TOKYO — The investigation into corporate malfeasance and fraud at Japan’s troubled optical equipment maker Olympus, took a new turn on Thursday when the Tokyo Prosecutor’s Office (TPO) and the Tokyo Metropolitan Police arrested three former Olympus officials, including ex-chairman Tsuyoshi Kikukawa, and four others on charges of violating the Financial Instruments and Exchange Act by filing false reports. The arrests are the culmination of an investigation that really began last October when Olympus’ former CEO Michael Woodford began probing into the company’s tainted books, ultimately costing him his job. In a short email responding to the arrests, Mr. Woodford wrote, “After going to hell and back this is a day to remember. My warmest wishes to everyone.”  

Olympus, which makes cameras and medical-imaging equipment, admitted last year it had hidden more than $1.5 billion in investment losses through inflated payments made in acquisitions in recent years. Some of those payments were made via companies with links to organized crime. Among those arrested today were former Olympus advisors Akio Nakagawa and Nobumasa Yokoo. Both men had worked at Nomura Securities, Olympus’s underwriter and one of Japan’s largest securities firms. More arrests may be coming as the authorities seek the whereabouts of others involved.

The arrests mark an attempt by Japan’s law enforcement agencies to put a scalpel into lax accounting and lack of transparency in Japan’s financial markets, but the real question is how far the investigation will really go, or whether anything will change at all. Despite three former executives of the firm being arrested on criminal charges that violate Japan’s most important financial transactions laws, the Tokyo Stock Exchange said , “it is very hard to imagine that we would delist Olympus.

According to statements by the Tokyo Prosecutor’s Office and other sources, the seven are suspected of collusion in making false financial statements. Kikukawa and company, during the period 2006-2008 allegedly used the acquisition of three shady companies in Japan and the English medical equipment maker, Gyrus, to generate nearly ¥135 billion. They then used this capital to cover-up losses from previous bad investments and losses at Olympus and twice submitted false financial reports to the Kanto Financial Bureau, padding the net assets of the firm by over ¥100 billion. According to sources close to the investigation, further charges, including money laundering and violations of the anti-organized crime laws are also being considered.

The FBI enters the investigation

In January, the Japanese government formally asked the US Department of Justice to cooperate with the investigation, which involves possibly illegal payments made to individuals in the United States and the Cayman Islands. The primary suspect in the US, Hajime "Jim" Sagawa, was also a former Nomura Securities employee. The FBI White Collar Crimes Division is handling the case, although the Asian Organized Crimes Division wanted to take the lead and was rebuffed, according to US Department of Justice sources. The Asian Organized Crimes Division, fueled by President Obama’s executive order declaring the yakuza an enemy of the state, are anxious for a chance to investigate Japanese organized crime influence in the international financial market. Due to FBI internal hierarchies, the White Collar Crimes Unit will probably remain the lead. However, internal squabbling as to which direction to take the Olympus case is not limited to the US.

How the Olympus Scandal Came To Light

The Olympus scandal would have never come into focus if it hadn’t been for the courageous actions of their former CEO, Michael Woodford. Woodford was a veteran employee of Olympus who rose through the ranks to head the firm last year, being the first non-Japanese executive to do so. However, he didn’t hold the position for very long. Japan’s alternative press, in magazines such as Zaiten and Facta, had first reported on financial troubles at Olympus early last year. Friends quietly gave Mr. Woodford copies of the magazines articles translated into English after he became the CEO. He conducted his own investigations into the mysterious losses at the firm, even ordering an independent audit via PriceWaterhouseCoopers. The audit found shocking irregularities and suspicious payments made by the Olympus management. In October of last year, when Woodford confronted Kikukawa and demanded his resignation. retaliation was swift. On the morning of October 14, at a hastily convened board meeting he was summarily fired, and on the same day warned ominously to get on the first plane out of Japan. Before returning to England, he had a clandestine meeting with a Financial Times correspondent, Jonathan Soble. Subsequent reports by the FT and New York Times set off a series of chain reactions that forced a reluctant Japanese government to look into the matter. The mainstream Japanese media initially reported Woodford’s sacking as “due to cultural differences” and ignored reports of wrongdoing at the company. Only when the Japanese daily newspaper, Sankei Shinbun, printed an interview with Woodford did the mainstream Japanese media began to really look at his allegations.

