A fall from grace

Never before has a home-grown Japanese entrepreneur fallen so far and so fast as Takafumi Horie, chief of the Livedoor empire. Julian Ryall reviews the case and asks whether Japan Inc should now expect tougher financial regulatory controls as a result of the scandal

Six months ago, Takafumi Horie bestrode Japan’s business world, his empire encompassing interests as diverse as a used car dealership, energy drinks and an on-line travel agency, but all rooted in his purchase of internet service provider Livedoor in November 2002.

Released on bail from the Tokyo Detention Centre on 27 April, 33-year-old Horie cut a very different figure. Visibly thinner after four months behind bars, he is likely to spend the next couple of years fighting through the courts to clear his name of accounting fraud and securities law violations. The first date ringed in his diary was 26 May, when four of his closest confidantes at Livedoor were due to appear before the Tokyo District Court.

The hearing, as well as those for Horie, who is being tried separately as he intends to plead not guilty, will inevitably hold the attention of an industry that has found itself in the firing line from both the media and the public, fielding accusations of being at least negligent and, at worst, collusive.

“We have to respond to the public’s expectations and rebuild their confidence in the accounting profession,” said Tsuguoki Fujinuma, chairman and President of the Japan Institute of Certified Public Accountants (JICPA). “We are aware that the public is watching how we respond to this matter and, while we have already taken many steps, they still expect more from us.”

Horie was arrested on 23 January, and has been charged with falsification of Livedoor’s financial report for the year to 30 September 2004, by conspiring to add ¥5.34bn (£25.55m) in sales to the firm’s consolidated earnings results. Consequently, instead of a pretax profit of ¥5.03bn (£24.07m) in the reporting period, the company actually had a pretax loss of ¥312.78m (£1.50m).

At their peak, individual Livedoor stocks were valued at ¥800 (£3.83); they were delisted from the Tokyo Stock Exchange on 14 April after sinking to ¥94 (45p).

“The Livedoor case is quite unique and we believe that, first and foremost, it was a case of market manipulation followed by the financial scandal,” said Fujinuma. “They apparently used a series of techniques such as stock-splits, share takeovers and investment funds, to conceal merger and acquisition transactions, and while individually these procedures may not break any laws, prosecutors say that, combined, they were illegal.

“Horie was a man driven by his ambitions who was great in finding loopholes in the capital market rules.”

The chicanery has also revealed some serious flaws in accountancy standards in Japan, he admits. “Even before the Livedoor case, we received a lot of enquiries from our members concerning the use of special purpose entities - such as those that Enron Corp set up in the US in that case - because they are new here and they did not know how to handle them,” he said. “We asked the Accounting Standards Board of Japan to set detailed standards, but they are still working on them.”

A first tranche of rules is expected at any time, while regulations on more complicated issues are due out within the next 12 months.

Many people are also questioning auditors’ independence from their clients’ management, Fujinuma agrees, so one immediate self-regulatory step that the JICPA introduced in April is adopting the US approach to rotating audit partners by reducing the rotation period from seven years to five years.

In addition, the institute is stepping up its quality control campaign by obliging members to undergo a minimum of 40 hours of education a year. Prior to April, two hours of the total was dedicated to ethics, but that has now been doubled to four hours each year. Inspections are also being stepped up of the JICPA’s 440 member audit firms, with Japan’s Big Four outfits, which audit 80% of public companies, being examined every two years and the remainder every three years. Plans are also under way for a training centre for listed auditing firms, and companies that are negligent in a case such as Livedoor will, in the future, not be able to hide behind privacy regulations and will be identified.

Deliberation

At the government level, the Financial Services Agency (FSA) on 26 April set up a CPA system deliberation group to examine the causes and effects of the Livedoor and other scandals, with the intention of strengthening regulations and amending the relevant laws, although Fujinuma points out that existing legislation, some of which is based on Sarbanes-Oxley, is already reflected in the revised CPA law, such as rules concerning the independence of auditors.

Others, however, are far less convinced that the authorities have all the bases covered. “I’ve seen a lot of politicians, auditors and the FSA all saying that they will ‘strengthen the system’, adopt US standards, appoint independent regulators, but, frankly, if you believe half the things they claim then Japan would be as regulated as the US, and I see absolutely no signs of that happening,” said a regulatory law expert at the Tokyo offices of an international legal firm.

The entire Livedoor saga has never been a regulatory issue, he believes. It is all politics. That belief is borne out by the fact that the original raid of Livedoor’s headquarters was carried out by the police, as opposed to the FSA; also, the fact that the media had been tipped off well in advance and were waiting with lenses poised for the fall of an entrepreneur that many more traditional businessmen considered a maverick and a threat to Japan Inc.

He probably made things even worse for himself by taking on Shizuka Kamei, one of the “Old Guard” in Japan’s ruling Liberal Democratic Party, who was blocking Prime Minister Junichiro Koizumi’s structural reform efforts in last year’s general elections. Kamei, by coincidence, was a senior member of the National Police Agency before entering politics, and has called on the Government to resign for backing a criminal, if it is proved that Horie was involved in any wrong-doing.

But the scale of Horie’s alleged crimes is also raising eyebrows. “Everyone thought this was going to be the next Enron but, now the dust has settled, it looks to be a long way short of that,” said the same lawyer. “I suspect it involved some technical infringements of the rules, but it’s not a huge financial scandal. There is another agenda behind this.”

In comparison with the arrest of four accountants of the Japanese affiliate of PricewaterhouseCoopers for collaborating with officials of Kanebo to produce false consolidated financial statements for 2001 and 2002, the Livedoor affair is “pretty small beer”, he said. “Are we going to see great swathes of new legislation? If I was a betting man, I’d say no,” he said. “And how long would it take to achieve that even if they did go through with it? They could study legislation in the US and Europe, and take the bits they like to cobble something together, but I am not at all convinced there is the political will to go through with it.”

Which begs the question: which company will be making the headlines next for all the wrong accounting reasons?

Julian Ryall is a freelance journalist who has lived in Japan for 13 years, covering business, politics and social issues.