Brief History and background of Daiwa Bank

Daiwa bank was established in Osaka by Tokushichi Nomura in May 1918 with Osaka
Nomura bank as its first name. The first operation of the bank was launched in August 1918.
The bank is created to fully utilize the advantage of the new capital which Japan has collected
from foreign commercial ventures and domestic industrialization. Besides that, it helps to
provide financing to small but promising companies where the bank can support the
companies to expand their operation even in difficult economic condition. Due to huge
growth in volume and profits, the securities division was split up and established as a
securities company in 1926. Daiwa become the first of Japan financial institutions that
manage both ordinary banking and trust business as a result of merging with Nomura Trust
Company Limited in 1944. After the war period, the bank changed its name to Daiwa Bank
Limited in 1948 after the dissolution of large financial conglomerates. On the same year,
Daiwa Bank open up a foreign department and a year after, it was approved as a foreign
exchange bank. Based on the asset size, Daiwa Bank was announced to be one of the top 20
banks in the word. The New York branch was established to handle the custody of the US
treasury bonds which they bought for themselves and also on behalf of the customers. Daiwa
Bank made its profits through lending, but when it comes to high-volume securities trading; it
failed to enforce proper oversight procedures.

What happened?
Toshihide Iguchi who was a car dealer before, became the vice president of Daiwa
bank after 7 years already joined Daiwa in 1976. In Daiwa, Iguchi learned on how to operate
small back office that handle the securities business. During this period, he reported to begin
his illegal trading in U.S. Treasury Bonds where he lost about $200 000 while trading those
bonds. To cover the losses of few hundred thousand dollars which he had incurred early on
in his trading activities, he enticed into selling off bonds in the Bankers Trust sub-custody
account. Besides that, he also sell US government securities which owned by Daiwa to
address the losses by forging account statement, 30 000 trading slips and other documents to
hide the sales of securities.

Iguchi settled the customer’s account by selling more securities and changing more
records if in case customers want to sold off securities that Iguchi had already sold off on his
own accord, or when customers want to paid interest on the bygone securities. In the end, to
recover back the trading losses incurred by Iguchi, about $377 million securities which
owned by Daiwa’s customers and about $733 million of Daiwa’s own investment securities
had been sold off by Iguchi. However, by the early 1990s, it became hard for Iguchi to
continue cover his tracks especially after 1993 when hardly make an effort to split up its
trading and back-office functions.

Iguchi conceal the facts for 11 years, that he created $1.1 billion worth of loses while
working for Daiwa Bank. What made Iguchi success to hide his malpractice for such a long
period was because he had several “co-operators”, employee in the bank’s custody
department and several brokers and traders who secretly helped him hide his wrongdoing.
This crisis tainted the image of Japan Financial Institutions and gave large impact to current
and former officials as they are needed to paid $775 million as a compensation to
shareholders.
What things went wrong?

Even tough senior manager of Daiwa already received confessions from Iguchi, they
did not report to US regulators immediately to cover the loss incurred from being known.
They tried to shift the loss to Japan to avoid inspection by US regulators. Even the Ministry
officials in Tokyo procrastinate on notifying the U.S Federal Reserve after discover about the
problem on August 8. The US Federal Reserve Board only discloses about the loses on
September 15, 1995 because Daiwa don’t want to harm their financial viability which may be
affected by the sudden revelation of the loss amount.

What make Iguchi’s wrongdoing stay unknown for 11 years was because Daiwa and
its internal auditors never verify the custody account statements by their own.

Prosecutors have accused Daiwa Bank and several top executives of conspiring for months to
cover up $1.1 billion in losses incurred by a trader, Toshihide Iguchi, through unauthorized
bond trading. In addition to the confession letter from Mr. Iguchi that set off the whole chain
of events, prosecutors say Mr. Iguchi wrote at least four more that figure in the cover-up.
Moreover, the two-month delay between when Iguchi informed his superiors about the losses
and when Daiwa told regulators here about them itself apparently violates U.S. and New
York state banking laws. Mr. Iguchi first confessed his losses in an extensive letter sent to
Daiwa's president in mid-July. Daiwa did not disclose the huge losses to American regulators
until late September, two months after Toshihide Iguchi, an executive at the bank's New York
branch, confessed to executives at Daiwa that he had lost $1.1 billion over 11 years in
unauthorized bond trading and that he had then illicitly sold securities belonging to the bank
and its customers to cover up his losses. Even when the bank did report the losses, as is
required by law, it attributed them to a rogue trader and did not mention that it had known
about the losses since July.

“What happens is that managements don’t ask any questions as long as things seem to be
alright,” Doug Henwood, editor of the New York-based Left Business Observer, said. “As
long as the trading desk is working well, they don’t watch.”

How things went wrong?

Iguchi’s problems began when he started hiding small trading losses by

selling bonds in sub-custody accounts in an attempt to trade his way out of
trouble, but the losses spiraled out of control. The bank's failure in implementing a
proper risk management and internal control system was the biggest blunder.

All in all, he supervised the securities custody department at the New York branch from
approximately 1977 right through to 1995. This lack of segregation, a relatively common
feature of small trading desks in the early 1980s but already a discredited practice by the
early 1990s, led to Daiwa’s downfall

In the late 1970’s, Iguchi was promoted to bond trader while still maintaining his duties as
clerk in the securities deposit department. This allowed him access to two major
responsibilities and to take advantage of each position and its authority. He learned the
process of trading bonds, the paper work that was required to complete transactions, and how
to seamlessly deposit securities. It was a perfect opportunity to learn each process and find
holes in the system to conceal fraud.

