38-41_JLG16_MDR_07.indd 38-39 stability of thestability market. of algorithm-utilizing HFTon the fairness, transparency, and and exchanges, including the impact the increase of of thoroughly various review issues regarding securities markets tem Council at the Financial Services Agency to begun has form trading. of in Beginning April 2016, the Financial Sys- anese securities regulators to is find a way to regulate this new small per-tradeof profits. One immediate challenge for Jap- ing alarge number trades of and accumulating alarge volume small per-trade profits, HFTcan large profits by repeat - thousands small-scale trades of per second. Despite relatively trading by which high-speed trading carried is out –typically defined algorithm-utilizingHFT is atype of as securities speed potential and scale of market manipulation. called High Frequency Trading (HFT), amplifies both the actually impact the market price. Today, the so- debut of took along time for the rumors to spread widely enough to at market manipulation were buttressed by the fact that it 38 securities laws’ “effect based approach” (which focuses on the ones the intention awrongdoer), of opposed as to the U.K. the U.S. securities laws’ “intent based approach” (which focus- part, on U.S. securities legislation, and it accordingly mirrors the Japanese securities markets. The FIEAwas modeled, in (the “FIEA”) one is law that governs market manipulation in Article the Financial 159of Instruments and Exchange Act 1. Overview II. Market Manipulation Regulations inJapan monds, inattempt to up run prices. coming trading companies’ ships were furs and- of dia full sterdam was to spread rumors false that in- Centuries ago, aclassic tactic to manipulate prices inthe Am - I. Introduction Attorney at Law (admitted inJapanandNew York) Ito &Mitomi| Morrison&Foerster LLP Daisuke Niwa Trading andIssues Facing Japan Market Manipulation Using High Frequency 1 3 2 Back then, such attempts Case. The Supreme Court settled this issue inthe Kyodo Shiryo ticle159(2)(i). inducement” or the “fluctuating transactions” portions of Ar market of manipulationillegality existed inthe “purpose of More specifically, courts disagreed on whether the essence of inducingpose of the purchase securities, and sales of etc.” disagreed about the meaning and role the phrase, of “the pur tuations inthe market. For atime, Japanese lower courts securities,chase and sales of etc. are thriving or (ii)cause fluc- that should (i) mislead aperson into that believing the pur etc. or offering to conduct such transactions (c)inamanner from conducting purchases securities, aseries of and sales of inducing of purchasepurpose securities, and sales of etc., (b) Article the FIEA prohibits 159(2)(i) of anyone (a) on Article 159(2)(i)and conduct the type of it covers. Article the FIEA. 159(2)(i)of This article, therefore, focuses nipulation through actual transactions, which governed is by its investigatorymost of resources on attempted market ma- change Surveillance Commission (the focused“SESC”) has In market terms of manipulation, the Securities and- Ex 2. inducement. of showing that the perpetrator misconduct the has of purpose etc., and violations of Article the FIEArequire 159(2)(i)of a leading others into that believing transactions are thriving, that the perpetrator- misconduct mis the has of of purpose violations of Article the FIEArequire 159(1) of a showing effect manipulating trades of on the market). For example, Article 159(2)(i)and construed this concept as “the purpose existsinthe illegality of “purpose inducement” of portion of Market Manipulation through Actual Transactions 5 There, the Supreme Court concluded that the essence Japan LawyersGuide 2016/17 for the 4 - - -

