Bubble Trouble - Thomson Reuters

SPECIAL REPORT | DECEMBER 2011
MOMENT OF TRUTH:
The independent
panel which included
former supreme court
judge Tatsuo Kainaka,
urged legal action
against “rotten”
Olympus executives
behind the cover-up.
Olympus wanted $1.7 billion in financial market losses from Japan’s
bubble days to fly away. Instead they came home to roost
BY NATHAN LAYNE, TARO FUSE and JAMES POMFRET
Tokyo/Hong Kong • Dec 16
REUTERS/KIM KYUNG HOON
Bubble Trouble
A
kio Nakagawa, a 60-yearold semi-retired Japanese
banker, had seemingly
vanished.
Nakagawa was at the
center of one of corporate
Japan’s biggest scandals: the decadeslong cover-up of losses at Olympus Corp.
Japanese and U.S. investigators wanted
to quiz him about the record $687 million
advisory fee his firms had received on a single
deal from the famed maker of cameras and
endoscopes.
When a reporter tracked him down in
Hong Kong on a recent Sunday afternoon, he
was in no mood to talk.
“Get out of here. Get out of here,”
Nakagawa yelled in English to the concierge
staff as he waited for an elevator to his
$13,000-a-month serviced apartment. “I
don’t want him here.”
Until Nakagawa and other key players
talk, many unanswered mysteries will
remain in the $1.7 billion accounting fraud
at Olympus. Two in-house architects of the
cover-up resigned and have yet to speak.
The whereabouts of Nakagawa’s partner at a
boutique investment firm is unknown.
BUBBLE BLOWBACK
Briton Michael Woodford, who briefly
served as Olympus CEO until being sacked
this autumn after blowing the whistle on
suspicious acquisitions, suggested Japanese
yakuza gangsters may have been involved.
No such links have yet been established —
or ruled out. It’s unclear how many people
inside and outside Olympus knew of the
irregularities.
And no one has been able to pin down
how much, if any, of the $1.7 billion was
stolen. An independent panel appointed by
Olympus reported this month it was mainly
used to hide investment losses dating
back a generation, though that probe’s
thoroughness has been called into question.
The case is in part a tale of blowback
from the collapse of Japan’s 1980s bubble
economy. The panel’s report, and separate
interviews with more than a dozen people
familiar with what happened, shed fresh
light on how a secretive corporate culture
sustained, and was ultimately undone by, a
decades-long coverup.
At its center were an inner circle of
Olympus executives who sought to delay
the reckoning from mistakes that Olympus,
OLYMPUS
like many companies, made in that seminal
era of Japan’s economic history. They were
aided by a coterie of aggressive bankers who
promised to buy them time.
Three of the most important of these
men, including Nakagawa, had cut their
teeth at Nomura Securities, Japan’s top
brokerage and lord of the bubble era.
Nakagawa left Nomura for a series of western
investment banks where he specialized
in “zaitech,” or financial engineering, the
bubble-era practice of playing the markets
by manufacturing firms. And when the
bubble crashed he and his partner, Hajime
“Jim” Sagawa, practiced the art of “tobashi,”
accounting maneuvers that would make
problems “fly away” off balance sheets and
into overseas funds and shell companies.
Nakagawa has not responded to
repeated attempts for an interview. Neither
has Sagawa, now 64. At his waterfront
Manufacturing exporters, the engine
of the Japanese economic miracle, proved
a harder sell. Why would a company like
Olympus, established in 1919, the world’s
biggest maker of endoscopes and a top
producer of cameras, want to tie its fate to
the mercurial financial markets?
That mindset changed after the Plaza
Accord in September 1985, when major
industrial powers agreed to devalue the
dollar. The yen sharply appreciated, gutting
Japanese corporate profits. Operating profit
at Olympus in fiscal year 1986 halved and
the company sold property to support its
bottom line.
Suddenly the idea of using “zaitech,” or
financial engineering to pad earnings made
sense to Toshiro Shimoyama, then president
of Olympus.
“Until last year, I was against zaitech
but conditions have changed,” he told
Somehow we have to make up for
this yen strength through non-operating
income or our numbers will only worsen.
We can no longer sit here and dismiss
zaitech as an evil thing.
