In late 2020, the trading room of Japan’s third-largest brokerage firm, SMBC Nikko, cautiously returned to normal after months of the pandemic crisis. Makoto Yamada, the head of equities trading, known for his blue Berluti shoes and sharp suits, was back on the floor. Alexandre Avakiants, deputy global head of equity and owner of a Brazilian jiu-jitsu gym, revived animal spirits after lockdown.
All of this was overseen by Trevor Hill, the former UBS banker who parachuted seven years earlier to transform the native Japanese house into a global heavyweight while flattering the biggest global equity funds.
But the recovery was short-lived. Months later, the Securities and Exchange Surveillance Commission of Japan’s Financial Services Agency launched an investigation into Nikko. This culminated this month with the arrest of the three executives along with Shinichiro Okazaki, head of equity products, on suspicion of market manipulation related to block trades, large securities transactions that take place outside of trading hours.
What started as a routine inspection has turned into a sprawling investigation that threatens to bog down Nikko’s equities department as institutional clients sever ties. Japanese TV crews, warned by prosecutors, captured footage of a late-night raid on the company’s headquarters.
The four executives were thrown into the same criminal justice system that interrogated former Nissan boss Carlos Ghosn for more than 100 days and are scheduled for indefinite stays at the Kosuge detention center on the outskirts of Tokyo.
“We will refrain from answering the questions that are being investigated,” SMBC Nikko said in response to questions about the arrests and investigation. The SESC declined to comment.
At stake is Tokyo’s effort to present itself as a global financial center with transparent and fair markets. If regulators and prosecutors do indeed uncover systemic wrongdoing by a major brokerage firm, Tokyo’s image will be tarnished. But when the months of investigations drag on as unnecessarily, the supervisory authority is vindictive.
“Executing block trades is always a challenge, anywhere in the world. There should be a strict Chinese wall between the primary origination desk, the secondary sales desk and the trading desk,” said Nick Benes, executive director of the Board Director Training Institute of Japan. “Given Tokyo’s desire to remain a major financial hub, regulators appear to be cracking down.”
Since the FSA introduced Japan’s first corporate governance code in 2015 as a flagship of the “Abenomics” reforms under former Prime Minister Shinzo Abe, Japanese companies have come under increasing pressure to divest their sizeable cross-shareholdings.
The holdings are protective, mutually held shares that hold publicly traded companies together and which fund managers see as a recipe for management complacency.
Nikko is unusual in that it has both significant streams of block stock sales coming through its megabank parent company and a large network of branches that broker to domestic retail investors. People familiar with the disputed trades said Nikko has become an important vehicle for unwinding cross-holdings from companies with block trades.
Investigators suspect that SMBC Nikko used its proprietary trading desk to place large buy orders late in the trading day to artificially inflate the price of shares, which in many cases were sold through Nikko’s retail network.
Regulators believe Nikko’s practice of encouraging traders to buy shares at anything other than the lowest price disrupts the functioning of the market.
A clerk not directly involved in the trades said he was surprised the props counter was involved in the trades. “I would have thought this whole thing was just passed left to right and deserved a commission for trading. This is not what a block trade should look like.”
Company sources say compliance alerts often indicated suspicious trades, but the trade control department was unable to prevent the transactions.
By the end of June 2021, Nikko’s clash with the FSA was painful. It exacerbated tensions between the Japanese staff and its two most prominent foreign managers, and also deepened resentments between veteran brokers and the regular SMBC bankers who drove in to watch over their subsidiary.
Bankers were regularly pulled off the trading floor or from their homes to answer a long barrage of questions from inspectors. A Nikko dealer in his 50s died of a brain aneurysm after days of interrogation.
“A lot of the guys have had an FSA inspection before, either at Nikko or another bank, and they’re always nasty. But this was different. Much meaner. Like they have something to prove,” said one banker.
“The shock is difficult to describe. Trevor, Mak, Alex. . . By mid-February they thought it was basically over and Nikko’s lawyers had proved nothing illegal had happened,” said a former colleague.
“There was a sense that the regulator hadn’t gotten what they wanted, but there would be a deal for everyone to save face. . . no one knows what will happen next. For everyone, not just Nikko,” he said.
Nikko bankers say it may be too late to salvage relationships, as many large clients have already severed ties with the broker for fear of reputational damage.
In a desperate attempt to boost morale, Chief Executive Yuichiro Kondo on Monday tried to persuade employees the matter was more complex than the Japanese media portrayed.
But according to the brokers, he admitted that Nikko’s efforts to explain its actions to both regulators and prosecutors “were not accepted and we as a company have suffered a huge social penalty from the arrests.”
At least six junior traders have left the group in recent months. Traders are disoriented without Hill and Avakiants, who commanded tremendous respect and loyalty on the trading floor and were the brains behind the broker’s expansion into New York, London and Hong Kong.
A staffer said people abroad “have completely lost their bearings. Who will drive the hedge fund business? Who will drive the commissions? It was these two.”