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Mr. Yoshiaki Tsutsumi, the former leader of the scandal-tainted Seibu Railway group, has been arrested on charges of presenting false financial reports and selling stock to clients without sufficient information disclosure. His arrest, carried out Thursday jointly by the Tokyo District Public Prosecutors Office and the Securities and Exchange Surveillance Commission, is a wake-up call to a business empire long ruled by an autocratic owner under a cloak of secrecy.

The former chairman of Kokudo Corp., the privately held firm that effectively controls the Seibu Railway group, is suspected of underreporting Kokudo’s ownership stake in Seibu by using the names of employees to tag blocks of stock that were then sold to scores of the group’s business partners who were not told the truth about the reason for the sale. Prosecutors should conduct a thorough investigation into the role played by the 70-year-old business tycoon.

The scandals have exposed the dark side of the Seibu Railway group, one of Japan’s leading business conglomerates. In particular, they have focused a spotlight on its old-fashioned and clandestine corporate culture. Mr. Tsutsumi, who had ruled the group for 40 years, bears grave responsibility for all this. He has betrayed the trust and confidence of not only shareholders but also millions of ordinary people who use Seibu trains, hotels and department stores, and watch Seibu-sponsored professional baseball games.

According to investigators, Kokudo, the largest shareholder of Seibu Railway, lied about its Seibu ownership stake to get around a Tokyo Stock Exchange rule that caps holdings by major shareholders. To make its bloated ownership look smaller than it actually was, Kokudo allegedly transferred part of that stake to employees — on paper only — and presented financial reports that excluded the “transferred” portion.

Of course, such underreporting of stock holdings misleads bona fide investors and hampers the formation of fair market prices. That’s why it is prohibited by law. Any violator, not just Kokudo, should be duly punished. So the strong action taken by prosecutors should not come as much of a surprise, notwithstanding Mr. Tsutsumi’s high-profile career.

Investigations reveal that, because Kokudo and nine other major companies held more than 80 percent of Seibu stock before the reporting violation came to light, Seibu risked losing its membership on the stock exchange.

So, from August to September 2004, before publicly acknowledging its noncompliance (Seibu Railway was delisted in December), Kokudo sold large numbers of Seibu shares to some 70 business associates. Mr. Tsutsumi is said to have personally arranged sales without telling buyers about the possibility of Seibu’s being delisted. Prosecutors believe this constitutes a violation of the law against insider trading.

Insider trading refers to transactions in stock and other securities conducted by people with “insider information” — such as confidential knowledge that company executives and major shareholders might have acquired during merger or acquisition talks. The Securities and Exchange Law was revised in 1984 to prohibit deals that enable traders to make huge profits or avoid losses as a direct result of their being tipped off on “important facts related to the business” that may affect stock prices just before this information is disclosed publicly.

The law states specifically what kinds of information represent “important facts” and in what circumstances their disclosure is required. This definition, however, has tended to limit the extent to which the law can be applied, although attempts have been made to broaden its coverage. In the Seibu case, a number of questions have yet to be resolved legally in order to establish evidence against Mr. Tsutsumi beyond doubt.

It remains unclear, for example, whether Mr. Tsutsumi actually made profits or avoided losses behind the scenes — a question that cuts to the core of whether insider trading has occurred. The question provides an important criterion for deciding whether Mr. Tsutsumi should be indicted.

Prosecutors seem confident of their ability to build a solid case. It is likely, though, that the question will be contested in court if he is indicted.

However the case develops, it is certainly a disgrace for corporate Japan that one of its icons has been arrested on charges of false reporting and insider trading. To restore its credibility, the Seibu Railway group has no choice but to reinvent itself. That will require, first and foremost, transforming its autocratic, secluded and antiquated system of management into one that is liberal, open and modern — the kind of system that the market welcomes.

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