Japan's Nikko Cordial faces a record $4 million fine and possible delisting from the Tokyo Stock Exchange after regulators found that the brokerage improperly booked $156 million in profits.
Nikko Cordial, Japan's third-biggest securities house, acknowledged the faulty accounting on Monday and restated its earnings for the 2004/05 business year. The TSE put its shares on "administrative watch", a step that leads to a delisting in about 50% of cases.
Nikko Cordial executives said at a news conference that a combination of administrative errors and ill-judged interpretations of accounting rules led to the inflated profit, but that it had not intended to window-dress its results. "Our internal compliance systems didn't function as they should have," Executive Officer Osamu Morita said.
Nikko Cordial chief executive Junichi Arimura and other executives will give up half their pay for six months and reimburse the company for the fine, Nikko Cordial said.
Yet the brokerage's insistence that the accounting problem was the result of innocent errors appeared to conflict with the findings of Japan's financial market watchdog, the Securities and Exchange Surveillance Commission (SESC).
The SESC said Nikko Cordial back-dated documents related to a purchase of exchangeable bonds by its merchant banking subsidiary, Nikko Principal Investments, in order to inflate valuation gains arising from the transaction.
Nikko Cordial then included the gains as profit in its group earnings but left out a counter-balancing loss incurred by the issuing company, a special-purpose subsidiary of Nikko Principal. "The subsidiary should never have been excluded from the consolidated accounts," said Ichiro Kawano, director of the SESC's civil investigation division. "It's very unfortunate. They have a different understanding than we do."
The SESC recommended that Nikko Cordial be fined 500 million yen ($4.2 million), which would be a record penalty for a securities violation in Japan. The regulatory Financial Services Agency must sign off on the sanction.
Nikko Cordial cut its reported operating profit for the year to March 31, 2005, by 24% to 58.8 billion yen ($498 million).
The reduction roughly matched the 18.4 billion yen ($155.8 million) in unjustified profit identified by the SESC -- 14.5 billion yen in gains from the exchangeable bond plus another 3.9 billion yen in fees and other income related to the transaction.
Nikko also cut its net profit for that year by 25% to 35.1 billion yen. Profits for the subsequent 2005/06 business year were revised fractionally higher.
Analysts and media had raised questions for more than a year about the bond issue, which was used to finance an acquisition made by Nikko Principal through the special-purpose subsidiary, NPI Holdings.
Nikko Principal enjoyed a gain on the deal due to a rise in the share price of the acquired company, Bellsystem24, an operator of telephone call centers.
But NPI Holdings incurred an equivalent loss, meaning the impact on profits at the Nikko group as a whole was essentially nil. Nikko Cordial kept the loss side of the transaction off its books by classifying the purchase of Bellsystem24 as a venture capital investment rather than a standard acquisition.
"Nikko Principal clearly had control of the company, so calling it a venture capital deal was inappropriate," the SESC's Kawano said.
It was unclear how likely it was that Nikko Cordial would be delisted from the TSE, a result that would badly hurt its image and constrain its access to capital.
TSE spokesman Toru Onoda said roughly half of companies put on administrative watch in the past have ended up being delisted.