— TOSHIRO SHIMOYAMA
Olympus president, 1984–1993
home in Boca Raton, Fla., last month,
Sagawa’s wife Ellen said: “My husband was
on Wall Street for many years and was wellrespected. My husband is clean as a whistle,
I assure you.”
HIGH TECH TO ZAITECH
As the Nikkei stock average roared to new
heights in the 1980s, investment bankers
gained riches and new respect in Japanese
society. They exerted increasing influence
over corporate clients, relationships
cemented at upscale bars and hostess
clubs in Tokyo with thousand-dollar bottles
of champagne and gold-dusted chocolate
mousse deserts.
Brokers found willing customers in
dying industries such as basic chemicals
and textiles, persuading them better returns
could be had investing in stocks or bonds
than in core operations.
Nikkei industrial daily in November 1986.
“Somehow we have to make up for this yen
strength through non-operating income or
our numbers will only worsen. We can no
longer dismiss zaitech as an evil thing.”
Hideo Yamada, a rising star in the
Olympus finance department, and his
understudy, Hisashi Mori soon began
pouring money into riskier securities, such
as structured bonds composed of interest
and currency swaps, according to the panel’s
230-page report.
Nakagawa had already won over
Olympus as a client by 1988 when he joined
Drexel Burnham Lambert, before the firm
went under after illegal activities in the junk
bond market. He had honed his skills as a
salesman during prior stints at Merrill Lynch
and E.F. Hutton.
“Nakagawa was a genius when it
came to persuading people in the finance
2
department,” said an ex-colleague. “He
convinced them it was the job of a finance
department to create more money by
investing the company’s funds, and told
them they should do that aggressively
because it was their core business.”
LOST DECADE
The Nikkei average peaked on the final
trading day of 1989 and promptly went
into a tailspin, losing nearly 40 percent the
following year, crushing stock portfolios
across the corporate sector.
An indication something had gone awry
in Olympus came in July 1991, when it figured
prominently on a list of companies receiving
compensation from Yamaichi Securities,
its main broker, to cover 1.2 billion yen in
stock trading losses. The scandal rattled the
brokerage industry and led to a ban on such
reimbursement schemes, because they were
only given to large and favoured clients.
But shuffling bad assets off balance
sheets was still within the rules. Yamada
and Mori doubled down on Olympus’ bets
with investments in riskier securities, the
panel report says, while moving loss-making
investments to affiliates and offshore funds
in tobashi schemes, bankers familiar with the
matter said.
Among their investments were high-risk
instruments that paid interest up front but
required the buyer to pay the interest back
if the bonds were in the red at maturity,
exacerbating the loss, according to the
panel’s report.
Olympus was also one of several
Japanese firms that bought high-yielding
notes from an affiliate of a foreign-owned
firm called Princeton Economics. Those notes
later proved worthless, dealing Olympus and
others huge losses in what prosecutors years
later would call a giant Ponzi scheme.
Yamada and Mori could not be reached
for comment through Olympus.
Masatoshi Kishimoto, who took over as
president in 1993, knew of the loss-covering
activities, the Olympus panel concluded this
month, but did nothing to stop it. Kishimoto
could not be reached for comment.
FOREIGN BANKS ROLE
By the mid-1990s the losses had grown
to tens of billions of yen, threatening the
financial health of the firm. To hide the
deficit, Olympus turned to foreign banks,
more versed in structuring deals involving
offshore funds.
“It was a really lucrative business,” said
a former executive at a Western investment
bank in Tokyo, speaking about tobashi
transactions. “You could get 20 to 30 percent
of the amount of losses being shuffled off the
balance sheet as commission.”
Enter Credit Suisse First Boston. It signed
a contract with Olympus in January 1992
to shift losses into a money trust with a
principal value of 14.7 billion yen, according
to a client list provided to the financial
regulator and seen by Reuters. It was similar
to other tobashi schemes: bad securities
were sold at book value to a trust off
Olympus’ balance sheet, thus disguising the
true nature of the consolidated accounts.
A spokesman for Credit Suisse in Tokyo
declined to comment.
By then, Nakagawa had joined
PaineWebber in Tokyo, in charge of
equities and involved in the Olympus
account, working with Sagawa. The two
had worked at Drexel in the 1980s before
Sagawa was named a managing partner at
PaineWebber, according to a 1991 profile in
Securities Week.