Japan LawyersGuide 2016/17 thus, so to speak, value-neutral as (i.e. not per seillegal) fluctuations securities inasecurities market” inprices of and, the law broadly to mean, “sales and purchase that would cause clear that it construes the “fluctuating transactions” portion of the securities inthe price securities market. of It made also the element to mislead by artificial fluctuation of inducement by adding, to inducement the of purpose itself, clarified its that it narrowly interprets the of purpose by artificial manipulation.” This means, the Supreme Court ply and demand although prices are, infact, made to fluctuate the securities areof formed by natural relation between sup- marketties by misleading them into that believing the prices inducingof investors to or sell purchase securities inasecuri- a result market of manipulation sufficient. is the possibilityof that investors may beinduced to transact as ducement” under Article 159(2)(i). In , mere awareness the awareness level of needed to demonstrate “purpose in- of Courts and legal commentators have attempted also to clarify orders at aprice to equal or below the best ask price and a entrustment thereof by placing alarge number purchase of ment, conducted purchases the and sales above of futures and 2013), that alleging such person, with induce the of purpose - anese futures (to bedelivered September against an individual inSingapore with regard to 10-year Jap- ministrative monetary penalty payment order beissued On September 5, 2014, the SESC recommended that an ad- algorithms atool as (the “JGB Futures Case”). an individual inSingapore who engaged inspoofing using article introduce will the market manipulation committed by through algorithm the useof trading. As acaseexample, this monetary penalty regarding cases market manipulation tion using HFT, but there are precedents administrative of have publicly been announced market of cases - as manipula At present, in Japan, there are no uncovered precedents which III. CaseExamples and accessory relationship between the co-existing purposes. the existence another of co-existing or purpose the principal marketment of manipulation unaffected, is for instance, by that, awareness as thislevel as of exists, the establish- 7 It construed is 9 6 . . 8 * * * nal court precedent. Courttrict Decision, December 7, 1981, Hanji No. 1047, at- acrimi 164)as * edited by Hideki Kanda al., et p. 29(Shojihomu, 2011) * ket manipulation. the manner and regulators’ scope of investigations into specific mar of cases pretation of Article 159(2)(i), this decision not is expected to greatly impact * July 20, 1994, Keishu Vol. 48, No. 5, at 201. * ment (Decision), July 26, 1988, Kousai Keishu Vol. 41, No. 2, at 269. cision), July 31, 1984, Hanji Vol 1138, at 25and Tokyo High Court Judg- * Agency, April 19, 2016) / Stock Exchanges)” (Planning and Coordination Bureau, Financial Services “Secretariat’s Handouts of Various (Review Issues Surrounding the Market * Manipulations, The Journal Investing of (Summer 2001). * the author belongs to or belonged has to. belong to the author, and do not represent the the opinion organizations of market misconducts such market as manipulation. All opinions expressed Commission Japan of and engaged insurveillances and investigations into (Nikkei; September 6, 2014) SESC inMarket Japanese Manipulation of Government Bond Futures” famous Chinese university, and he reportedly had rewritten investment management company, studied mathematics at a cording to newspapers, profits by repeating such trading cycles multiple times. Ac- tion was less than amere 300milliseconds) and accumulate from the placement the of order and the cancella- in an incredibly short time (the period average of time elapsed The tool allowed also the trader to complete one trading cycle match with the Singapore trader’s small order to benefit. his to induce others inthe market to place orders that would several billion), which he never intended to execute, inorder opposite best ask (bid) (from JPY several hundred to million JPY 400 million), while placing large spoofing orders at the place small orders at the best bid (ask) on (all ascale around In thiscase, the individual inSingapore used an algorithm to 330,000. The amount the administrative of monetary penalty was JPY executed. This trading type known of activity is as “spoofing.” best offer over 13cycles without intention for the orders to be large number sale orders of at aprice to equal or above the 10 9 8 7 6 5 4 3 2 1 http://www.fsa.go.jp/sesc/news/c_2014/2014/20140905-1.htm See, e.g. the so-called JFMA Stock Price Manipulation (Tokyo Case - Dis See “Annotated Financial Instruments and Exchange Act 4” written and In practice, while the Supreme Court offered has clarity on the legal inter Kyodo See the of Case Shiryo, Supreme Court Judgment (Decision), See, e.g. Kyodo the of Case Shiryo, Tokyo Court Judgement District (De- Sectional Committee on Financial System, Financial System Council See David J. Leinweber & Ananth N. Madhavan, Three Hundred Years of The author previously served on the Securities and Exchange Surveillance “Deceiving the Market with 0.3 Second Orders – Recommendation by 10 the individual was an officer an of 39 2016/08/31 16:46 - -

