(Bloomberg) -- At 8:45 am on a spring day in 2021, a Nomura Holdings Inc. trader began a series of complex transactions over five hours on the Osaka Exchange that would earn Japan’s largest securities firm next to nothing but cost it dearly.
Using a tactic called layering, a version of spoofing, the trader offered to sell derivatives linked to more than a billion dollars worth of Japanese government bonds only to subsequently cancel the positions. As rivals cut their own prices in response, the trader snapped up the cheaper contracts and then resold them.
The profit from the flurry of trades was just ¥1.5 million ($10,000).
The repercussions are only now becoming clear. Last month, Japan’s Securities and Exchange Surveillance Commission recommended a ¥21.8 million fine as punishment for the trade, following an investigation. In quick succession, a slew of clients took the firm off of debt underwriting deals, and the broker lost its primary dealer privileges at government debt auctions for about a month as Nomura admitted it had manipulated the market.
In addition to the financial penalties, Tokyo-based Nomura is suffering a fresh blow to its reputation following various scandals over recent years — including several data leaks and a multi-billion dollar loss in the collapse of Archegos Capital Management.
The firm’s problems are deepening as Nomura's rivals double down on efforts to poach clients. Faced with a wave of public criticism, the firm is hunkering down and some staff have been encouraged to avoid meals with people from outside the company, according to people familiar with the situation. Human resources have gone so far as to call new recruits scheduled to join the company next year or their parents to offer explanations about the setback as well as reassurance about starting their careers at Japan’s biggest brokerage.
“The damage is done,’’ said Hideyasu Ban, an analyst with Bloomberg Intelligence. “The firm will need to explain how it changed and reinforced the system and monitoring to prevent similar events in the future. Whenever firms and the industry face these issues, they need to work hard to regain the market participants' confidence and trust.”
The latest setback marred what has otherwise been a very good year for Nomura. Chief Executive Officer Kentaro Okuda has led a revival in earnings with trading surging in Japan’s domestic markets. The company is forecast to show an 79% increase in net income when it reports its financial results on Nov. 1. That would mark the third straight quarter of expansion, the longest period of growth in nearly a decade, based on filings. The company’s performance has helped shield its stock from the scandal, with its shares gaining 3.8% since Sept. 25 when news of the scandal first broke, compared with a 1.2% gain in the benchmark Topix.
The company has also focused on improving internal controls. Christopher Willcox, who took the helm of Nomura’s wholesale business of trading and investment banking in the aftermath of both the Archegos losses and the layering trades, has based his tenure on achieving “stability.” He cited the word six times in a May 14 presentation. Willcox's division has thrived in recent years, generating increases in revenue from both fixed-income and equities trading amid the heightened volatility. There are few better examples than its domestic market: hedge funds have flocked to the market for Japanese sovereign debt as a shift in central bank policy stimulated trading in the country.
Still, he has little room for error. Costs at the wholesale division account for more than 90% of revenue, compared with 70% at Morgan Stanley’s institutional securities unit and less than 60% at Goldman Sachs Group Inc.’s global banking and markets business
That progress is now threatened by the scandal. At least 10 firms, which include major life insurers, trust banks and asset management firms, have temporarily suspended some business activities with Nomura because of the breach, according to people familiar with the matter. Additionally, other clients have taken the company off of underwriting Japanese debt. That’s damaged Nomura’s ranking in the corporate debt market, where it dropped to fifth place in October from No. 3 the previous month, according to data compiled by Bloomberg. The bonuses for many bankers are tied to the company’s ranking in the market.
Rivals are also trying to take advantage of Nomura’s woes by aggressively pitching deals to Nomura’s clients. Most market participants are trying to grab market share from Nomura, according to executives at both domestic and international rivals, who asked not to be named discussing their companies’ strategies. The firm takes the situation seriously and has asked employees based in Japan to refrain from internal and certain external social gatherings, a spokesman said, declining to comment on the actions of the company’s competitors.
“Even if the law was broken by an employee, the problem lies with the organization that allowed it to happen,” said Yumiko Miwa, a professor at Meiji University, who studies corporate governance and is a former employee of the brokerage. “Nomura needs to improve its internal control systems and manage risks specific to financial firms.”
Nomura is the latest Japanese financial institution to admit to breaking the law. In 2018, Mitsubishi UFJ Morgan Stanley Securities Co., MUFG’s majority-owned brokerage, faced a similar manipulation charge and the company announced voluntary pay cuts by top executives in response. SMBC Nikko Securities Inc. was found guilty last year of market manipulation, which dragged the brokerage to a record loss.
The Nomura trades under scrutiny occurred on March 9, 2021 in the market for 10-year Japanese government bond futures, a contract to buy or sell the assets at a future date, according to Japan’s SESC. It was the day after a senior Bank of Japan official indicated that the central bank would loosen its control of the bond market, which was welcome news for debt traders.
The volume of orders placed by the Nomura employee dominated the market. At times, they accounted for about 70% of the top bids and offers in the market, the commission said. Nomura ended up placing and canceling 2,466 units of sell orders and 1,619 units of buy orders during the five-hour spree. Each unit has a face value of ¥100 million.
Regulators in the US have clamped down on the practice of spoofing, defining it through the 2010 Dodd-Frank Act and making it illegal. Bank of America Corp. paid a $24 million fine last year to settle allegations that two former employees spoofed the market for US Treasuries hundreds of times. In 2021, NatWest Group Plc pleaded guilty to fraud in the US and paid about $35 million in fines while Toronto-Dominion Bank agreed to pay more than $20 million to resolve similar claims in September.
If the fallout from the market manipulation drags on, it will likely besmirch Nomura’s 100-year anniversary next year. The company was founded in 1925 in Osaka by Tokushichi Nomura as a specialist for public and corporate bonds with 84 staff. In the intervening century, the company survived the Second World War and boomed during Japan’s bubble era in the 1980s. It has swelled to more than 27,000 employees and has operations worldwide. The scandal should serve to remind the company how it became successful, according to Meiji University’s Miwa. “Nomura needs to return to the spirit of its founder, who preached putting the customer’s interest before your own,” Miwa said. “Nomura needs to straighten up its act.’’
--With assistance from Nao Sano.
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