During this time, Iguchi’s financial transactions were not maintained or properly recorded as
a financial institution or international financial institution. His process was to first trade then
record trades manually on paper rather than on a computer. Trading transactions could not be
over seen by the Daiwa corporate office due to this process. This created the ability to freely
make trades and conceal and alter transactions when needed. In 1979, Iguchi became
executive vice president and head of government and bond trading in the New York branch
where he answered only to himself.

The fact that Iguchi was able to conceal the losses for a period of 11 years showed that there was
inadequate control and supervision of Iguchi's trading activities. His superiors failed to manage him
properly and instead gave him full control of the New York branch. This allowed him to set
his own schedule, standards, rules, and operate the branch how he deemed fit. In addition,
Iguchi was seen as a “trustworthy” employee due to his history with Daiwa, position,
dedication, and sacrifices he made as a vice president and bond trader. This gave confidence
to his superiors that they did not need to oversee Iguchi or question his actions. Iguchi’s
expertise in the US government bond market was something that no one else in the company
could match.

Daiwa failed to train or hire another worker in the field which allowed Iguchi to take full
control of its operations and responsibilities without another’s input of his actions. Daiwa
Bank had numerous opportunities for fraud in its New York branch office. These
opportunities for fraud could have been avoided in the past; however, creating a strong action
plan will help deter opportunities for fraud in the future. Deterring Fraud in the Future
Opportunities of fraud almost always lead to the occurrence of fraud. The best defense for
this is the need for a strong action plan to deter fraud in the future.

Daiwa lacked in several areas including strong internal controls and conducting regular
internal and external audits. Strong internal controls are essential to the proper management
of a company’s operations and success. Daiwa did not exercise the separation of duties in its
New York branch. Separating of duties can ensure that each positions process is efficiently
executed by being checked by an independent party. The implementation of a separation of
duties also prevents a single business process from being completely managed by a single
individual.

This increases the difficulty of successfully performing fraudulent activities which reduces
them in return. Daiwa and Iguchi did not use a company system or computer system to track
transactions made by employees. Requiring all banking transactions to be reported in a
company computer system is beneficially to management and the accounting
department. Activity of each employee and branch can be monitored which can
ensure duties are being fulfilled and fraud is not being performed. Daiwa’s Japan
corporate office failed to supervise and over oversee Iguchi and the New York
branch.

Increased oversight of international branch’s and branch executives ensures that

operations are in accordance to company objectives and processes, and abide by
government laws and regulations. Daiwa depended solely upon Iguchi to trade
bonds in the US market because the company failed to train or hire another
individual with similar expertise. Employing more than one knowledgeable and
skilled individual in a specialty field increases its effectiveness and decreases
issues related to improper actions. Daiwa failed to conduct regular internal and
external audits of company policies and financial statements. . Iguchi was given charge
of both trading and back-office duties and consequently, was well placed to manipulate the
statements received from the Bankers Trust...

Regular internal and external audits can determine whether financial statements are
in accordance with company policies and government standards. Audits can also
disclose fraudulent transactions and discrepancies. Daiwa Bank had numerous
opportunities for fraud which lead to Iguchi’s ability to conceal trading losses for
such an extensive period of time. In order to prevent a similar situation from taking
place, it is essential to find why these violations occurred in the first place.
Creating a proper action plan is essential to deter fraud in the future.

..

Effect of the crisis

Daiwa president Fujita said that he and the bank’s chairman would take 30 percent pay cuts for the next six
Federal and
months, and that other bank directors would have salary cuts of between 10 and 30 percent.
state bank regulators yesterday ordered Daiwa Bank Ltd., the big
Japanese bank, to close its operations in the United States within
three months. The order came as a Federal grand jury accused the
bank of illegally covering up $1.1 billion in trading losses at its New
York branch. If convicted, Daiwa could face fines of as much as $1.3
billion. The charges against Daiwa include conspiracy, mail and
wire fraud, obstructing an examination of a financial institution,
falsification of bank records and the failure to disclose Federal
crimes. 'The Daiwa case has increased overseas expectations for the
ministry to tighten its supervision and exact stiffer penalties,' said Jim
McGinnis, senior financial analyst at Schroder Securities Ltd. 

the Federal Reserve ordered Daiwa's New York branch to cease most
trading activities. Takemura, the Japanese finance chief, announced
yesterday that his agency may order a full or partial suspension in
Daiwa's business. The bank's president and two other top executives
resigned on Monday to take responsibility for the crisis, in which senior
Daiwa officials are expected to face questions from the FBI. Daiwa's
problems have hurt the stock market performance of other Japanese
financial institutions, with foreign investors especially having grown leery
of banking issues. 

Five years later, Daiwa was still enduring the impact of the New York scandal when a
Japanese court ruled on the shareholder suit when a number of former and current
management officials were ordered to pay $775 million in damages to shareholders for
failing to properly oversee Iguchi's trading.

References

https://www.referenceforbusiness.com/history2/2/The-Daiwa-Bank-Ltd.html#ixzz6SHdPtFNz

https://www.icmrindia.org/casestudies/catalogue/Finance/Daiwa%20Bank%20-%20Lessons%20in
%20Risk%20Management%20-%20Finance.htm#Exhibits

https://www.cnbc.com/2014/04/29/im-not-a-criminal-daiwa-rogue-trader-who-lost-1-billion.html

https://phdessay.com/daiwa-bank/

https://studymoose.com/daiwa-case-study-essay

http://www.ipsnews.net/1995/09/japan-finance-daiwa-scandal-leads-to-questions-on-bank-
oversight/

https://www.upi.com/Archives/1995/10/12/Japan-admits-error-Daiwa-Bank-crisis/1233813470400/