Articles 38-41_JLG16_MDR_07.indd 40-41 40 alties that are often imposed by foreign securities regulators pears extremely low when compared with the large- pen civil in the JGB Futures was Case merely JPY 330,000, which ap- The amount the administrative of monetary penalty imposed (1) tary Penalty System Administrative Mone the to pertaining Issues 2. manipulation for aviolation of Article 159(2)(i). investors may beinduced to transact aresult market as of Court, which only requires awareness the possibility of that derstanding consistent is with the stance the Supreme of aprogramuses or algorithm to mislead investors. This un- satisfied where amarket participant knowingly or designs to establish market manipulation, that requirement may be subjective requirement of “purpose inducement” of required is manipulation may beliable for such misconduct. While the pants who usealgorithms or computers to engage inmarket chine with no intent. In the same manner, market partici- cused from crime on the his ground that the robot was ama- commit the crime, that defendant could not plausibly beex- However, adefendant if inamurder case used arobot to those orders were objectively suspicious. ket manipulation inducement such the as of purpose if even puter would never satisfy the subjective requirement mar of constitute market manipulation orders as placed by acom- One might argue that algorithm-using HFTwould never regulations under the FIEA? Is algorithm-using HFT subject to the market manipulation der the FIEA Marketand HFT 1. Manipulation Regulations un- IV. IssuesFacing JapanGoingForward ed by the SESC. the FSAultimately found the the violation facts of assert as - trial proceedings, the individual submitted an admission, and systems, but not did deceive people,” but inthe administrative had reportedly stated to the regulator that he “surely deceived to manipulate the market. In the the beginning, individual ownhis automated trading program so that it could beused Inexpensive administrative monetary penalty amount - - lions, or more even trading cycles taking place inthe market, within HFT, milliseconds via there could be thousands,- mil that case. What’s more, orders if are placed and cancelled and analyze asubstantial amount trading of data to support imagine that regulators and investigators needed to review only asingle trading day inthe JGB Futures Case, easy to it is Since there were many as 13violated as trading cycles within (2)Enormous volumes oftrading data ty amount imposed was relatively low. securities market, the administrative if even monetary- penal protecting investors by drawing prompt attention from the interest rates. The regulators, therefore, likely succeeded in tures could have adversely affected the actuals price and of action, the 10-year price of Japanese government bond- fu served other purposes, however. Absent swift enforcement The SESC’s the handling JGB of Futures to seems Case have tions –was achieved through this case. monetary penalty system’s – purpose which to is deter viola- alty, difficult it is to say for sure whether the administrative (and more deserved) penalty. Given this seemingly light- pen to feel like the wrongdoer successfully evaded amore severe likely to besubstantial.” the profits he gainedillegally through the manipulation were lated the market appears to belonger than the findings, and that “the period during which the individual actually- manipu ited to one that trading of day. However, there was areport conducted, the act which was found to beaviolation was- lim In the JGB Futures Case, among the trades the individual specifically found to violate the securities laws. doer’s profits resulting from particular trades that regulators terrence, and limited is to an amount equivalent to the wrong- the as set been has minimum level necessary for violation de - administrative monetary penalty calculated by such formula nates the regulators’ discretion. The the level amount of of marketry of misconduct inaform which completely- elimi amount administrative of monetary penalties for each catego- The FIEAprovides formulas for of aset calculating the and covered indetail inthe press. 