Daiwa Bank Japan Case Study

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Tokyo moved today to prevent possible panic over the sanctions against Daiwa from spreading to the rest of the banking system. And Japan's Finance Ministry ordered Daiwa to cut back its international operations and asked Sumitomo Bank to help close Daiwa's businesses in the United States. [Page D5.]

The charges against Daiwa include conspiracy, mail and wire fraud, obstructing an examination of a financial institution, falsification of bank records and the failure to disclose Federal crimes. The former general manager at the Daiwa branch, Masahiro Tsuda, was also indicted on charges of conspiring to deceive regulators. Mr. Tsuda's lawyer, Stanley Arkin, said yesterday that his client, who had only become general manager in July, was innocent. Mr. Tsuda resigned from the bank last month.

Daiwa, based in Osaka, said in a statement yesterday in New York that it intended to defend itself against the Federal charges. Takashi Kaiho, the recently appointed president of Daiwa, said the bank was motivated by its desire "to investigate thoroughly the unauthorized activities by which it was victimized, to take all necessary action to protect our customers, and to act in a way that was not harmful to the international banking system."

Mr. Iguchi, the Daiwa trader, pleaded guilty last month to bank fraud and is cooperating with the United States investigation. At his hearing, Federal prosecutors said for the first time they believed that Daiwa executives had participated in a cover-up of the losses for two months.

The indictment against Daiwa sets out new information detailing a more extensive and intricate deception at the bank, involving misrepresentations made to bank regulators and examiners for several years. In early August, the indictment said, as top management became involved in the cover-up, the bank even considered concealing the whole trading loss at a company in the Cayman Islands.

That plan, though, was "ultimately rejected by Daiwa's senior management as not feasible," the indictment said. Daiwa had used that technique before, the indictment asserted, when in about 1987 the bank "successfully concealed a multimillion-dollar trading loss at Daiwa Bank Trust through a Cayman Islands entity." The Daiwa Bank Trust Company is a Daiwa subsidiary in the United States.

Mr. Iguchi first confessed his losses in an extensive letter sent to Daiwa's president in mid-July. But yesterday's indictment detailed as many as five letters that Mr. Iguchi wrote to his superiors as they pondered what to do about his horrendous losses. It also outlined Mr. Iguchi's associations with his bosses as they discussed the losses, including meetings held in late July at the Park Lane Hotel in Manhattan.

As she announced the indictments at the Federal courthouse in Foley Square, Mary Jo White, the United States Attorney for Manhattan, said that "The message to the financial community from today's indictment should be clear and unambiguous: Law enforcement will not tolerate financial institutions who unlawfully attempt to mislead regulatory authorities and cover up criminal conduct by their employees."

The order to shut down the operations was issued by the Federal Reserve Board, the Federal Deposit Insurance Corporation, the New York State Banking Department and regulators in California, Illinois, Massachusetts, Florida and Georgia, states where Daiwa has operations. Even though operations here are closed, Daiwa can still trade with American firms from Japan.

The tough action against Daiwa comes as Japanese financial institutions are under considerable pressure because of billions of dollars of nonperforming loans, a slow economy and sagging confidence.

It is now several weeks since the news of Daiwa's trading losses became public and markets have already adjusted to them. The Standard & Poor's Corporation, the rating agency, for example, said the actions yesterday would not immediately affect Daiwa's credit rating because the agency had already downgraded Daiwa two notches from A- to BBB.

"The action taken by U.S. regulators goes a bit further and will have a more serious effect on the bank's activities than we expected," said Ernie Napier, an S.& P. analyst. "It's a major setback, but it's one they can cope with," he added, noting that overseas operations represent only 10 percent of Daiwa's profit.

But Mr. Napier expressed concern that the bank's business in Japan could be hurt by the defection of Japanese clients who want a more international bank, or at least one with full access to markets in the United States. Mr. Napier said that even if Daiwa was hit with a large fine, the penalties should not have a ripple effect on the troubled Japanese banking system.

While Daiwa has been shaken by the scandal and its two top executives in Japan have resigned, analysts said it should be able to pay whatever penalties it might suffer. At the end of 1994, Daiwa had equity capital of $6.9 billion and total assets of $304 billion, ranking it the 15th largest bank in Japan and the 19th largest bank in the world, according to American Banker, a trade publication. (Daiwa Bank Ltd., its New York branch and its United States subsidiary, the Daiwa Bank Trust Company are not related to the Daiwa Securities Company, the Japanese brokerage firm.)

The charge that the bank deliberately evaded regulators has had a damaging effect on confidence in Federal regulation, some experts said. Daiwa's conduct "is very disruptive because it has undermined the examination process," said Michael Bradfield, a former general counsel to the Federal Reserve and a partner at Jones, Day, Reavis & Pogue.

Deliberately concealing information, as prosecutors contend Daiwa Bank did in the last several years, is inconsistent with the entire theory and practice of examinations, Mr. Bradfield said.

