) it did not stop them. One problem with the law is that once a manager has paid a sokaiya, he dare not report any subsequent threat to the police for fear that he himself will be sent to prison. Moreover, the police are notorious for leaking secrets to the press. Blackmailed managers thus often face an awkward choice. If they report the blackmail, they face criminal charges, the sokaiya will be out for revenge, and their secret will probably come out anyway. Simply paying off the gangster is a more attractive option. Moreover, even if sokaiya activity is reported, the law enforcement apparatus has been ineffectual in providing much deterrent. Until recently there has been little coordinated effort between the Tokyo Police Department and the Ministry of Finance in tackling white collar crime. Penalties for sokaiya are slight even when they are caught: in 1975, Koike publicly threatened to kill the president of Rikin Vinyl Industry Co., but was given only a suspended sentence. Things have improved somewhat since then. In April 1999, Koike received a 9-month prison sentence and a 693-million-yen fine for his extortion of Nomura and the Dai-Ichi Kangyo Bank. The sokaiya won't go away until it is no longer in the interests of company managers to pay them off. It would be nice to think that the Koike scandal will be the last, but there are good grounds for believing that the corrupt corporate culture has not fundamentally changed, and that Japan's financial industry won't clean itself up on its own. In 1991, Nomura Securities was caught manipulating stock for a known crime syndicate. The company chairman and president both resigned and Nomura loudly proclaimed that it was cleaning up its act. But in 1995, the company was paying off sokaiya to keep quiet at the shareholders' meeting where both disgraced officials were reinstated. Successful implementation of all of the proposed Big Bang reforms is a necessary condition for the eradication of the sokaiya. First, better disclosure will undercut the threats that sokaiya can hang over the heads of management, since more corporate information will be widely available anyway. Second, a wider and more open system of shareownership will dilute the ability of a few crooked shareholders to dominate and control the annual general meetings. Third, a more effective system of monitoring securities regulations and punishing offenders will help deter both the bribers and the bribed. Finally, Japanese corporations need to follow the lead of companies such as Sony, refuse to play the collusive and secretive game of shan shan sokai, and make a genuine attempt to be accountable to all shareholders. The current package of Big Bang reforms should help on all of these fronts. Whether they actually do or not remains to be seen. HENRY LAURENCE is an Assistant Professor of Government and Asian Studies at Bowdoin College. He was formerly a fund manager for the Bank of Tokyo International, and has just completed a book on financial market reform in Britain and Japan.