Risks Relating to the Group and its Business
The Group has a limited operating history and has incurred net losses in the past
Monex Group, Inc. (formerly known as Monex Beans Holdings, Inc.) was established in August 2004 as the holding company for Monex, Inc. and Nikko Beans, Inc. ("Nikko Beans"), each of which began operations as an online securities company in Japan in October 1999. On 1 May 2005, Monex Inc. merged into Nikko Beans with Nikko Beans as the surviving company (immediately after the merger, Nikko Beans changed its trade name to Monex, Inc. ("Monex")) and their operations and information technology systems were integrated and unified. Due to the effects of the integration, the Group's historical financial statements and operating data may be of limited value in assessing its future results.
In addition, according to the Issuer's Company Law Financials, the Issuer incurred an audited consolidated net loss of ¥2,145 million for the year ended 31 March 2009. The net loss was principally attributable to a significant downturn in the Japanese economy and securities markets resulting in a reduction in commission revenues and the write-off of investment securities. Although the write-off of investment securities for the year ended 31 March 2009 was unusally high compared to previous years, the Issuer believes that such significant write-offs are non-recurring and that in any event the total residual amount held in investment accounts as at 31 March 2009 (¥6.8 billion) does not constitute a significant proportion of the Issuer's audited consolidated total assets. There can be no assurance, however, that the difficulties the Issuer experienced for the 2008/2009 financial year will not persist or reoccur in the future and adversely affect the Issuer's business and financial condition and results of operations.
Market condition and volatility in stock trading volumes may adversely affect the Group's brokerage business
A significant majority of the Group's consolidated net operating revenues is derived from brokerage commissions. For the year ended 31 March 2009, brokerage commissions accounted for 54.0 per cent. of its consolidated net operating revenues (as derived from the Issuer's Company Law Financials). Accordingly, the Group's operations are directly affected by conditions in the Japanese securities markets. The Japanese securities markets are volatile and influenced by factors such as changes in levels of investor confidence, general economic conditions in Japan, trends in other major world markets and political and regulatory developments in Japan and elsewhere. The current downturn in the Japanese economy and securities markets may have an adverse effect on both the Group's revenues and future growth prospects through decreased trading volumes or otherwise. Furthermore, trading activities by its customers and individual investors in Japan have experienced volatility. Trading volumes are sensitive to market performance and general economic conditions, as well as factors such as unexpected news or events, corporate results and regional political tensions. Trading activities by highly active major investors also affect market volatility. Changes in the behaviour of such investors could have a material adverse impact on the Group's results of operations. Volatility in the trading volume of the Group's customers caused by these factors directly results in volatility of its earnings and may have a material effect on the Group's financial condition and results of operations. As a result, the unpredictability of the level of market participation by individual investors in Japan may make it difficult to evaluate the Group's performance and assess its future prospects.
Increased competition for individual investor accounts may force the Group to lower its brokerage commissions
The operating environment for the Group's online brokerage services and foreign exchange margin trading business in Japan, is becoming increasingly competitive due to an increasing number of newcomers into the market. In addition, due to financial deregulation, it is expected that the Group will increasingly need to compete against large Japanese integrated financial service groups newly entering into such markets.
As a consequence, the Group intends to focus on strengthening its business by providing differentiated financial services to gain a competitive advantage over its competitors. However, if such strategy to differentiate itself from competitors is not successful, it may lead to a decrease in profitability of the Group and have an adverse effect on the business and financial condition of the Group.
Expanding the range of the Group's products and services exposes the Group to various risks
A major part of the Group's business strategy has been, and continues to be, expanding the range of its products and services including business outside Japan. Expansion of its business activities to offer new financial products and services exposes the Group to a number of risks and challenges, including the following:
- new business activities may require greater marketing and compliance costs than its traditional services;
- new business activities may have less growth or profit potential than the Issuer anticipates, and there is no guarantee that they will become profitable at the level the Issuer desires or at all;
- the Group may fail to identify and offer appealing new services in a timely fashion, putting it at a disadvantage with competitors that offer those services;
- competitors of the Group may have substantially greater experience and resources in relation to the business activities the Group wishes to commence, and the Group may not be able to attract customers to its services from competitors with existing relationships with those customers;
- the Group may need to hire or retrain personnel who are able to supervise and conduct the relevant new business activities; and
- the Group may need to add to the capability of its information technology systems to support a broader range of activities.
However, there can be no assurance that the Group will be able to achieve the administrative, systems and logistical improvements necessary to achieve its goals and other aspects of its growth effectively. In addition, competition for highly skilled business, technical and other personnel is high due to the increasing competition in Japan's financial services industry. Accordingly, the Group's personnel expenses may increase or it may have difficulty in recruiting and retaining properly qualified personnel. Furthermore, to the extent its business model and practices are unfamiliar to regulators, the Group may encounter unexpected restrictions on its planned activities.
