provisional

New Legislative Framework
for Investor Protection- “Financial Instruments and Exchange Act”-

Financial Services Agency, Japan

Table of Contents
Ⅰ. Schedule・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・1
Ⅱ. Basic Framework of the Legislations
1.
2.
3.

Basic contents of the Legislations ・・・・・・・・・・・・・・・・・・・・2
Acts to be amended or abolished by the Legislations ・・・・・・・・ ・・3
Effective date of the Legislations ・・・・・・・・・・・・・・・・・・・・4

Ⅲ. Contents of the Legislations
1. Purport and objective of “the Financial Instruments and Exchange Act” ・・・・・・5
2. Cross-sectional coverage of “the Financial Instruments and Exchange Act” ・・・・6
3. Collective Investment Scheme (fund) and Derivatives ・・・・・・・・・・・・・・7
4. Cross-sectional and flexible regulatory system ・・・・・・・・・・・・・・・・・8
5. Regulation of “financial instruments businesses” ・・・・・・・・・・・・・・・・9
6. Regulatory treatment of funds business ・・・・・・・・・・・・・・・・・・・・10
7. Regulation of conduct of “financial instruments business” ・・・・・・・・・・・・11
8. Classification of customers: professional investors and general investors ・・・・・12
9. Disclosure requirements ・・・・・・・・・・・・・・・・・・・・・・・・・・14
10. Review of Tender Offer system and large shareholdings reporting system
・・・・15
11. Strengthening independence of self-regulatory functions of financial instruments
exchanges ・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・16
12. Financial instruments firms association (Self Regulatory Organizations (SROs), etc.) 17
13. Review of the regulation on sale and purchase within 6 months by fund (partnership) 18
14. Enhancement of civil liability for sales of financial products ・・・・・・・・・・・19
15. Expansion of the scope of penalties against “misegyoku” ・・・・・・・・・・・・20
16. Increase in maximum criminal liability ・・・・・・・・・・・・・・・・・・・・21

Ⅰ. Schedule● December 22, 2005
Report of the First Subcommittee of the Financial System Council titled as “Legislationfor ‘the Investment Services Act (provisional title)”● March 10, 2006
Cabinet decision on the following two bills for legislating the “Financial Instruments andExchange Act”
- bill for amending the Securities and Exchange Act and otherfinancial acts
- bill for abolishing and amending the related acts to implement theabove bill for amending the Securities and Exchange Act andother financial acts

● March 13, 2006
Submission of the bills to the Diet (Japanese Legislature)● June 7, 2006
Passage of the bills in the Diet

● June 14, 2006
Promulgation of the legislations
1

Ⅱ. Basic Framework of the Legislations
1. Basic contents of the Legislations(1) Establishing cross-sectional framework of a wide range of financial instruments and servicesz

Establishing a comprehensive definition of collective investment scheme (funds) and wide-ranging
definition of derivativesz

Broadening the scope of “financial instruments business operators”(2) Enhancing disclosure requirementszIntroduction of a statutory quarterly reporting system for listed companieszEnhancing internal control over financial reportingz

Reviewing regulations on tender offers and large shareholding reports(3) Increasing the maximum criminal penalties against various market frauds and expanding the scopeof penalties against “misegyoku”
zIncreasing the maximum criminal penalties against such frauds as false annual reports and market
manipulations from 5 years in prison to 10 years(4) Providing organizational structures for self-regulatory functions of exchanges in the form of stock
corporationsz

