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OSAKA — The Financial Services Agency on Monday declared an Osaka-based mortgage-backed securities company insolvent, sending shock waves across the country as 20,000 investors saw their principals suddenly vanish.

Daiwa Toshi Kanzai was controlling 130 billion yen in investments, and its clients now have little chance of recovering that money; the principal in mortgage-backed securities is unprotected under the law.

Police were later called in to search offices and buildings related to the firm in Osaka, Tokyo, Hokkaido and six other prefectures; the FSA suspects one of its affiliates of illegally guaranteeing the principal of some investments.

The sequence of events began in the morning when the FSA asked the Osaka District Court to invoke liquidation procedures against the firm, which agency sources said is believed to have a negative net worth of 5 billion yen.

The FSA made the application under a provision of the Commercial Code and was immediately issued an order to begin liquidation procedures, including measures to seize and protect assets.

It was the first time for the provision to be invoked since it was established as part of a 1938 revision to the code.

According to investigative sources, the firm, which sold mortgages and mortgage-backed securities, is suspected of failing to invest its customers’ capital and instead using the money as operating funds and to pay interest.

The police conducted the search on suspicion that General Finance Partner, one of Daiwa’s 10 affiliates, sold 170 million yen worth of fund certificates to 14 clients between January 2000 and last month by guaranteeing the principal and a dividend of 8 percent to 10 percent, the sources said. It is illegal to guarantee the principal of this type of investment.

The affiliate had collected a total of 15 billion yen in funds from investors, according to the sources.

The FSA, which has been examining the company since October 2000 on suspicion of falling into negative net worth, stopped the firm from renewing its business registration in December, the sources said.

Hiroshi Okumura, a former professor at Chuo University, said the financial authorities could have taken quicker action.

“Mortgage-backed securities are a reasonable financial product developed in the United States,” he said. “But it is difficult for ordinary customers to properly check the extent of risks on mortgaged assets. Had the financial regulators checked the firm’s operations and forced them to stop the sale of securities at an earlier stage, the damage could have been minimized.”

He also said that even though the company and its customers must share part of the responsibility, the biggest responsibility is with financial regulators.

Daiwa Toshi Kanzai’s investors reacted with shock.

A 36-year-old woman, who quit her job five years ago and had invested all her savings and retirement allowances, said: “I don’t know what to do from now on. I have no other savings.”

She said she bought the mortgage-backed securities from the firm after she saw an advertisement touting the high yields and security of the investment.

“The salespeople were soft in their approach, and I was not at all concerned (of any possibility of its failure) at that time,” said a 79-year-old man who has invested more than 4 million yen.

Although he lost money from the failure of another mortgage-backed securities firm previously, he said he trusted Daiwa Toshi Kanzai as he was regularly receiving dividends from the firm.

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