The final chapter in the Olympus scandal

Lawsuit reveals how Commerzbank and other banks together with a number of Cayman Islands registered entities played a part in one of the largest loss-hiding schemes in Japan’s corporate history.    

When Commerzbank agreed to pay $1.45 billion in March to settle U.S. allegations of money-laundering and sanctions breaches, the German bank resolved not only investigations into suspected violations of laws prohibiting transactions on behalf of Iran, Sudan, Cuba and Myanmar, it also closed the final chapter in a multibillion-dollar fraud by Japanese optical equipment maker Olympus Corp. 

The lawsuit revealed how Commerzbank and other banks together with a number of Cayman Islands registered entities played a part in one of the largest loss-hiding schemes in Japan’s corporate history. 

The Olympus scandal came to light in 2011 when British-born Michael Woodford was ousted as head of the company only two weeks after he was named chief executive officer and six months after his appointment as president.  

Woodford, who would turn whistleblower and later write a book about his experience, had raised questions about seemingly irregular and outsized payments for three acquisitions made by his company between 2006 and 2008. 

The transactions, first revealed by Japanese financial magazine Facta, were unusual in that they involved three companies – Humalabo, a face-cream maker, News Chef, a microwave-plate manufacturer and Altis, a medical-waste recycler – that were completely unrelated to Olympus’s traditional business lines of cameras and optical medical equipment.  

The companies were also not particularly successful and had never turned a profit. The purchase price, however, was so high that the acquisitions were immediately written down to a quarter of their book value on the balance sheet of the Nikkei-listed company. 

Moreover, Facta alleged at the time that the sellers of the companies, Cayman Islands-registered Neo Strategic Ventures and Dynamic Dragons II, had ties to organized crime organizations in Japan.  

Another Olympus acquisition of British medical technology company Gyrus for $2 billion in 2008 raised eyebrows for both its excessive price tag and outrageously high consultant fees of $687 million, or 38 percent of the purchase price, paid in cash and Gyrus preference shares to Cayman Islands-based company Axam.  

Axam and U.S.-partner company Axes, a broker dealer, were run by Hajime “Jim” Sagawa, a former Japanese investment banker who lived in Boca Raton, Florida, and who had also spent some time prior to 2007 living in a Cayman Islands condo in Snooze Lane on Seven Mile Beach.  

What Woodford did not know when he ordered an outside review of the deals, and what Olympus was forced to admit later, was that the questionable transactions were part of an elaborate scheme designed to cover up massive losses incurred over more than a decade. 


Olympus losses  

The losses began in the mid-1980s when a sharp appreciation of the Japanese yen against other currencies caused the operating profit of Olympus to fall precipitously, and the camera manufacturer began to engage in a practice known as zaiteku: the boosting of earnings through speculative investments unrelated to the core business. 

These investments suffered substantial losses when the Japanese economy collapsed in 1990. In response, Olympus executives doubled down, increased their risk allocations to the investments and incurred ever higher losses of nearly $700 million by the end of 1990.  

To avoid a markdown and recognition of the loss-making assets in its financial statements, Olympus executives moved the assets into so-called tokkin trusts, Japanese trusts in which a settler-appointed registered investment adviser instructs the trustee in the investments of the trust assets. 

According to Japanese accounting rules at the time, the losses of assets in a tokkin trust did not need to be disclosed as long as their market value did not decline by more than 50 percent.  

However, by 1995 the steadily falling value of the soured ventures made it increasingly difficult for Olympus to find profit-making investments to offset loss-making assets in the trusts. 

Olympus executives had to find another way to hide the losses. 

The company entered into lending arrangements with a number of banks, which entailed funding a deposit account as collateral for a revolving credit facility that would be used to fund the tokkin trusts. 

In its financial statements, Olympus would account for the cash deposits but not disclose that the cash was used as collateral for the loans to the trusts. The trusts drew down $535 million, a sum that was large enough to cover the difference between the market value and the book value of the loss-making investments, and transferred the cash and their portfolios to several entities in Cayman and the British Virgin Islands.  

The offshore entities issued units to the tokkin trusts, which thereby became the owners of the Cayman and BVI companies. The relationship between these entities and the fact that the cash they held was in fact a loan was not disclosed by Olympus in its accounts. 

While the losses were thereby effectively moved off the Olympus balance sheet, it caused the company to lose even more money.  

The U.S. Securities and Exchange Commission, which is one several regulators worldwide that investigated the scheme, noted in documents that “because the complex nature of the scheme required devoted advisers, lawyers, and bankers to execute it, the fees charged proved extremely costly.” 

The fees and interest payments to support the scheme were in fact so large that they soon exceeded the losses they were designed to hide, the SEC said. 

To pay for these costs, the company would arrange additional loans with the same banks. 


Repaying the loans  

The repayment of the bank loans, in turn, called for an additional scheme. The cash collateral for the loans could naturally not be used, as it was not declared as such on the company’s books. 

Therefore, two Olympus executives devised a plan that would divert funds from corporate acquisitions by overpaying for Humalabo, Altis and News Chef and by paying inflated advisory fees in relation to the purchase of Gyrus to Sagawa and Axam in the Cayman Islands. 