Providing organizational structures of a self-regulatory corporation or a self-regulatory committee22. Acts to be amended or abolished by the Legislations(1) Acts to be amended (89 Acts in total)z Securities and Exchange Act
z Act concerning Investment Trust and Investment Corporationz Banking Act
z Shinkin Bank Act
z Trust Banking Act
z Insurance Business Act
z Norinchukin Bank Act
z Agricultural Cooperatives Act
z Commodity Exchange Act
z Real Estate Syndication Act
z Act Concerning the Regulation of Commodity Investment Businessz Act Concerning the Sale of Financial Productsz Others(2) Acts to be abolished (4 Acts)z Financial Futures Trading Act
z Act Concerning Foreign Securities Firms
z Act Concerning the Regulation of Investment Advisory Service Relating to Securities
z Act Concerning the Regulation of Mortgage Business33. Effective date of the Legislations
Measuresz Increase in maximum criminal penalty
z Countermeasures against trading orders withintention of canceling immediately (“misegyoku”)

Effective datez Twenty days after the promulgation of thelegislations (= July 4, 2006)z December 13, 2006
z Review of regulations on tender offers and large

shareholding reports

z Introduction of statutory quarterly reporting

requirementz Enhancement of internal control over financial
reporting※ January 1, 2007 for the shortening of reporting
deadline of special large shareholding reports※ April 1, 2007 for the mandatory electronic filing oflarge shareholding reportsz Date to be designated by cabinet order notexceeding 1 year and 6 months after the
promulgationz Applied to business year starting on and after
April 1, 2008

z Establishment of cross-sectional framework of awide range of financial instruments and services
z Enhancement of independence of self regulatory
functions of exchanges
z Othersz Date to be designated by cabinet order notexceeding 1 year and 6 months after the
promulgation
4

Ⅲ. Contents of the Legislations
1. Purport and objective of “the Financial Instruments and Exchange Act”
● Fraudulent cases among the loopholes between regulations● Different rules for financial instruments whose economic functions
are identical● Interruption of financial innovation and development of new financial
instruments beyond existing business lines

Sectional acts and application
for specified securities

Regulatory structure of
the Securities and Exchange Act

Enhancement of userprotections

Cross-sectional protection of users

Flexible regulatory structure● Full set of rules are uniformly applied once regarded as “securities”

Enhancement of users’ convenience
Promotion of financial innovation
Facilitation of finance

Development of market
infrastructure bearing
comparison with majorcountries and regions= Establishing a cross-sectional framework of a wide range of financial
instruments and services= Introducing different rules depending on the characteristics of financial
instruments, or knowledge and experience of the investor
5

2. Cross-sectional coverage of “the Financial instruments and Exchange Act”
Coverage under the Financial Instruments andExchange Act
Current coverage under the Securities andExchange Act

・Local bonds
・Corporate bonds

・Government bonds

・Stocks

・Local bonds

・Interests in investment trusts and investment

・Corporate bonds

corporations

・Stocks
・Interests in investment trusts and investment
corporations
・Securities derivatives etc.

・Government bonds(limited list)

・Interests in trusts・Interests in collective investment scheme (fund) (basket
clause)・Derivatives

etc.

Application of the same rules of conduct
・Deposits with strong investment characteristics(Banking Act)
(foreign currency denominated deposits and derivative
deposits)
・Insurance with strong investment characteristics(Insurance Business Act)
(foreign currency denominated insurance, and variableinsurance and annuity)・Commodity futures (Commodity Exchange Act)・Real estate syndication business(Real Estate Syndication Business Act)6

3. Collective Investment Scheme (fund) and Derivatives
Collective Investment Scheme (fund)【Definition】
Any scheme that・collects money or similar properties from two or more persons
・conducts business using the money, and・distributes profits or properties to investors originated from thebusiness

Investment

Tokumei-Kumiai,
Minpou-Kumiai,
etc.

lease

・objects ofinvestment
・businesses

profits/dividendz Including any forms of funds such as partnership based on the

Civil Law or secret partnership based on the Commercial Act.

