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Japan Post scandal shows external directors unable to do their jobs

Lack of communication, skepticism and risk management put Japan Inc in harsh light

The resignations of group presidents Kunio Yokoyama, left, Masatsugu Nagato, and Mitsuhiko Uehira have done little to explain how the Kampo insurance scandal was allowed to fester. (Photo by Arisa Moriyama)

TOKYO -- The insurance sales scandal that this week chased three presidents from Japan's postal services group has cast a harsh light on external directors' ability to spot illicit corporate activities.

On Dec. 27, the Financial Services Agency ordered Japan Post units to suspend parts of their operations for three months. The group later announced the resignations of three company presidents, including Masatsugu Nagato, president and chief executive of Japan Post Holdings.

The resignations took effect on Sunday.

The scandal reflects an absence of corporate governance at the postal services group. But it also shines a light on a lack of thorough risk management by external directors and shows how difficult group governance can be at public companies and their listed subsidiaries.

Questions are arising about whether these directors -- often excluded from, or unwilling to learn of, crucial information on corporate activities -- can really play their roles when companies are at risk.

In a report released on Dec. 18, a special committee of external lawyers blamed the scandal on the ineffective utilization of external directors and other "outside" board members. "The (illicit sales activities) were caused due to directors' and auditors' lack of knowledge and their unwillingness to find out about the problem," an external director at Japan Post said.

Another of Japan Post's external directors said these board members "only received reports on the number of cases deemed illegal and how the figures were improving." This allowed the organization to carry on with allegedly abusive sales tactics.

Both Japan Post Insurance, the insurance unit of the postal group, and its holding company, Japan Post Holdings, have nominating, audit and compensation committees under their boards of directors. External directors make up a majority of the committees' members. Japan Post -- responsible for selling the postal group's life insurance products, known as Kampo, to private customers -- also has an audit committee with a majority of external directors.

"The Japan Post fiasco reaffirmed that adding external directors and setting up committees may give the impression of strong corporate governance but is not enough to build a thorough risk management system," said Tadashi Kunihiro, a lawyer specializing in corporate risk management.

A similar mirage kept an accounting scandal at Toshiba from coming to light before it finally rocked the conglomerate in 2015. Toshiba had the same three committees, though the chairman of its audit committee was an internal director. A third-party report revealed how a request for a probe was made by an audit committee member but was ignored by the chairman.

"This audit committee member never told the external directors about the possible accounting issue," Kunihiro said. "The risk information was kept internally, and outside directors could not get involved as they should have."

In the case of the Kampo scandal, it is unknown how much information each director was given regarding the sales malpractice. Yoichi Namekata, a lawyer specializing in financial scandals, wondered whether external directors should have been more skeptical and forceful in carrying out their duties. "The external directors," he said, "were informed of unlawful sales cases that needed to be reported to the Financial Services Agency. However small the number was, they should have been more dubious of the situation. It may not be considered a violation of [their duty] but can be seen as negligence."

In the amended Companies Act, passed in 2019, large listed corporations with audit committees that submit annual securities reports are required to appoint an outside director. The revision also allows companies to partially outsource their business operations to external directors. With the new law in place, outside directors are expected to not only list their names as directors but improve governance on an operational level -- one that external directors at the postal services group were far from achieving.

A lack of communication between the holding company and group companies was also at play in allowing the pressure sales tactics to fester. Japan Post Holdings owns all issued shares of Japan Post and 64% of those of Japan Insurance. However, the report points out that "there was no consensus among the directors on the role of the holding company and how group governance should be shaped."

The report also says that while some directors insisted that "the holding company should have monitored the group's corporate governance," others maintained the position that "listed subsidiaries should be responsible for their own governance, while the holding company focuses on coordinating various interests among its group companies." In the report, some interviewees said hotlines need to be set up between the subsidiaries.

But overall, no clear picture emerged regarding the role of the holding company.

"Japan Post has set up a groupwide medium term business plan and sales goals," Namekata said. "The holding company should have been mindful of the associated risks."

Takayuki Asami, a lawyer specializing in corporate legal affairs, said the report's quotes from directors are a "telling sign that these directors were not fully competent. The fact that some of them defined the role of a holding company simply as 'a coordinator' shows how little they understood the standards of group governance required today."

Finding effective ways to govern subsidiaries is an urgent matter, especially at large corporations, where conflicts of interests could emerge between a holding company and the shareholders of its listed subsidiaries. Operational guidance on group governance systems released in June by Japan's Ministry of Economy, Trade and Industry states that it is "practical" for parent companies to ask listed subsidiaries to discuss matters relating to a group's risk management.

In mismanaging risks, the postal group showed how difficult it is to maintain corporate governance at state-owned enterprises that have been privatized.

The former Japanese National Railways (today's Japan Railways family), Nippon Telegraph and Telephone Public Corporation (today's NTT group) and Senbai Kosha (today's Japan Tobacco) all massively expanded after privatization.

Faced with the shrinking domestic tobacco market, JT in 2007 acquired its U.K.-based peer Gallaher Group. JT offered large incentives to directors who started their careers at the company, and expanded through mergers and acquisitions inside and outside Japan. The company is now one of the world's largest tobacco companies, with a market capitalization of 5 trillion yen (around $46.2 billion), a nearly threefold increase from 2000.

Like Japan tobacco, Japan Post Holdings realized its business was also shrinking. But it has had to manage the challenge while also providing services everywhere in the nation. Another issue: The nature of postal services make it prone to heavier interference from the government and politics. This has resulted in an inappropriate back-scratching relationship. In one favor, the government leaked information to the postal group about impending administrative sanctions due to the insurance scandal. This played a role in this week's resignations.

But the resignations have not put the scandal to rest. Shareholders have yet to receive adequate information they can use to question the directors about their responsibility. The postal group's special committee report notes that a probe into the improper sales practices and the extent to which the directors were aware of the problem is expected to be completed before April.

Which of the directors knew of the illicit sales tactics, how did they process the information and what steps did they take? There is much to be clarified if the group is to regain the trust of the market, its customers and business partners -- and if it is to dispel doubts about Japanese corporate governance.

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