INVENTING ASSETS
Executives of managing director class and
above from all departments at PaineWebber
would meet regularly to come up with
solutions for clients pummeled by the
A TROUBLING PAST
Olympus’s woes trace back to the 1980s when it started making risky investments to pad its earnings and the 1990s when
it made use of tobashi schemes to shuffle securities losses off its books
6000
Share price – yen
5000
Nov 1986
Olympus President
Shimoyama tells a
newspaper the firm
would use zaitech
(financial engineering)
to boost earnings and
soften the blow of the
strong yen.
4000
3000
2000
Jan 1992
Olympus signs
contract with
Credit Suisse First
Boston for tobashi1
scheme to cover up
securities losses.
Mar 1997
Olympus holds 2.9 bln
yen worth of Princeton
bonds on its books. These
bonds were bought by
many Japanese firms
to cover losses by
exchanging a portfolio of
problem assets for bonds
at book value.
Oct 2011
Olympus fires CEO
Michael Woodford
and admits to
using M&A deals3
to hide losses
for decades.
Jan 2000 – Mar 2011
Olympus made several dubious acquisitions3 during this
period to hide securities losses dating back 20 years.
1000
0
May 2000
Olympus posts a net
profit of 1.8 bln yen for
FY2000 (-80% y/y),
citing 17 bln yen in
special charges to
write-off investments
in tokkin2 funds.
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010 '11
Tobashi = a practice prevalent in Japan in the 1990s where bankers help companies temporarily shuffle securities losses off its books; 2tokkin = a type of short-term investment fund;
Deals include Gyrus ($2.2 bln), ITX ($780 mln), Altis, Humalabo and News Chef ($773 mln), and Stryker ($60 mln).
*Source: Thomson Reuters.
1
3
OLYMPUS
3
bubble’s collapse, according to a person who
worked at the firm.
Nakagawa helped devise a scheme using
Bermuda-based vehicles to “invent” assets
and disguise securities losses that at one
point reached 84 billion yen, according to an
ex-colleague who showed documents of the
transactions.
Olympus made sure its bankers knew
they were appreciated. Late one December
a large cardboard box filled with 50 cameras
arrived at the PaineWebber office, a year-end
gift for the staff, said a former assistant at
the firm.
PaineWebber shut down its Japanese
equity business in 1996, partly due to
growing unease within the bank about its
role in helping Japanese firms manage their
balance sheets, the ex-colleague said.
After a two-decade career at some of the
world’s biggest investment banks, Nakagawa
for the first time struck out on his own. He
formed Axes (Japan) Securities in 1998 as
the Japanese arm of a business called Axes
Group. His long-time friend, Sagawa, had set
up Axes America the year before.
THE COVER-UP
Tobashi transactions and other debts
triggered the collapse of Yamaichi Securities
in November of 1997. It was a near cataclysmic
event for the economy and markets, already
rattled by the Asian financial crisis.
Japan’s financial regulator finally
outlawed tobashi schemes in 2000. That
same year, Japan introduced new markto-market accounting rules, requiring
companies to account for securities at market
value instead of at their purchase price.
Olympus by then was staring at a 100
billion yen hole in its balance sheet, the panel
report says, and so turned to an even-more
complex tobashi solution. The company
began working with Nakagawa, Sagawa and
Nobumasa Yokoo.
Yokoo’s ties with Olympus and its
portfolio manager, Yamada, stretched back
to his days at Nomura Securities in the 1980s,
the panel report says.
At Nomura, where he was in charge of
Olympus’ account, he built a reputation for
devising financial stratagems for clients
before leaving in 1998 to set up his own
consulting firm, Global Company, a person
familiar with the matter said.
“Yokoo was an incredible salesman,”
said Shuhei Abe, a former Nomura banker
OLYMPUS
who now heads hedge fund Sparx Asset
Management.
Yokoo, Nakagawa and Sagawa helped
Olympus craft what the panel called a “loss
separation scheme” comprising various
funds and bank accounts to get impaired
securities off its balance sheet and out of the
view of regulators, the panel report says.
It was built on three funding routes: a
bank account in Lichtenstein, another in
Singapore and investment funds in Japan.
All three worked on the same principle:
the anchor provided financing to “receiver
funds,” which bought bad assets from
Olympus at book value and removed them
from the Olympus balance sheet.