Provisionof moneyContribution
Distribution

z Including any business that funds conduct such as investment inany properties (securities, real estate, commodities, etc.)
investor(Note) The following are to be excluded in accordance withcabinet orders:・in cases that all the investors are involved in the business,investor

investor

investor

investor・in cases that there are no distribution of profits or properties
to investors beyond the amount of original investment

Derivatives【Categories of derivatives transactions】
futures, forwards, options, swaps, credit derivatives, weather derivatives, and others to be designated by cabinet order【Underlying assets defined as “financial instruments”】
securities, rights, currency, other assets to be designated by cabinet order, standardized contracts【Indicators defined as “financial indicators”】
prices or interest rates of financial instruments, weather variables, economic statistics to be designated by cabinet order74. Cross-sectional and flexible regulatory system
Current system(sectional regulations)

Regulatory system under the Financial
Instruments and Exchange Act【sales and solicitation】
Securities and Exchange Act
Foreign Securities Firms Act==

Financial futures trading Act=

Commodity Fund Act=

Securities business
Securities business
Financial futures tradingbusiness
Commodity fund sales
business【investment management and advice】
Securities Investment Advisory Act=

Discretionary
investment business

Financial instruments
business operators

Investment advisory business

Investment Trusts and Investment
Corporations Act=

Investment trust
management business【administration of money and securities】
No regulations【financial instruments intermediary service】
Securities and Exchange Act(No regulations) Introducing brokerage of discretionary
investment contracts and investment advisory contracts

Financial instrumentsintermediary service providers
85. Regulation of “financial instruments businesses”〔Basic concept〕●●

Coverage should be “sales and solicitation,” “investment management,” “investment advice,” and “administration of money and securities.” ⇒Expanding core businesses ⇒ Cross-sectional regulatory structure
Regulations are tailored to types of businesses financial instruments business operators conduct. ⇒ Flexible regulatory structure

Regulation of financial
conditions

Regulation ofother business・all financial instruments businesses
dealing with all the securities andderivatives

・minimum capital andnet asset requirements
・CAR regulation

notification orapprovalrequirement“investment
management business”

・investment management including
discretionary investment businesses

・minimum capital andnet asset requirements

notification orapprovalrequirement“type Ⅱ financial
instruments business”

・sales and solicitation of securities
with lower liquidity and market
derivatives

・minimum capitalrequirement onlyNone

“investment advisory
and agency business ”

・Investment advice

・no minimum capitalrequirement
・business security
deposits requirement

None“financial instrumentsintermediary service”

・introducing brokerage of deals
entrusted by other financial
instruments business operators“financial instruments
businesses”

Type of businesses“type Ⅰ financial
instruments business”

Entry
regulation

Registration
requirement

Registration
requirement

None

None

(Note 1) Entry requirement for proprietary trading system (alternative trading system) is approval.
(Note 2) Items on which applications for registrations are to be rejected are tailored to types of businesses.

96. Regulatory treatment of funds businessCurrent regulatory treatment of funds such as partnership or limited partnershipz No business regulation on sales and solicitations of interests in funds by members offunds themselves.
z No business regulation on investment management of interests in funds by membersof funds themselves.

Regulatory treatment under the Financial Instruments and Exchange Act
z Introducing business regulations on sales and solicitation business and investment
management business by members of funds themselves
type Ⅱ financial
Funds for general investors

Registration requirement

Funds for professional investors(qualified institutional investors + 49 persons)zNotification requirement

instruments business
investment managementbusiness

Introducing conduct of business regulations on sales and solicitation business andinvestment management business
Funds for general investors
Funds for professional investors

conduct of business regulations as type Ⅱ financial instruments
business and investment management businesslimited regulations (prohibition of providing false information and ofcompensating customers for their losses)107. Regulation of conduct of “financial instruments business”○ Considering current regulations in the Securities and Exchange Act and the Investment Advisor Act, conduct of businessregulations should be reorganized by function and strengthening in a cross-sectional manner.
○ Application of regulation and its contents should be prescribed depending on types of customer in sales and solicitation or types offinancial instruments (flexible regulatory structure).

