TOKYO, May 28 (Reuters) - The escalating probe into insider trading at Nomura highlights one of the worst-kept secrets in the Japan market: for years brokers have fed clients confidential information on stock offerings with little fear of a regulatory crackdown.
The spotlight is on Nomura after the emergence this weekend of a second case in which sources say an employee at the broker told a fund manager about a share offering before it was made public, giving its client an unfair advantage to unload those shares.
The Securities and Exchange Surveillance Commission (SESC) has said it is investigating a wide range of deals, including those not underwritten by Nomura, with the aim of stamping out a culture of collusion that has helped give Japan the reputation as a haven for insider trades.
"So far the finger has pointed at Nomura because they had an overwhelming percentage of stock offerings. It's not surprising that their name keeps coming up," said Nicholas Smith, Japan strategist at CLSA who has published research on the issue.
"But if you look at the underwriters in the most egregious cases it certainly is not only Nomura."
The schemes under investigation made for very lucrative business that became harder for brokers to pass up as other sources of revenues dried up after the financial crisis, financial industry sources with knowledge of the trades say.
Brokers involved profited in several ways. First they collected underwriting fees on secondary share offerings. At the same time their sales departments collected interest from investors borrowing stock to short. They also won commissions when those same funds bought back the stock to close out the insider trade.
"This is a problem for the sales operations of brokerages as a whole. It's true that we receive a lot of information," said the head of investment at a Japanese hedge fund who spoke on condition of anonymity due to fear of recriminations.
"At the moment all the blame is going to Nomura, but I think other brokers are watching the developments very cautiously."
The SESC is also investigating a share sale by Tokyo Electric Power, underwritten by Nomura, and an offering by Nippon Sheet Glass that was managed by Daiwa Securities Group and JP Morgan Securities, among others.
Nippon Sheet Glass, upset news of its offering had leaked, asked JP Morgan and Daiwa to conduct internal investigations into their compliance, sources with knowledge of the matter said. Both eventually reported back to the company that they were clean, although it remains to be seen what the regulator will determine in its probe.
The SESC's investigations have exposed a weakness in the safeguard known as a "Chinese Wall" designed to keep information on securities underwriting from reaching sales staff.
"There is no way that information crossed our company's Chinese Wall," Daiwa Securities CEO Takashi Hibino told a group of reporters when asked about the SESC's investigations following a strategy briefing this month. "I believe we are OK."
In March the SESC found that a fund manager at a unit of Sumitomo Mitsui Trust Holdings sold shares of energy firm Inpex after receiving a tip on its plans to issue new shares in 2010 before it was made public.
While the SESC did not name the source of the leak, people with direct knowledge say the regulator has evidence it was an employee of Nomura's institutional sales division.
In a similar case, sources said on Saturday the SESC plans to fine the Sumitomo Mitsui unit again, this time for t rading with inside information on the offering of Mizuho Financial Group. Again, a Nomura employee provided the tip, the sources said.
Nomura declined to comment, while Sumitomo Mitsui said in a statement that it was cooperating with regulators. JP Morgan declined to comment. Daiwa could not be reached for comment.
The SESC's probe was prompted in part by the research of CLSA's Smith, who was at MF Global at the time he published a report in 2010 noting the sharp underperformance of Japanese stocks in the weeks before a firm unveiled plans to sell stock.
That trend does not appear to have changed despite increased scrutiny on the issue. While U.S. stocks mirror their benchmark prior to an offering, Japanese shares underperformed by an average of 3.7 percent in the three weeks before announcing a new stock issue, data gathered by Smith for 2011 shows.
Smith believes changes in the law, such as provisions allowing for prosecution of the person that provides the inside information like in the United States, are needed before the regulator can act as an effective deterrent.
For example, in the Inpex case the Sumitomo Mitsui unit was fined 50,000 yen ($630) based on the estimated commission from the trade while the Nomura employee involved is not expected to face official sanctions of any kind.
By contrast, dozens have been convicted in a broad U.S. government crackdown on insider trading in recent years. In the highest-profile recent case, former hedge fund manager Raj Rajaratnam was convicted of 14 criminal charges and is serving a prison term of 11 years.
The SESC set a precedent with Nikko SMBC Securities, ordering it in April to bolster compliance after it was found to have leaked information on a stock offering to retail clients, although no insider trading is thought to have taken place.
What punishment awaits Nomura will not likely become clear until next month when the SESC is expected to conclude a probe it launched in late April by dispatching a team of investigators to the broker's offices in central Tokyo.
Nomura was slapped with an order to improve internal controls following its last insider trading case in 2008, but it could face stiffer penalties this time if the regulator finds the compliance breakdowns to be widespread.
"If the case proves a serious malfunction of corporate governance and the FSA ends up deciding to levy a tough penalty, the reputational risk may negatively affect their client-based business," said Fitch Ratings Director Miki Murakami.