By Emi Takeda

This English newsletter is a translation of the original Japanese-language newsletter dated November 29, 2006. Subsequent to November 29, 2006, the Japanese government published the final orders related to the amended substantial shareholding reporting rules. The amendments related to "significant proposals" described in Part 1(2) below took effect on December 13, 2006. The rest of the amendments discussed in this newsletter took effect as of January 1, 2007 except for the amendments regarding mandatory filing through EDINET, which are scheduled to come into effect on April 1, 2007. Although the discussion in this newsletter is based on the September 13, 2006 drafts of those orders, there are no differences between those drafts and the final orders that would materially affect the discussion in this newsletter.

Background to the Revisions

This newsletter explains the revisions to the substantial shareholding reporting system under the Securities and Exchange Law of Japan.

Japan's substantial shareholding reporting system requires a person or entity to file (a) a Substantial Shareholding Report if it becomes a beneficial holder of more than 5% of the shares or other equity securities of a listed company or certain other entities and (b) an Amendment Report if, after filing a Substantial Shareholding Report, its shareholding percentage in the entity covered by such Report increases or decreases by 1% or more or there is a material change to any other entry in such Report. This system was put in place in 1990 with the aim of protecting investors and making the market more transparent by providing investors with timely information on substantial shareholdings of specific shares.

Recently, however, there has been an increase in cases of investors acquiring large percentages of shares or other equity securities of listed companies in a short time period, raising questions about the current substantial shareholding reporting system. There have also been increased calls for more timely and accurate disclosure of shareholding percentages through Substantial Shareholding Reports in connection with so-called hostile takeovers.

In response to these concerns, the substantial shareholding reporting system has been reviewed in the form of revisions to Chapter 2-3 of the current Securities and Exchange Law, which revisions are set out in Article 2 of the Law for Partial Amendments to the Securities and Exchange Law (enacted on June 7, 2006, and promulgated on June 14, 2006) and other laws and ordinances.

Summary of the Revisions

1. Revisions Concerning the Preferential Reporting System

Under the substantial shareholding reporting system, in general, a person or entity must file (a) a Substantial Shareholding Report within five business days of the day its shareholding percentage of a listed company exceeds 5% and (b) an Amendment Report within five business days of the day there is a change in any of certain specified material entries in its Substantial Shareholding Report (the "general reporting system"). There is, however, a preferential reporting system in place available for securities companies, banks, and other entities designated by Cabinet Office Ordinance that trade securities on an ongoing and regular basis as part of their daily business activities ("Institutional Investors").1 This preferential reporting system reduces the required frequency and timing of the filing of reports by Institutional Investors to ensure the substantial shareholding reporting system does not place an excessive administrative burden on Institutional Investors (Article 27-26 of the current Securities and Exchange Law).2

There have, however, recently been calls for a review of how the preferential reporting system functions. The system has been criticized as being vulnerable to abuse, for example, by investment funds and other entities that actively exercise their voting rights or intervene in the business activities of companies in which they have invested while still enjoying the advantages of the preferential reporting system.

Others have countered that, in addition to creating greater administrative burdens for Institutional Investors,3 increasing reporting requirements may cause the investment activities of Institutional Investors to become too open, creating a risk of speculative investments by other investors (including non-Institutional Investors) based on information disclosed in such reports, which may cause foreign Institutional Investors to avoid the Japanese market.

Based on these arguments, the following revisions have been made.

(1) Increased reporting and shorter reporting periods under the preferential reporting system.

Once these revisions take effect, Institutional Investors will be required to file Substantial Shareholding Reports under the preferential reporting system within a period of five business days roughly every two weeks (Paragraphs (1) through (3) of Article 27-26 of the amended Securities and Exchange Law). Institutional Investors using the preferential reporting system will therefore need to file reports twice a month (sometimes three times a month) instead of once every three months, as was required before the amendment.

It is important to note that, in order to enjoy the advantage of the preferential reporting system under the amended Securities and Exchange Law, an Institutional Investor is also required to give advance notice of its reporting dates.4

(2) Clarifying shareholdings that are not subject to the preferential reporting system.

Under the current law, an Institutional Investor that holds shares or other equity securities for the purpose of "controlling the business activities of the issuing company" must file reports under the general reporting system. This language is intended to prevent the preferential reporting system from being used in a manner that subverts the intent of the system. In order to further clarify the scope of shareholdings for which the preferential reporting system is not available, the relevant language of the Securities and Exchange Law will be amended to provide that shareholding may not be for the purpose of proposing "any act as stipulated by Enforcement Order that significantly changes or has a material effect on the business activities of the company (a significant proposal)5 " in order to qualify for using the preferential reporting system for such shares (Article 27-26(1) of the amended Securities and Exchange Law).