Overall framework of conduct of business regulations【all businesses】● Duty of sincerity and fairness○ Prohibition of promotions without confirming will of customers on● Obligation of notification of signspecified contract● Prohibition of name lending● Prohibition of compensating customers for their losses● Prohibition of becoming a trustee of a corporate bond offering○ Requirement for suitability○ Regulation of advertisement● Requirement for proper treatment of customer information【sales and solicitation】○ Obligation of defining best execution policy○ Obligation of making advance indication of a trade form
【investment management and investment advice】○ Obligation of delivering documents in advance● Fiduciary duty
○ Obligation of delivering documents as entering into contract● Duty of loyalty○ Obligation of delivering documents as receipt of deposit money●○ Prohibited acts （transaction raising conflict of○ Cooling-offs
interests/advancement of money/securities lending etc.）● Prohibition of providing false information○ Obligation of delivering investment management report● Prohibition of providing conclusive judgment【asset administration】○ Prohibition of unsolicited promotions on specified contract● Obligation of segregation of asset○ Prohibition of call against will on specified contract(Note) While the regulations (●) will be applied to all investors, the regulation (○) will not be applied when dealing with professional investors.

Concrete measures○ Enhancing requirement for suitability
・ Adding “objective of making contracts” to the current requirement of “knowledge, experience, and assets”○ Introducing regulatory duty for explaining in line with the civil duty to explain under the Financial Products Sales Act・ item to be included in documents to be delivered to customers in advance○ Introducing prohibition of unsolicited promotions, promotions without confirming will of customers, and promotions against will・ Establishing a general framework of prohibitions for user protections
・ Actual application will be designated by cabinet order.
○ Introducing obligation of disclosure of fees customers should pay and of presentation of being a financial instruments business operator
・ items to be included in document to be delivered to customers in advance11

8. Classification of customers: professional investors and general investors
Purport： considering contents of regulations on financial instruments firms, and setting different rules for
activities such as sales and solicitation, depending on the nature of investors: professional or
general investors

Realization of both proper
protection of users and facilitation of provision of risk capital.

(e.g.) 1. For sale and solicitation to professional investors, conduct of business regulations aimed at an correction of theinformation disparity (obligation of delivering documents before entering into contract, obligation of delivery of
documents as entering into contract, etc.) should be exempted.
2. Regulations set for the market integrity should not be exempted.

professional
investors

generalinvestors① a professional
qualified institutional investor
investor without anJapanese government
option to be classified as
Bank of Japana general investor② a professional
corporation to be designated byinvestor with an option
cabinet ordinanceto be classified as a(e.g.) ・public company
general investor
・a company above a certain size
③ a general investor
corporations other than ① and ②with an option to be・individual customers meetingclassified as acriteria to be designated byprofessional investor
cabinet ordinance④ a general investor
without an option to be
individuals (except those whoclassified as ameet the above criteria)
professional investor

always treated as aprofessional investor
optionoptionalways treated as a
general investor
12Procedures for investors to change their status
Common procedures for professional investors to be treated as general investors
and general investors to be treated as professional investors
z Customers make requests to financial instruments business operators to change
their status.
z Financial instruments business operators shall deliver documents to customers
upon consenting to the requests.
z Effective period of status change is 1 year.
Specific procedures for general investors to be treated as professional investorsz Financial instruments business operators shall get consents of customers throughdocuments which describe contents and effects of status change.
z In case that requesting customers are individuals, financial instruments business
operators shall confirm whether those customers meet statutory requirements tobe treated as professional investors.
13

9. Disclosure requirements
Disclosure requirements tailored to the nature of investment instruments○Disclosure requirements, focusing on types of investment instruments

Investment
instrument

Corporate finance type instruments (stocks/bonds,
etc.）:Backed by credit value of issuer itself
Asset finance type instruments (fund/ABS, etc.):Backed by asset value held by issuer

Developing disclosure contents
and procedures tailored to eachtype of investment instruments○Disclosure requirements, focusing on the liquidityof investment instruments
Introducing statutory quarterly reporting system for listed companies○Introducing statutory quarterly reporting system○Integration of semi-annual reporting system to quarterly reporting system
Investment
instrument withhigh liquidity