The three men also provided Mori and
Yamada with important introductions. Yokoo
set them up with people at LGT Bank in
Lichtenstein, for instance, where they created
an account for “secret M&A” using cash and
Japanese government bonds as collateral,
the report says. In an email statement,
LGT said it cooperated with the panel but
declined further comment.
Having hived off the losses to offshore
vehicles, Olympus set out to find companies
to buy. The idea was to put large values on
the acquisitions, circulate the money spent
on them back to the receiver funds and close
out the accounting loop, the report says.
VENTURE CAPITAL FUND
In March 2000 Olympus invested 30 billion
yen into a venture capital fund run by Yokoo
called G.C. New Vision Ventures L.P. One
INSIDER
Olympus was ‘stuffy’, lacked oversight
Interview with Olympus ex-director Koji Miyata
http://r.reuters.com/faz45s
MORE...
Click link below to launch video
Olympus whistleblower: I can fix it
Interview with Olympus ex-CEO Michael Woodford
http://r.reuters.com/mut55s
of his first targets was ITX, a technology
incubator. G.C. New Vision invested 2.3 billion
yen in ITX ahead of a planned initial public
offering of ITX shares. ITX was meant to reap
profits for Olympus as a central vehicle in the
loss-covering scheme. That plan backfired
when the IPO flopped in 2001, the panel
report says. But Olympus eventually bought
all the ITX shares for at least 60 billion yen.
Yokoo’s older brother, Akinobu, was
ITX CFO at the time,and would later rise
to ITX CEO and a senior post at Olympus in
2005. Akinobu, now president of an aviation
equipment firm, saw no conflict of interest
because he didn’t know his younger brother
was behind the fund.
“This doesn’t have anything to do with
me,” Akinobu told Reuters, adding that he
didn’t think his younger brother had done
anything wrong. He said Nobumasa was
likely in Japan but he didn’t know exactly
where he was.
THREE OBSCURE FIRMS
Between 2003 and 2005, G.C. New Vision
found the three obscure, loss-making
Japanese firms into which Olympus would
eventually invest $773 million: medical waste
recycler Altis, cookingware maker News
Chef and health food firm Humalabo. It then
quickly wrote down the investments.
Yamada and Mori had by then risen to the
executive suite at Olympus. They needed one
more big deal to finish off hiding the bubbleera losses, which had only grown, the panel
report says.
Olympus was coming off a strong
year financially in 2004 with a 63 billion
yen operating profit. The president then,
Tsuyoshi Kikukawa, had declared a strategy
of acquisitions to grow the firm. He was
also aware of the loss-covering plan before
assuming the top job in 2001, the panel
report said.
“We have plenty of money. But if there
is a big target that requires more there are
various ways to procure funding,” Kikukawa
told Reuters in March 2005. “The most
important thing is finding the target then you
can worry about funding, not the other way
around.”
Olympus announced a “big target” in
November 2007 — the $2.2 billion acquisition
of British medical device maker Gyrus. The
bill for Gyrus would be far more expensive,
however. Nakagawa and Sagawa’s firms
were given a $687 million advisory fee for
4
THE PROTAGANISTS
According to the third-party panel report, Nobumasa Yokoo, Akio Nakagawa and Hajime Sagawa helped Olympus craft
several “loss separation” schemes to get impaired securities off its balance sheet and out of the view of regulators
Firm acquired by Olympus
M&A advising firms
Funds/investment firms
Brothers
Akinobu Yokoo
Helped broker
acquisition of Altis,
Humalabo and News
Chef for $773 mln
Nobumasa Yokoo
Former
chief
ITX
GLOBAL
COMPANY
Head
Purchased for $780 mln
(2000 – 2011)
OLYMPUS
Paid $687 mln* in
adviser fees for Gyrus deal
(2006 – 2010)
AXAM
Transferred
Gyrus
shares
Minority
shareholder
SKY WARD
Director
Shareholder
PROMOTECH
Shigenori Komuro
Shareholder
Former
President
AXES
Takuya Ichimura
Placed
orders for
Japanese
stocks
Founder
GENESIS
Founder
Owner
Director
CARIBBEAN
PROPERTIES
Founder
Director
Japanese
arm
President
Akio Nakagawa
President
AXES JP
Were also colleagues at
Drexel Burnham Lambert
and PaineWebber
Hajime Sagawa
*Includes $17 mln in fees to AXES.
