Japan demonstrates how too many rules can ruin governance

by Colin P.A. Jones

Eons ago, as a young corporate lawyer in Tokyo, I received an email from a Japanese lawyer representing a foreign company I also worked with. Attached were draft minutes of the meetings of the board of directors and shareholders of the company’s local subsidiary. He asked me to confirm the contents of the minutes and, if acceptable, have the company’s directors sign and send them back.

This presented a challenge because no meetings had actually been held on the date indicated in the minutes. Or ever. Actually, the need to even have such meetings was first brought to my attention by this email, which presented them as a fictitious fait accompli.

Briefly, it seemed that this lawyer from one of Japan’s top firms was inviting me to collaborate in forging corporate documents. But I was just naive: The subsidiary existed solely to own assets in Japan for tax purposes. The directors were all busy executives at the parent company, which was also the sole shareholder. To hold real meetings would have been a waste of everyone’s time.

In fairness, the proposed minutes themselves reflected that nothing much transpired, other than the things the law mandates happen periodically: reappointment of directors and confirmation of annual accounts. The former was a formality, and the financial scrutiny imposed by the latter was already taking place at the parent company level with greater rigor than required by statute. The law was the law, however, but it seemed to have made the manufacture of essentially fake corporate records a widely accepted practice.

Today the Companies Act still requires joint stock corporations with boards of directors to hold board meetings at least once every three months and prepare and retain minutes of the proceedings in accordance with Justice Ministry regulations. A shareholders meeting is also required at least once a year, and failure to hold one is (in theory) punishable by a civil fine.

This sort of requirement is not uniquely Japanese; I recently encountered a Japanese company whose management was horrified to learn the director of their Indian subsidiary was potentially liable for criminal penalties — including imprisonment — for failing to comply with statutory meeting requirements there. While I have not done a thorough survey, the most common formulation in countries that do have a periodic meeting requirement is a mandatory annual shareholders meeting to ensure the yearly financials are properly sorted and the directors duly appointed. Some of these also require corporations to have more than one shareholder, so mandatory meetings make more sense.

In some places the law requires certain decisions be approved by the board of directors, or even the shareholders. If the company is not public, however, such matters can usually be approved by a circular resolution signed by the directors without holding a board meeting. Japanese law permits resolutions to be passed this way, but they do not count as meetings, which must still be held quarterly to ensure the management directors “report the status of the execution of their duties to the board of directors.”

The Companies Act must anticipate a wide range of uses for corporations, including large, publicly traded companies where there is a significant divergence between the identities of management and the people who own shares. In this context, having rigid formal requirements is logical from the standpoint of ensuring shareholders not participating in management have regular opportunities to review the performance of those who do and get rid of those not up to snuff. Publicly traded companies are, however, a small minority of the total universe of companies subjected to these rules.

For Japanese companies that are wholly owned subsidiaries within a corporate group, or small family-run firms where management and shareholding overlap completely, these requirements probably remain a bothersome waste of time. Some may duly hold the required meetings (I know companies that do). It would be surprising, however, if everyone was so scrupulous; I suspect legal fees are still earned from drafting minutes of meetings that never happened.

How far a fudge is too far?

So what? Large public companies — like Toshiba, Kobe Steel or Kubota, to name a few recently in the news for scandals involving the falsification of financial records or product data — are Jupiter-like gas giants orbited by countless smaller subsidiary moons, most of which are insignificant in comparison and completely subject to the gravity of the parent company’s will. The greater universe of companies is mostly invisible, neither large nor publicly traded.

It thus seems reasonable to extrapolate that many board of directors and shareholders meetings of Japanese corporations are meaningless formalities and some do not even actually take place except in minutes produced to show “compliance” with regulatory requirements. We can also assume, however, that in the vast majority of cases nobody is harmed by their fabrication — directly.

Everything may seem fine so far; they are just minutes of unnecessary meetings, right? But what does it mean for a company — or some other institution — to have employees and managers who come to accept it as a normal part of their day to create spurious records, albeit for perfectly understandable reasons? How are they supposed to know it is unacceptable to do the same thing with the other types of bothersome records that laws and other rules require them to create and maintain, whether about finance, metal strength, the provenance of meat or any of the other areas where Japanese industrial scandals have arisen.

Corporations fudging their records is not a uniquely Japanese problem. Yet it seems to be particularly persistent in Japan. Moreover, when one Japanese company in a particular industry is caught engaging in some version of this behavior, it is boringly predictable that other companies in that industry will also get busted for the same practice.

Rules from cradle to grave

Perhaps it is easier for Japanese people to become numb to rules that make little or no sense, even if only by being unreasonably strict or otherwise difficult to comply with. From grade school, Japanese children are expected to obey a plethora of rules, some of which likely make little or no sense even to adults. Asking why the rules exist is not welcomed or rewarded.

Those who end up studying law later in life will likely do so in the context of one or more testing regimes (such as the bar exams or other professional qualification tests) that are heavily focused on what the law is rather than why it is. The latter question, however, is arguably more important, since understanding the rationale behind a rule is generally conducive to complying with it.

Running a business or just entering the workforce or the public service in Japan means encountering a dizzying array of rules, some of which are counterintuitive and rarely explained. You may not interview your temporary secretary before she is deployed to your company. You may not renew that worker’s fixed-term contract even though you both want to. You must not send letters by takkyūbin (express delivery service). There are reasons behind these rules, of course, but it can take some effort to discern them, particularly if you are already too busy just trying to comply with them.

Here’s a test: If you are a foreign national, next time you check into a Japanese hotel and the front desk clerk asks to make a copy of your passport or residence card, ask “Why?” The invariable response will be that it is required by law. This is a questionable response if you are a resident, but leaving that aside, I guarantee none of the people — who are engaged in the business governed by the law in question — will be able to tell you why it is required by the law. It just is, and their interest stops once they have satisfied the bothersome record-keeping requirement.

When ‘why’ gets you nowhere

Perhaps there is no upside to knowing “why” anyway because the rules may suddenly change, making whatever reason you thought made sense irrelevant.

For example, after years of forcing universities to exercise more stringent quality control in awarding academic credit to students — including ensuring adequate, objectively measured classroom time and attendant record-keeping — hey presto, the Education Ministry suddenly thinks it is fine, no, strongly recommended, that universities give students credit for “volunteering” for the Tokyo Olympics rather than sitting in class. Why? Because we said so.

I predict that universities granting credit will be required to create records showing that “learning” occurred while volunteering, but that these will be as meaningless as the board minutes described above.

Another example: Remember when, after the Fukushima nuclear accident, the government decided “safe” levels of radiation exposure for children were actually 20 times higher than they had been before? Outrageous, of course, but what if the pre-meltdown levels had also been unrealistic — lower than natural background radiation?

Using rules to establish bright-line quantitative requirements, whether frequency of board meetings, hours spent in class, acceptable radiation levels or metal strength, can be inherently arbitrary. This is not to say they should not exist, but just like other silly rules, they can be problematic if set at unrealistic levels by bureaucrats or politicians who don’t themselves have to deal with compliance.

In a world full of impossible or impractical specifications and compliance requirements, it may be understandable if some get addressed by fudging the records. This does not make it commendable, of course, but the next time one of these corporate scandals breaks, it would be nice to see a little more attention devoted to not only corporate governance but government as well. As Winston Churchill once said, “If you have 10,000 regulations, you destroy all respect for the law.”

Colin P.A. Jones is a professor at Doshisha Law School in Kyoto. The views expressed are those of the author alone.

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