Frequent and detailed
investment information
should be provided(Note) introducing disclosure requirement of non-consolidated financial statements at thesecond quarter together with consolidated quarterly reports for banks and insurancecompanies

Enhancing internal control over financial reporting○Introducing mandatory management assessment (internal control report) andauditors audit of management assessment○At the same time, introducing a mandatory certification of annual
reports (including quarterly reports and semi-annual reports) by management

Investment instruments with low
liquidity including interests ininvestment-type funds

Introducing the system of direct delivery of documents to investors instead of thesystem of public disclosure

1410. Review of Tender Offer system and large shareholdings reports
System of Tender Offer (TOB)The Main framework of the Current System
・To purchase shares beyond the threshold off markets, such as more than 1/3 shareholdings, the purchaser is required
to disclose the period, the amount, the price and etc. in advance and to offer shareholders an equal opportunity to sell.
Taking measures against transactions that are evading TOB regulations:・Clarify that it is subject to TOB regulations to rapidly increase shareholdings beyond the threshold of 1/3 by combining apurchase of the stocks off the markets and a purchase on the markets.
Providing more information to investors:
・Require further disclosure in the “registration statement” of a TOB;・Require the filing of a “position statement report” by a target company;
・Giving the opportunity for a target company to ask a questions to the tender offerors.
Extending the TOB period:
・Extend upper and lower bound of the TOB period from 20 days and 60 days to 20 business days and 60 business days;
・Allow a target company to extend the TOB period to the extent of 30 business days when necessary for shareholders totake time when considering whether to sell or not.
Expand the scope to allow withdrawal of a TOB:
・Allow withdrawal of a TOB and change in TOB conditions when the target company decides to activate takeover defenses.
Require a bidder to make a offer to buy all stocks in a certain situation:
・Require a bidder to make an offer to buy all shares when ratio of shareholdings by the bidder becomes beyond a certain
threshold of shareholding such as 2/3 to protect small shareholders from the risk of delisting of his/her shares.
Ensure impartiality between bidders:・Require a large shareholder (such as a one with more than 1/3 in shareholding) to make a TOB during the period of
another TOB made by another bidder.
System of Large Shareholdings Reports
The Main framework of the Current System
・Standard reporting requires disclosure of shareholdings in excess of 5% within five business days.
・”Special Method”reporting for professional investors requires less frequent disclosure
Amend the Special reporting system for professional investors:
・Shorten the reporting cycle and deadline under the Special reporting system to the one such as twice a month or more
and within five business days (currently once in three months and within 15 days).

15

11. Strengthening independence of self-regulatory functions of financial
instruments exchanges●Organizational structure that financial instruments exchanges in the form of stock corporation may take●Approval of the FSA is necessary for shares of an exchange to be listed.
① Establishment of independent corporation② Establishment of independent self regulatorycommittee within the organization

Exchange

Holding company
Exchange
Board of directors

Self-regulatory corporation

Exchange

Self-regulatory committee

Self-regulatory corporation

Board of directors
Authorities for deciding self-regulatory functions
・Listing or delisting of financial instruments
・Examination of state of trading participant’s compliance with
acts or regulations
・Monitoring of trading in the markets○ three or more members (a majority are outside members)
Independence○ Approval of a majority of outside members is necessary
for decision-makings○ Approval of the FSA is necessary for an exchange toentrust self-regulatory functions to self-regulatory
corporation

1612. Financial instruments firms association (Self Regulatory Organizations(SROs), etc.)● Legal basis of SROs will be integrated to the Financial Instruments and Exchange Act● Establishing equivalent functions of all the SROs in line with the current functions of the Securities Dealers Association● Establishing system of recognized investor protection association which non-SRO association may apply for todeal with settlement of complaints and dispute mediation

Current legal structure

Legal structure under Financial
Instruments and Exchange Act

Securities Dealers Association (Securities
and Exchange Act)

