SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. Litigation Release No. 15861 / August 27, 1998 Accounting and Auditing Enforcement Release No. 1070 / August 27, 1998 Securities and Exchange Commission v. The Nikko Securities Co. International, Inc. No. 98 Civ. 2058 (D.D.C.) (August 27, 1998) On August 27, 1998 the Securities and Exchange Commission ("Commission") filed a settled complaint in the United States District Court for the District of Columbia against The Nikko Securities Co. International, Inc. ("Nikko New York"). The Commission's complaint alleges that Nikko New York, in connection with certain sales of its mortgage- backed securities ("MBS") portfolio, violated the broker- dealer recordkeeping and reporting provisions of the federal securities laws. The complaint further alleges that Nikko New York failed to comply with the terms of a prior order issued by the Commission in May 1993 requiring Nikko New York to comply with these same recordkeeping and reporting provisions. Without admitting or denying any of the allegations in the complaint, Nikko New York consented to the entry of a final judgment which orders Nikko New York to comply with the Commission's prior order and to pay a $2.5 million civil penalty. The complaint alleges that from August to November 1994, Nikko New York, by improperly using an internal interest rate forecast rather than the market's interest rate forecast, overstated the fair value of its MBS portfolio in its books and records and FOCUS reports filed with the New York Stock Exchange. The complaint alleges that during the summer of 1994, MBS market prices declined following an increase in long-term interest rates and a drop in demand for MBS derivative securities like those held in the Nikko New York portfolio. Consequently, the fair value of Nikko New York's MBS portfolio declined. The complaint alleges that Nikko New York carried the MBS portfolio at values exceeding fair value by $9.6 million at the end of August 1994 and by $17.5 million by the end of October 1994. The complaint alleges that in November 1994, Nikko New York sold the majority of the MBS portfolio to its London-based affiliate, Nikko Europe Plc ("Nikko Europe"), for $134 million, at least $17 million above fair value. Nikko New York then improperly booked the entire transaction as trading proceeds and failed to report the $17 million loss that would have been recognized had the securities purchased by Nikko Europe been properly valued. Several months later, in February 1995, Nikko New York, acting as broker for Nikko Europe, sold a portion of the MBS portfolio. In connection with those sales, two Nikko New York employees violated the antifraud provisions by misappropriating approximately $842,000 from Nikko Europe. The employees arranged to sell the MBS portfolio securities in four swap transactions with an unaffiliated broker in which the prices were deliberately marked down to allow Nikko New York to profit at the expense of Nikko Europe. In order to conceal the scheme, the employees falsified the books and records to hide the illicit profits. As a result of these activities, Nikko New York's books and records and FOCUS reports were inaccurate. Throughout the period of these violations, Nikko New York was subject to a May 19, 1993 Commission administrative and cease-and-desist order for violating the same provisions and was working with a consultant on a report to be delivered to the Commission with respect to its compliance with the Commission's outstanding order. In a related settled cease-and-desist and administrative proceeding (In the Matter of The Nikko Securities Co. International, Inc., Masao Ebina, Tadao Osada, and Toshiyuki Sagiuchi, Admin. Proc. File No. 3-9687), the Commission found that Nikko New York violated the broker-dealer recordkeeping and reporting provisions, and failed reasonably to supervise its employees with a view to preventing violations of the antifraud provisions and broker-dealer recordkeeping and reporting provisions of the Exchange Act. Without admitting or denying the Commission's findings, Nikko New York settled the administrative and cease-and-desist proceedings. The Commission censured Nikko New York, ordered Nikko New York to cease and desist from committing or causing any violations and any future violations of the broker-dealer recordkeeping and reporting provisions, and further ordered Nikko New York to appoint two unaffiliated directors to constitute an audit committee. The Commission also found that three senior officers of Nikko New York, Masao Ebina (Chairman and Chief Executive Officer during the relevant period), Tadao Osada (President during the relevant period) and Toshiyuki Sagiuchi (Senior Vice President and General Manager of the Fixed Income Division during the relevant period) each knew that Nikko New York's books and records relating to its MBS portfolio were inaccurate, but failed to take steps to correct them. The Commission found that Ebina, Osada and Sagiuchi willfully aided and abetted Nikko New York's violations of the broker-dealer recordkeeping and reporting provisions. In addition, the Commission found that Sagiuchi failed reasonably to supervise the two Nikko New York employees in connection with the swap transactions. Without admitting or denying the Commission's findings, all three settled the administrative and cease-and-desist proceedings. The Commission suspended Ebina, Osada and Sagiuchi from association with any broker or dealer for a period of six months, ordered each to cease and desist from committing or causing any violation or any future violation of the broker- dealer recordkeeping and reporting provisions and further ordered each to pay a $50,000 civil penalty. The Commission is continuing its investigation of the matter.