If an Institutional Investor makes a significant proposal within a certain period6 from the day that its shareholding percentage of another company exceeds 5% or from the day that its shareholding percentage as set out in its most recent report increases by 1% or more, it will be required to file a Substantial Shareholding Report or an Amendment Report by no later than five business days prior to making of such proposal (Paragraphs (4) and (5) of Article 27-26 of the amended Securities and Exchange Law).7

(3) Reporting if an entity's shareholding percentage drops below 10%.

Under the current law, even an Institutional Investor must file a report under the general reporting system within five business days of its shareholding percentage of a company exceeding 10%, but it only needs to file a report under the preferential reporting system, not the general reporting system, if it conducts a transaction resulting in its shareholding percentage falling below 10%. In order to ensure greater transparency for investors, once these revisions take effect, an Institutional Investor will be required to file a report under the general reporting system rather than the preferential reporting system if its shareholding percentage falls below 10% (Article 27-26(2)(iii) of the amended Securities and Exchange Law, Article 12 of the Proposed Substantial Shareholding Reporting Ordinance).

2. Required Electronic Filing of Substantial Shareholding Reports.

Under the current Securities and Exchange Law, a person or entity must, in principle, file its disclosure documents through EDINET (an electronic disclosure system), but it has been possible to file paper Substantial Shareholding Reports because it is possible for an individual to be required to file a Substantial Shareholding Report. However, given that an individual who is required to file a Substantial Shareholding Report must have considerable funds and other assets to hold over 5% of the total outstanding shares of a listed company, the revisions will require Substantial Shareholding Reports to also be filed electronically through EDINET with the aim of improving stock market efficiency (Article 27-30-2 of the amended Securities and Exchange Law).

To file documents through EDINET, an entity must register in advance. In practice, it normally takes about two to three weeks to complete the registration procedures that are necessary to file through EDINET, including preparation of necessary documentation.

3. Expansion of the Scope of Securities Subject to the Substantial Shareholding Reporting System.

Investment units issued by listed investment corporations (such as REITs) can be viewed as securities that, like shares, have voting rights and correlate to control over the investment corporation. For this reason, investment units issued by listed investment corporations became subject to the substantial shareholding reporting system.＊

4. Other Revisions.

Prior to the revisions, if more than one person or entity jointly held shares included in the calculation of a shareholding percentage to determine if an entity was required to file a Substantial Shareholding Report, it was possible for such jointly held shares to count towards the shareholding percentages of both of the joint shareholders. The revisions, however, provide that jointly held shares that are calculated for both joint shareholders will be rationalized by being excluded from the calculation of each entity's shareholding percentage (Article 27-23(4) of the amended Securities and Exchange Law).

From the perspective of more thorough disclosure under the substantial shareholding reporting system, the revisions will also explicitly provide that if any shares held by a reporting shareholder are on loan to that shareholder or by that shareholder to another party, the shareholder must disclose the terms of the "loan contract" for such shares.＊

Effective Dates

The revisions related to "significant proposals" described in Part 1(2) above are scheduled to take effect during November, 2006, but the exact date has not yet been announced. The rest of the revisions are scheduled to take effect on January 1, 2007. The revisions that will make filing Substantial Shareholding Reports and related documentation through EDINET compulsory are scheduled to take effect on April 1, 2007.

(Reference materials - Note: these references have been updated from the original Japanese-language letter in preparing this English translation)

See http://www.fsa.go.jp/common/diet/164/index.html for summaries and comparisons between the new version and the old version of the "Law for Partial Amendments to the Securities and Exchange Law" and the "Law Concerning Adjustment of Related Laws, Etc. Accompanying the Enforcement of the Law for Partial Amendments to the Securities and Exchange Law."

See http://www.fsa.go.jp/news/18/syouken/20061213-1/02.pdf for comparisons between the new version and the old version of the "Securities and Exchange Law Enforcement Order."

See http://www.fsa.go.jp/news/18/syouken/20061213-1/06.pdf for comparisons between the new version and the old version of the "the Cabinet Office Ordinance Concerning the Disclosure of the Status of Substantial Shareholdings."