Tokyo Story (Continued)

By Maria Trombly | Securities Industry News | January 16, 2006

For the Tokyo Stock Exchange (TSE), 2005 was annus horribilis. Asia's largest equity market was second to none when it comes to serious trading glitches and breakdowns, and it has become even more of a cautionary tale for the global capital markets and their participants in the two months since we first editorialized on these problems (Securities Industry News, Nov. 14), noting how senior executives in Tokyo suffered the consequences through firings and pay cuts.

On Nov. 1 the exchange shut down for the entire morning when computer upgrades from principal vendor Fujitsu went bad. The upgrades were intended to improve the TSE's capacity to handle growth in incoming orders from Internet traders. Then, on Dec. 8, Mizuho Securities Co. mistakenly placed an order to sell 610,000 shares of a staffing company called J-Com Co. at 1 yen each, instead of selling a single share for JPY610,000 ($5,334). J-Com had just 14,500 shares outstanding; not only did Mizuho's computer fail to flag the error, but before the TSE responded to a request to cancel the error--a ten-minute delay--investors bought up some 100,000 nonexistent shares. Yet another botched trade was reported Jan. 4: a JPY1 billion order by Nikko Citigroup for Nippon Paper Group that exceeded internal compliance limits. On Friday, Daiwa Securities reportedly entered a mistaken sell order for Sumitomo Mitsui that cost it almost JPY500 million.

Interestingly, the brokerages have proven to be open and proactive in the face of such embarrassments. The Associated Press reported Friday that Daiwa realized its error at 9:05 a.m. and issued a buy-back order, but investors had already bought 13,000 shares as the price fell. The brokerage repurchased all those shares by the end of the session Friday, and the Sumitomo Mitsui shares posted a 0.85 percent gain at the close.

Mizuho--the case study that set the example--promptly made public statements about what went wrong and how it planned to correct it. It said it lost the equivalent of $344 million. It has published a road map that includes a systems improvement plan and the implementation of a crisis management plan. Until new systems are in place, the firm will take short-term steps such as requiring a second party to confirm IPO trades and deactivate alarm messages. Mizuho will also separate its sales and order execution functions, and it has formed a committee of outside experts, headed by a retired judge, to investigate the situation and suggest additional preventive measures.

Amid the considerable public outrage, brokerages that profited from the mistake have agreed to relinquish their gains, though they are not legally required to. The money will mostly likely go to a Japan Securities Dealers Association investor protection fund. The biggest unintended beneficiary was UBS, which, ironically, itself lost about JPY16.2 billion in 2001 from a similar error. UBS had to eat the entire loss. Its share of what will go into that fund is about JPY11.8 billion.

While the brokerages were forthcoming and looked for what needed fixing, the exchange has played the blame-and-punishment game, which got personal. Instead of creating a climate of improvement, it has only engendered fear and resentment. Three top TSE executives were forced to step down, and several others had their salaries reduced. The process has been less than transparent; the exchange hasn't released a detailed analysis of what went wrong.

Japanese computer giant Fujitsu, though it has trumpeted TSE as a major customer, has not commented at all on these incidents. Scott Ikeda, a Fujitsu spokesperson, said the company has a policy of not commenting on individual customers. He pointed out that there is no one-size-fits-all trading system: "They're all customized for customers."

Last week, exchange officials finally submitted to interviews with local newspapers. TSE president Taizo Nishimuro told the daily Yomiuri Shimbun that the exchange will spend tens of billions of yen to revamp its systems and hire necessary staff. He admitted that no one stepped forward to halt the bad order by Mizuho. "We cannot face international competition if we fail" to upgrade systems and staff, he said. "Also, I have to admit there hasn't been enough communication within the TSE itself."

Nishimuro promised that a chief information officer will be appointed this month, recruited from an outside organization, and that about ten computer specialists will also be hired. Nishimuro said that it could take a few years to bring the new system online and until then the current system will be beefed up, with additional capacity to handle orders and prevent mishaps.

However, Norio Suzuki, a staffer in the TSE's trading systems department, told SIN that system development procedures are still not fully determined.

The problems at the TSE go deeper than a computer system that needs upgrading. The culture needs to be more open and responsive to its constituents. Barring evidence of malfeasance or deliberate and malicious behavior by TSE personnel, the value of a hand-wringing, scorched-earth policy is questionable. It may temporarily address the public embarrassment, but it will take a more constructive, longer-term perspective to create a positive, functional management culture.