"The whole system of bank regulation works on the basis of full availability of records to examiners and a willingness to cooperate with supervisors when they discover problems," he said. Mr. Bradfield said that harsh action against Daiwa was justified.

But the stiff potential penalties could leave the Government open to criticism that it has employed a far harsher standard for a foreign bank than has been applied in cases involving American brokerage firms.

For example, prosecutors elected to bring no criminal charges against Salomon Brothers Inc. for having illegally obtained millions of dollars through fraudulent bids in the Treasury markets in 1991. No charges have yet been brought in a case involving a trader at Kidder, Peabody & Company, who was accused by the firm of engaging in a series of bogus trades strikingly similar to those at Daiwa.

And last year, Ms. White, the Federal prosecutor, chose not to indict Prudential Securities for taking more than $1 billion from 100,000 investors through the fraudulent sale of risky limited partnerships. Indeed, while the Government said in court filings that Prudential executives knowingly committed the fraud, no individual has ever been charged with a crime.

Some prosecutors yesterday drew parallels with previous Federal regulatory action against the Bank of Credit and Commerce International. B.C.C.I. was the rogue bank based in Luxembourg and with headquarters in London that was closed by regulators around the world in July 1991 after it had become extensively involved in money laundering, falsifying accounts and many other infractions.

But B.C.C.I., unlike Daiwa Bank, was never formally admitted into the United States, or allowed to operate branches in this country. It did, though, secretly and illegally buy banks and other financial institutions in the United States.

Just what regulators in the United States knew about Daiwa's New York branch, and when they knew it, is still a murky issue. According to several former Federal Reserve officials, there was considerable concern about Daiwa's sloppy controls and trading practices as long ago as 1993. But it seems Fed regulators took Daiwa's assurances that the bank would redress the shortcomings they had identified.

Congress is now preparing to hold hearings on Daiwa, the trading debacle at its New York office and regulatory oversight of the bank. Senator Alfonse M. D'Amato, the New York Republican who heads the Senate Banking Committee, said in an interview yesterday that the actions against Daiwa were "an appropriate response to illegal activities."

Senator D'Amato said that his committee's hearing would look into what procedures might minimize the chance of a recurrence of the Daiwa scandal. He said his purpose was "not to admonish the regulators, but to ascertain from them what they are doing" and "to ask them to explain what did happen."

Iguchi's Letters

Prosecutors have accused Daiwa Bank and several top executives of conspiring for months to cover up $1.1 billion in losses incurred by a trader, Toshihide Iguchi, through unauthorized bond trading. In addition to the confession letter from Mr. Iguchi that set off the whole chain of events, prosecutors say Mr. Iguchi wrote at least four more that figure in the cover-up.

1. The Original Confession -- July 21

Addressed to Daiwa's then-president, Akira Fujita; Mr. Iguchi characterized it as his "honest confession" and said he had "caused approximately a $1.1 billion loss from trading in United Staes Treasury bonds at the New York Branch." He suggested that the bank should "keep the secret until the bank and possibly the Japanese authorities can take appropriate measures," and he added that "it is clear from a legal standpoint this will make the continuation of the U.S. operation difficult."

2. No One Will Catch On -- July 24

Along with another copy of the confession letter, Daiwa received a second letter from Mr. Iguchi in which he said, "I can clearly say on the basis of the experience I gained from the Fed inspection the year before last, that there is a zero possibility that this case would be found out in the United States if we bought back (the Unites States Treasury obligations). . . "

3. Ways to Hide the Losses -- July 25

Addressed to the deputy president of Daiwa Bank Limited; the indictment says that in this third letter Mr. Iguchi "outlined his suggestions for ways in which the defendant Daiwa could continue to conceal the $1.1 billion loss."

4. More Details on the Trading -- July 28-29

According to the indictment, three senior executives met with Mr. Iguchi in late July. Masahiro Tsuda, Daiwa's managing director in New York, said at the meeting that the losses would not be announced until late November, after Daiwa was due to announce financial results, and that keeping the losses secret in the meantime was imperative, the indictment says. The next day, the indictment says, Mr. Iguchi gave the three executives a fourth letter explaining his trades, losses and unauthorized sales of bonds to cover his losses in greater detail; Mr. Tsuda then asked Mr. Iguchi "to destroy the computer disk on which he had prepared the confession letter."

5. A New Undated Confession -- Aug. 4

The indictment says another of the three executives directed Mr. Iguchi to "prepare another version of the confession letter, which was to be undated," and told Mr. Iguchi "to discuss only his unauthorized trading losses and the losses that resulted from that trading" and omit mention of "other matters" addressed in the first confession letter in July.

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Case Details:

Case Code : FINC033
Case Length : 8 Pages
Period : 1996-2006
Pub. Date : 2004
Teaching Note :Not Available
Organization : Daiwa Bank
Industry : Banking
Countries : Japan / US

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This case study was compiled from published sources, and is intended to be used as a basis for class discussion. It is not intended to illustrate either effective or ineffective handling of a management situation. Nor is it a primary information source.

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