Daiwa Bank

THE DAIWA BANK SCANDAL received significant media coverage in both the United States and Japan. On September 25, 1995, Daiwa Bank, one of Japan's largest banks with offices worldwide, admitted that Toshihide Iguchi, the head of bond trading in the bank's New York City branch had misappropriated $1.1 billon of customer securities over a period of 10 years to conceal trading losses. On October 9, 1995, Daiwa officials made the additional disclosure that it had concealed more losses in excess of $97 million dollars that had been shifted to a corporate shell in the Cayman Islands between 1984 and 1987.

On November 2, 1995, the U.S. Federal Reserve announced the closing of the bank's American operations. The bank was required to provide federal regulators with status reports every 5 days over the 90-day period within which it was required to terminate and withdraw all operations from the United States for three years.

The severity of the penalties originally faced by Daiwa Bank (expulsion and a 24-count federal indictment carrying $1.5 to $4.4 billion in fines if convicted, rather than fines alone) was attributed to the fact that the bank was not more forthcoming with disclosure of its losses. The bank did not inform the powerful Japanese Ministry of Finance until August 8, 1995, and the ministry did not, in turn, inform U.S. regulators until September 15, 1995. By these actions, both the bank and the ministry showed a disregard for U.S. law, resulting in a breach of trust between governments. Fortunately, the bank had enough money to cover the losses.

The Daiwa Bank fiasco was not a problem particular to the Japanese institutional and cultural context. Rather, Daiwa Bank underscored how lenient internal controls and regulatory scrutiny had created conditions that contributed to similar scandals threatening the viability of top financial institutions around the world.

In banking circles, it is widely accepted that employees have incentives to breach management controls and compliance procedures. Banks need to respond by adopting internal controls and submitting to regulatory oversight in an effort to locate violators before the firm is exposed to billions of dollars in risk.

Prompt and immediate disclosure and cooperation with regulators has been recommended as the most immediate remedy to the ongoing problem of employees finding loopholes in the management controls and compliance procedures. Doing so not only protects a firm from the accumulation of higher losses in the long-term, but a prompt response enables a firm to establish a credible track record. U.S.-based traders such as Prudential Securities and Salomon Brothers, have, upon report of major infractions, been allowed to continue business with payment of substantial fines.

Although these firms were found guilty of infractions varying from failure to inform investors of the extent of risk associated with their purchased investments to concealment of losses, immediate disclosure allowed them to preserve their reputations.