A recent incident involving Japanese conglomerate Toshiba bears important lessons for corporate governance in Japan, in particular shareholder activism and the possibility to acquire shares in Japanese firms for foreign investors.

Toshiba is one of Japan's best-known companies and has played a key role in nuclear power and other strategic industries; however, it has been plagued with governance failures for years, starting with an accounting fraud case in 2015. After the company raised $5.4 billion from as many as 60 foreign investors in 2017, it faced increasing demands from activist shareholders to enhance its governance. On 23 September 2020, Toshiba shareholder Effissimo Capital Management (Effissimo), a Singapore-based activist fund, requested an investigation by a third-party committee—consisting solely of independent members—to determine whether the annual general meeting of shareholders (AGM) held on 31 July 2020 had been managed fairly. When it became clear that the third-party committee would not easily be established, Effissimo took special steps to request an extraordinary shareholder meeting and to appoint an investigator of materials submitted to the 2020's AGM.

Finally, on 17 December 2020, Effissimo requested that Toshiba convene an extraordinary shareholders meeting. Further, the shareholder made a proposal for the appointment of persons who would be in charge of investigating the status of the operations and property of a listed company as stipulated in article 316(2) of the Japanese Companies Act. The report of that investigation, released on 10 June 2021, found that Toshiba executives had colluded with Japan's trade ministry to pressure shareholders regarding their votes on the appointment of directors etc in the previous AGM. Toshiba had thereby aimed to limit activist investors’ influence. The independent probe, conducted by three lawyers, details how Toshiba allegedly coordinated with officials from the Ministry of Economy, Trade, and Industry to block activist shareholders from submitting proposals and exercising their voting rights. The report concluded that Toshiba's AGM in July 2020 was ‘not managed fairly’.

Toshiba responded by removing two of its directors from its list of board nominees for the 2021 AGM and by vowing to reconstitute and diversify its board to include more foreign representatives. However, most shareholders were still critical of Toshiba's nomination process. They were also critical of its list of revised board candidates, which still included audit committee members who had taken part in an earlier investigation of the 2000 AGM that did not detect any problems. Therefore, Toshiba shareholders successfully voted to remove them as board members at the 2021 AGM.

The Toshiba incident highlights important corporate governance issues. One is the advantages and disadvantages of the government's discretionary response to the acquisition of shares by foreign funds and the act of making proposals for security purposes. The root of the problem is that the system in the revised Foreign Exchange Act has been used exclusively to deal with issues that should be dealt with under company law because shareholders voting at the AGM is a matter of company law in the first place. The impact on the depth of the problem is significant. In principle, it would be legal for the Ministry to take discretionary measures from the national security perspective based on the provisions of, for example, inward foreign direct investment, in the Foreign Exchange Act. This situation is similar to that in other countries (eg USA, UK). However, the regulations on, for example, inward foreign direct investment, include the acquisition of shares and the consent/joint exercise of voting rights, which are closely related to company law. The exercise of authority under the Foreign Exchange Act should be exclusively focused on the national security perspective so as to not erode the scope of company law.

The other main issue is an investigation based on the provisions of article 316(2) of the Companies Act. Introduced in 2006, this provision, unlike the conventional system, gives investigators strong authority to instruct company officials. Prior to this investigation, the Toshiba incident had been investigated by the audit committee of the company, but the report by the audit committee (Feb 2021) concluded that there was no particular problem. Therefore, among people who value shareholder engagement, many opine that the investigation based on article 316(2) of the Companies Act is much contributes to an ‘effective corporate governance of Japanese companies’. However, there are advantages and disadvantages to the ‘digital forensics’ method used in this investigation. By analysing a huge number of e-mails of the people, using artificial intelligence, the investigator succeeded in revealing the facts and their problems that had not been clarified thus far. However, there are concerns about generalising such methods in the future, in consideration of the privacy of the parties concerned.

Toshiba opted for a US-style establishment with a nominating committee etc., among others, at an early stage in Japan. The company was seen as a model company in terms of corporate governance prior to the turmoil induced by various scandals in recent years. Therefore, this case strongly suggests that it is meaningless to improve corporate governance by merely formalising it. This is surprising, given that, in Japan, the Corporate Governance Code was just revised in June 2021 and formalized to enhance board independence, eg, the ratio of independent directors (see my recent post). This case suggests that understanding how to build a substantially effective governance system is a fundamental issue.

Hiroyuki Watanabe is a professor of law at Waseda University.