Brokerage scandal puts Japanese stocks scene in the dock

There is little, at this point, that can be called predictable about the scandal that has engulfed Japanese domestic brokerage giant, SMBC Nikko – a company that authorities have turned from slave wolf to the sacrificial lamb within a few weeks.

Two executives have been arrested, five staff members are behind bars and the number of people named by prosecutors in connection with market manipulation allegations continues to climb. Extrapolate just a little about the frequency of SMBC Nikko block trading activity under scrutiny, and the entire Japanese equities scene is, to some extent, in the dock.

What can be anticipated with some confidence is Japan’s mortified pearl embrace once the trial process has ushered the country into the daily banter of a Tokyo stock court.

One of the many problems for SMBC Nikko, which has been the subject of a combination of unrestricted regulatory and criminal investigations for a year now, is that prosecutors appear to be sitting on an unusually deep archive of documents.

These are things that, with minimal effort on the part of prosecutors and regardless of whether they actually prove guilt, will seem damning when read aloud in court. According to people familiar with the situation, prosecutors not only have a number of vaguely worded emails that have flown between traders and their bosses, but, following steps taken by the bank to continue trading at height of the pandemic (an always-on phone line between offices), rare hours of audio from the floor itself.

No one in any industry can appreciate having their internal communications stripped bare. Even in relatively soft trades, the professional cant has a callous, transactional edge that inevitably looks terrible out of context. The merchant cat, which can take on a pirate tone, travels particularly badly beyond its habitat, especially into the hands of those who aim to show that it is always the little one who gets hurt.

The tongue is steeped in adrenaline, partly because it’s a game ruled by greed and partly because the nature of the environment demands, in the minds of many participants, a certain bravado.

According to accounts by former SMBC Nikko staff, the material now in the hands of prosecutors was nothing out of the ordinary – exactly what one would expect from what was, before the imbroglio, a hall of very profitable markets, convinced that she had earned her swagger. .

At the heart of the criminal charges against SMBC Nikko and those arrested is the allegation that the bank’s proprietary trading desk was strategically buying shares that were being sold by corporate clients in large off-market block trades. . Prosecutors allege that these price-boosting transactions were undertaken to prevent lucrative bulk trade deals from collapsing if the price fell too low. Four of the five people arrested so far maintain their innocence and, according to legal experts, are likely to argue that simply buying stocks on the open market does not cross the price-fixing line.

That will be up to lawyers to discuss and the outcome will have significant implications for the future of block trading in Japan – particularly by brokerages such as SMBC Nikko, attached to one of the megabanks and with close ties to the Japanese companies. The risk for defendants in the court of public opinion, however, is that even the most rigidly compliant trading floor – with their perpetual one-upmanship – can easily sound to outside ears like a den of conspirators.

The inevitable public shock may be exactly what prosecutors and regulators are hoping for. SMBC Nikko’s stock trading floor is described by those who still populate it as a place of mourning. Customers have severed their relationships; friends and bosses are behind bars; internal pep talks from senior management will continue to ring hollow until the arrests actually stop.

This state of affairs is no coincidence. On many levels, authorities seem determined to make an example of this particular national brokerage, perhaps because they suspect it was happening elsewhere and may represent, in their minds, the easiest way to solve a problem. wider. By bringing charges against a wide range of SMBC Nikko bankers, from board members to relatively junior staff, the financial regulator and prosecutors are implying systemic error and anticipating any “bad apples” excuse from the bank as a whole .

There is a longer game being played here. Prosecutors seem to have valuable cards to play and can rightly gauge the public’s appetite for titillating revelations of unsupervised trader gossip.

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