11 If thisreport If true, is hard it is not Japan LawyersGuide 2016/17 * * ticipant up sets or operates algorithms. Meanwhile, inorder tors to establish “purpose inducement” of where a market par manipulations by HFT, possible Ithink it is for the regula- lators must take also prompt action. With respect to market market manipulations by HFT, the Japanese securities regu- countries struggling with how to and regulate HFTitself lation practices. Amid the regulatory authorities invarious evolved the speed conventional and scale of market- manipu HFT involving algorithms the dramatically useof has V. Conclusion nowpersons of inFY2016) as administrative monetary penalty system inFY2005and 763 SESCstart inFY1992, of the 552persons the start of as of misconduct increasing been has (i.e. the 202persons of as bureaus incharge surveillance and of investigation market of rities regulators including the SESC and local finance nese regulators. Although the number personnel of at secu- tial manipulation. This poses asignificant challenge to Japa- that regulators would need to monitor and analyze for poten- which would to give amount trading rise an immense of data Japan LawyersGuide 2016/17 HFT by devising effectiveHFT by devising proving methods of wrongdoings. should seek away to combat market manipulation using transactions. Considering these, the securities regulators the market SESC inacaseof manipulation through actual no administrative precedents which an assertion dismiss by at the same level the as standard. civil Also, there have been able doubt”, the standard persuasion of said to is begenerally procedurecriminal which requires aproof “beyond areason- Especially inthe administrative trial procedure, unlike inthe ministrative trial and procedures, criminal respectively. excessive the proof required degree of of inview inthe ad- the securities regulators’ current investigative practices are ods. Rather, that Ibelieve necessary it is to examine whether bat advancing technology solely with labor-intensive meth- My that is not it is view aworthwhile strategy to tryto com- tions suspected market being of manipulation by HFT. sufficient to exhaustively investigate and analyze transac all - 12 11 http://www.fsa.go.jp/sesc/english/aboutsesc/04.pdf Id. 12 , this increase may not yet be - such manipulation within the current framework the law. of tem and to come up with amethod for providing proof of flexibly construe and apply the administrative monetary sys- tive and efficient, Japanese regulators should seek away to to make market regulations of manipulations by HFTeffec- · · · · · Seminars · · · · Publications Securities regulation; compliance; investigations & anti-corruption Practice Areas https://www.mofo.com/people/daisuke-niwa.html Japan; New York, US;Certified Fraud Examiner Professional Qualifications April 2015) Monetary Penalty System” (FinancialManagement Forums, Inc., Law Amendments, Administrative CasesandAdministrative Regulations –Basedon Topics including Recent “SESC’s Investigation Practice onMarket Misconducts &Issueson “Laws &Regulations onMarket Manipulation” (SESC, July2014) Administrative Cases”(SESC, 2014) January “Legal IssuesonMarket Manipulation –Lessonsfrom Criminal& 2014) “Material Facts underInsiderTrading Regulations” (SESC, January “Recent Administrative Trial Cases”(SESC, 2013) January http://www.mofo.jp/topics/publication/201510bljniwa.html (Business Law Journal,December2015)(onlyinJapanese) “Amendments to Exemptions from Insider Trading Regulations” (both inEnglishandJapanese) Offers” (Ito &Mitomi Newsletter, November 2006) (co-author) “Expanded Disclosures to Shareholders andInvestors inTender ter, November 2006)(co-author) (bothinEnglish andJapanese) ed SecuritiesandExchange Law ofJapan”(Ito &Mitomi Newslet “Expanded Coverage oftheTender Offer RulesundertheAmend- Japanese) Mitomi CompaniesActNewsletter vol. 15,March 2006)(onlyin “Issuance ofShare (Ito Certificates & underCompaniesAct” Fax: +81-3-3214-6512 Tel: +81-3-3214-6522 Tokyo 100-6529,Japan 5-1 Marunouchi1-chome,Chiyoda-ku Address: ShinMarunouchiBuilding29F, URL: http://www.mofo.jp Email:[email protected] Ito & Mitomi | Morrison & Foerster LLP Access: Daisuke Niwa

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