ANATOMY OF A TOBASHI SCHEME
In the 1990s, bankers often used tobashi schemes to help Japanese firms temporarily shift losses off their books
STEP 1
Company buys a financial instrument X for
$100 but the value of X falls to $50. The firm
suffers an unrealised loss of $50.
$100
STEP 2
To hide its losses, the company shifts the bad
asset X (now valued at $50) and the unrealised
loss ($50) to a fund.
STEP 3
The fund transfers another asset representing
the book value of X ($100) back to the firm, to
temporarily disguise the $50 unrealised loss.
+
$100
$100
$50
Book value
Market price
$50
Unrealised loss
COMPANY
FUND
COMPANY
FUND
Sources: Olympus, Thomson Reuters.
OLYMPUS
5
CEO TURNS WHISTLE-BLOWER
The oddities on Olympus’ books were turned
up by a little known investigative magazine
called Facta. It raised questions in a July
article about the acquisitions of Altis, News
Chef, and Humalabo, and highlighted the
hefty premium Olympus paid for Gyrus.
Woodford, a 51-year-old Briton and newly
minted president of Olympus, requested
a lunch meeting with Chairman Kikukawa
and Vice President Mori in August to ask
them about those allegations. The meeting
was “good humored”, Woodford recalled in
a recent interview, until he produced a copy
of the Facta article, and “the mood changed
markedly”.
Kikukawa told him he had decided
Woodford should not be told about the
allegations because Woodford was “too
busy” dealing with other matters. “You’re
the president,” Woodford says Kikukawa told
him. “I told people not to tell you.”
Woodford wrote six letters to Mori and
Kikukawa in the ensuing weeks demanding
answers about the transactions, while
commissioning PriceWaterhouseCoopers to
investigate. On Oct. 14 he was dismissed by
the Olympus board.
Days later, Olympus admitted it had paid
the exorbitant advisory fee and overpaid for
three acquisitions, and said it would set up
an independent panel to probe the scandal.
With the FBI sniffing around the case,
Chairman Kikukawa quit on Oct 26.
Kikukawa, Mori and Yamada are now
awaiting possible criminal charges.
NICE OLD MAN
Before the scandal
broke,
Nakagawa
REUTERS/TORU HANAI
brokering the deal — a fee about 30 times the
industry norm.
In fact, they pocketed much less, about
3.5 billion yen, according to panel head
Tatsuo Kainaka. The rest was used to help
close out the receiver funds, which was finally
completed with a 31.5 billion yen payment
to Olympus in March 2011 from a Caymanbased vehicle called SG Bond Plus Fund.
WHITE KNIGHT: Michael Woodford, Olympus’s former CEO, said investors are flocking to meet him and
are willing to back his campaign to regain control of the disgraced endoscope maker.
was living a quiet life, said a person with
knowledge of his business and personal life
in Hong Kong. There he is registered as a
shareholder in an outfit called PromoTech
Investment Limited along with an old
colleague from Axes Japan.
Nakagawa had been taking extra
care of his health following surgery for an
aneurysm a few years ago, the person said.
His routine included hiking in the hills after
work and lots of sushi, often at the Nadaman
Japanese restaurant near the Pacific Place
condominium where a reporter found him.
“He was half-retired,” the person said.
“He was a nice old man.”
And he remains out of the public eye. A
Reuters reporter who re-visited his apartment
last week was blocked by a concierge. “He’s
not here anymore,” the concierge said. “He’s
already left.”
BILL TARRANT
ENTERPRISE EDITOR
william.tarrant@thomsonreuters.com
NATHAN LAYNE
FINANCIAL SERVICES CORRESPONDENT
nathan.layne@thomsonreuters.com
James Pomfret reported from Hong Kong;
additional reporting by Emi Emoto, Tim Kelly,
Reiji Murai, Maki Shiraki, Yuko Kubota and
Chikafumi Hodo in Tokyo; Kevin Gray in Miami
and Kirstin Ridley in London. Editing by Bill
Tarrant and Mike Williams.
FOR MORE INFORMATION
MICHAEL WILLIAMS
GLOBAL ENTERPRISE EDITOR
michael.j.williams@thomsonreuters.com
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