The Attempts To Downplay and Scuttle the Investigation

Even at the early stages of the scandal the authorities and Olympus made strenuous efforts to bury any real investigation. Olympus officials repeatedly denied any wrongdoing. The Japanese government and financial regulators tried to minimize the scale of the crime.

As early as November, the Japanese government leaked to the press that Japan’s Securities and Exchange Surveillance Commission (SESC) would only recommend that Olympus Corp. be fined under the Financial Instruments and Exchange Law for repeatedly window-dressing its accounts. According to the Yomiuri, Japan’s largest newspaper, the commission reportedly did not seek criminal prosecution of the company, “because Olympus was going to retroactively make adjustments to its books.” Sources close to the SESC said that the leaks to the press came from the office of the Minister of Financial Services and that they were a surprise to the ground level investigators, who felt they had been hamstringed. Officially the SESC refused to comment on what recommendations they did or did not make.

The same sources when reached today said, “It’s obvious that there was a crime committed and the prosecution and police are doing their jobs well. Why the top people in our agency felt that only administrative punishment was appropriate is a mystery.” According to several sources, since 2009, when Shizuka Kamei, who is also known for his links to the organized crime syndicate, the Yamaguchi-gumi, was appointed the Minister of Financial Services, the agency has been turned from a pit bull cracking down on criminal activity in Japan’s financial world into a lap dog of the ruling coalition. During Kamei’s reign under the guise of “freeing up credit”, the Financial Services Agency inspections manual was rewritten to be laxer and banks were strongly encouraged to loan money without doing strict due diligence. This greatly benefitting organized crime entities which often take out small business loans on fraudulent pretenses and default on them, keeping the bulk of the money. The current minister of financial services, Jimi Shozaburo, is a member of Kamei’s political party and his protégé.

J-Bridge, one of the companies involved in Olympus’s fraudulent investments was listed as a Yamaguchi-gumi front company by the Japanese government, and former executives of the firm have been convicted for insider trading.

Unanswered Questions and the Unusual Suspects

Sources close to the investigation say that those involved in the Olympus scandal are certainly more than the seven people arrested today and as Michael Woodford has pointed out, there are many questions still unanswered.  For example, there still has not been an accounting for the ¥70 billion paid by Olympus between 2006 and 2008 for three Japanese start-ups--Altis Co., an industrial waste disposal firm; Humalabo Co., a health food and cosmetics sales firm; and News Chef Inc., a cookware manufacturer and investment advisor. The money was funneled into six investment funds based in the Cayman Islands and elsewhere. How much of that fell into the hands of criminal elements getting a kickback from the deals? (No one covers up financial losses out of the goodness of their heart). Why were three of the chief suspects in the crime former Nomura Securities employees?

One of those three ex-Nomura boys is Akio Nakagawa, former head of Axes Japan Securities. Although the firm’s website has long since vanished (as has the money they handled)—a peek at their former website in English is enough to make anyone dubious. Admittedly, in Japan, there is a saying, “The customer is God” (お客様は神様) but it’s a rare thing for a financial services CEO to promise a massage to his best customers.

On the other hand, when a firm claims their ambition is to “establish our axes in the international financial arena”, one can’t help but wonder why they can’t afford to hire someone to do a simple spell-check. Maybe they thought no one would ever look too closely. Well, maybe they did become “an axis in the international finance arena” if you consider financial crime part of that arena. Maybe the greatest mistakes Olympus made was not in trusting “Axes Japan” but in giving Michael Woodford the axe.