Authorized financial instruments firms
association

SRO

Public interest corporation-type financial
instruments firms association

Investment Trust Association (Investment
Trust and Investment Company Act)

【common functions】

Securities Investment Advisers Association(Securities Investment Advisory Act)・rule-making
・examination of the state of compliance with acts, regulations

Financial Futures Association

and rules by members(Financial Futures Trading Act)・guidance and recommendation to members
・settlement of complaints
・dispute mediation・task of registration of financial instruments firms
representatives
・spreading of knowledge, enlightening and promoting public
activities on finance

Non-SRO

Certified investor protection association

1713. Review of the regulation on sale and purchase within 6 months byfund (partnership)(duty of officer and principal shareholder)

Listed companies,
etc.

○ Reporting ： filing report to the FSA which ismade public○ Restitution of profits : sale within the 6 monthsof purchase, purchase within the 6 months ofsaleOfficer

Shareholder who has
10% or more of
voting rights（「principal
shareholder」）

The listed company may demanda surrender of profits.

（１５％）
Partnership（５％）
investor（５％）
investor（５％）
investor

Judgment of whether an investor of partnership falls under the 10% threshold
Current ：judging based on ratio of shareholding by each investor⇒ Amendment ：judging based on ratio of shareholding by partnership as a whole18

14. Enhancement of civil liability for sales of financial products
Principles on actions for damages undercivil act (section 709 of the Civil Law)

Financial Products Sales Act

Customers (sufferers) shall prove all therequirements from ① to ④ to win actions fordamages against financial firms.

The Act prescribes special treatment on actions fordamages regarding a wide-range of financial products
including deposits, insurance, securities, etc.

No fault liability offinancial firms

Duty to explain・possibility of loss
to principals② intention or negligence

Violation of
duty toexplain・risk④ damages① malfeasance

Proof of ①

③ causation

Presumption of loss asloss to principals
No need for customers
to prove requirementsfrom ② to ④

Strengthening Financial Products Sales Act● Enlarging the scope of duty to explain
・ Adding a possibility of losses beyond original principals
and important part of schemes of financial instruments inthe scope of duty to explain● Introducing prohibition of provision of conclusive judgment
・ no fault liability and presumption of loss in case of theviolation

19

15. Expansion of the scope of penalties against “misegyoku”【“Misegyoku”】● Trading orders with intension of canceling immediately● Need for effective penalties in cases that “misegyoku” leads to market manipulation【Penalties】
criminal penalty

administrative monetary
penaltycustomers

○

× → ○

financial instruments
firms(self-dealing)

× → ○

× → ○

(Note)

indicates expansion of penalties under the bills.

2016. Increase in maximum criminal penalty
Prohibited unfair trading
Current maximum criminal penalty

Acts of violations
z general unfair tradingz spreading of rumorsz resorting to deceptive devices
z market manipulation

Imprisonment
Fine
Imprisonmentz insider trading

Fine

To be amended

5 years

10 years【individual】 ¥ 5 million【corporations】 ¥ 500 million¥ 10 million¥ 700 million

3 years

5 years【individual】 ¥ 3 million【corporations】 ¥ 300 million¥ 5 million¥ 500 million

Violation of disclosure requirements
Current maximum criminal penalty

Acts of violations
z submission of false registration

To be amended

Imprisonment

5 years

10 yearsFine【individual】 ¥ 5 million【corporations】 ¥ 500 million¥ 10 million¥ 700 million

statements, securities report, tender
offer statement, large shareholding
report, and the othersz submission of false large shareholding
report and the others

Imprisonment

3 years

5 yearsFine【individual】 ¥ 3 million【corporations】 ¥ 300 million¥ 5 million¥ 500 million

z submission of false quarterly report

Imprisonment
Finestatement, false securities report(annual report), false tender offer
statement and the othersz non-submission of registrationand internal control report【individual】【corporations】-

5 years¥ 5 million¥ 500 million

21