SEC documents state that one Olympus executive who had worked with Sagawa in the past approached him with the idea in 2006. Sagawa signed an agreement with Olympus and did, in fact, undertake consultancy work by trying to arrange the acquisition of two target companies by the Japanese camera maker. After the first target was rejected by the Olympus board, the acquisition of Gyrus was completed successfully.  

As part of Axes’s advisory fee, the company was paid $177 million of Gyrus preference shares, which also received a dividend of 85 percent of Gyrus’s net profit and as a result were valued at more than $500 million. Axes transferred its rights to these preference shares to Axam, a company which was controlled by the two Olympus executives who hatched the plan and had Sagawa as its sole director. 

To complete the payment, Sagawa proposed on behalf Axam that Olympus purchase the preference shares. However, after this was initially approved by the board, the company’s auditors objected to the transactions given the exorbitant consultancy fee. The auditors were subsequently replaced. 

One year later, in 2010, Olympus purchased the shares from Axam on the second attempt for an even higher $622 million. Axam then wired the money to the various offshore entities that held the impaired investments so they could repay their loans to the banks. 

In September 2012, Olympus and three of its senior executives pleaded guilty in Japan to inflating the company’s net worth by approximately $1.7 billion. 


Commerzbank’s involvement  

Commerzbank was accused by the U.S. Justice Department of having created and managed parts of the structure that purchased the soured investments, including a charitable trust and a special purpose vehicle named Hillmore Investments Ltd., which would purchase the loan proceeds. The bank was also the lender in the structure and processed $1.6 billion to further the fraud, the Justice Department said. 

The structure was set up via the Commerzbank’s private banking subsidiary in Singapore through a relationship manager, who in September 2013 pleaded guilty in Manhattan federal court to conspiracy to commit wire fraud.  

When this employee moved to Société Générale, the Olympus loss-hiding scheme moved with him. He later managed an Olympus-related entity between 2005 and 2010 on behalf of which he submitted false confirmations to Olympus’s auditors.  

In 1999 and 2000, Olympus executives asked Commerzbank to provide false documents to Olympus’s auditors which would have failed to disclose that certain Olympus cash assets were pledged as collateral for loans from a Commerzbank affiliate. 

The bank declined after it obtained a legal opinion that, as one Commerzbank executive wrote to an Olympus executive, “ma[de] clear that our bank could be subject to both civil and criminal penalties if we are seen to be assisting or facilitating you in the non-disclosure.”  

But the bank’s “executives suggested a variety of ways Olympus could nonetheless fail to disclose the pledge,” the Justice Department said. 

When Olympus brought its business back to Commerzbank in 2005, after a five-year break, bank executives expressed strong suspicions about the Olympus transactions and structure. One senior executive was anxious that Olympus would have to “write off [the] full amount” of the relevant transactions, and considered the effects it would have on the bank if “any negative news is splash[ed] on the front page.”  

A senior legal and compliance officer responsible for Commerzbank’s Singapore branch and affiliates wrote at the time that he was “concerned” about fraud, asset stripping, market manipulation and tax offenses, and that “[i]f the [Olympus] structure and transactions can not [be] explained we must file Suspicious Transaction report as a matter of law and [Commerzbank] policy.” 

The investigations by U.S. authorities revealed that while the bank’s transaction monitoring was apparently working, additional due diligence of anti-money laundering “alerts” frequently failed as “alerts” were closed without any or sufficient information obtained in response to requests for information sent to affiliates.  

In March 2010, Commerzbank’s anti-money laundering monitoring software flagged two wire transfers for $455 million and $67 million from the Olympus scheme that were processed through Commerzbank’s New York branch on behalf of its Singapore subsidiary. The Singapore branch responded to a follow-up stating that the customers involved were a Cayman Islands special purpose vehicle and a fund administered by Commerzbank, which were both part of a structure to manage securities investments on behalf of a multinational corporation. And according to the relationship manager, the payments reflected the proceeds from securities transactions. 

The Singapore branch did not relay any of its internal concerns about the transactions.  

Commerzbank filed its first suspicious activity report in relation to any of the Olympus entities in November 2013, more than two years after the accounting fraud was revealed, the Justice Department said. 

In a statement about the $1.45 billion settlement with U.S. authorities, Commerzbank’s CEO Martin Blessing said, “We take these violations very seriously and deeply regret the actions that led to [the settlement].” 

The bank will continue to make changes to its systems, training and personnel to address the deficiencies identified, he added. Commerzbank also said it plans to more than double its U.S.-based compliance staff by 2016. 

In 2012, former Olympus CEO Woodford received $16 million in an out-of-court settlement with the company. 

In February 2015, the SEC and Hajime Sagawa came to a settlement which effectively bars Sagawa from acting in the securities business. 

The Japanese camera maker’s shares, which collapsed by more than 80 percent in the wake of the scandal, have recovered and now trade nearly 10 times their Nov. 11, 2011, low. 


Martin Blessing


Michael Woodford