The Group is subject to credit risk by extending margin loans to clients
The Group makes margin loans to clients collateralised by client securities and borrows securities to cover trades. A portion of the Group's operating revenues is derived from interest on margin loans. By allowing its customers to trade stocks on margin, the Group runs the risk of realising amounts less than amounts owed to the Group under the margin loans if the Group forecloses and sells collateral securities (upon a default by the customer) at a time that stock prices are low or declining. Some shares that the Group allows customers to deposit as collateral, for example, shares listed on the Market for the High-growth and Emerging Stocks (the "MOTHERS") of the Tokyo Stock Exchange, Inc. (the "Tokyo Stock Exchange"), may be less liquid than others. Their relative illiquidity increases the risk that the Group would not be able to recoup the full amount of its margin loans by selling these shares. Furthermore, the Group itself may need to provide additional collateral if a market decline reduces the value of the collateral previously given to securities finance companies, which lend the Group a significant proportion of the funds necessary to provide margin loans. Although the Group's margin lending policies are designed to reduce these risks, it could incur material losses in the event of a significant market decline or disruption, which may materially adversely affect the Group's financial condition and results of operations.
The Group faces risks associated with the underwriting of offerings of securities
The business of securities underwriting exposes the Group to different legal requirements, risks and uncertainties from those of brokerage services. The Group has investment risk on securities it underwrites on a firm commitment basis and may suffer additional losses as a member of an underwriting syndicate if an offering is not successful. The Group may face claims or litigation from disappointed investors or lose the trust of its customers if investors in its underwritten offerings incur losses.
Divestment by the Issuer's major shareholder of its shareholdings may adversely affect the Group's business and results of operations
As at 31 March 2009, approximately 26.29 per cent. of the Issuer's issued shares were beneficially owned by Nikko Citi Holdings Inc. (changed its name to Citigroup Japan Holdings Corp. on Oct. 1, 2009), the Issuer's major shareholder. If Nikko Citi Holdings Inc. sells or transfers its shareholdings in the Issuer to a third party, such third party's strategic goals may not be aligned with the Group's strategy which may adversely affect the Group's business and results of operations.
The Group's reputation and business could be harmed and it could be subject to legal claims if there is unintentional disclosure or misappropriation of its customers' personal information or other breaches of its security
Any disclosure or misappropriation of customer information or other breach of its security would likely have a serious impact on the Group's reputation and could significantly adversely affect its business. The secure transmission of confidential information over the internet and other public telecommunication networks is a critical element of the Group's online brokerage operations. There can be no assurance that customer information has not been and will not be disclosed or taken without consent or that the computer systems of its third-party service providers or business counterparties will not be compromised. If a third party is able to penetrate its or its service providers' network security or otherwise misappropriate its customers' personal trading account information, the Group could be liable for unauthorized trades, impersonation or similar fraud claims, and its reputation could be damaged. Inadvertent disclosure or misappropriation of customer information by its own employees would subject the Group to similar risks. The standards applicable to the Group have become more stringent under the Personal Information Protection Act in Japan. The heightened standards of care under this law increase the probability of claims from customers in cases of inadvertent disclosure or misappropriation of customer information.
The Group's business relies heavily on computers and other electronic systems, including the internet, and failure of these systems could harm its business
The Group's systems include internet order systems, portfolio management tools, information services and related back office systems. The Group receives almost all of its trade orders through the internet and executes them through a series of computerised processing systems and third-party links such as those linking its systems to various securities exchanges. Any damage to or interruption in the functioning of the internet or these systems would seriously disrupt the Group's operations. Any delay could create dissatisfaction among its customers, lead to claims for compensation, harm its reputation and result in lost commissions or other business opportunities. The Group's systems are vulnerable to damage or interruption from various causes, including:
- hardware or software defects, including design defects in products or in its network and other systems architecture;
- unexpectedly high traffic volume;
- natural disasters;
- power loss;
- human error, sabotage, hacking or vandalism; and
- computer viruses.
In addition, because the Group's operations and the data facilities of its service providers are concentrated in the Tokyo area, an earthquake or other disaster affecting the Tokyo area could significantly disrupt its entire operations. The Group does not maintain insurance coverage for damages relating to casualty loss in the event of such disasters or for business interruption and there can be no assurance that its third-party service providers would be able to resume service in a timely fashion in the event of any such disaster.
Loss of third-party suppliers of key services may adversely affect the Group's operations
The Group has contracted with third parties to provide it with various back-office and system services. These services include computerised trading/processing system and other related maintenance services, including account opening services, preparation and delivery of execution reports and monthly customer statements. There can be no assurance that any of these providers will be able to continue to provide theses services in an efficient, cost-effective manner or that they will be able to adequately expand their services to meet the Group's needs. Interruption in or the cessation of service by any of these third-party service providers, whether as a result of systems failures, capacity constraints or any other reason, and the Group's inability to make alternative arrangements in a timely and cost-effective manner, may interrupt its provision of services to its customers or increase its operating costs.
The Group depends on its computer link to the Tokyo Stock Exchange, where a significant majority of its customers' orders are placed, for execution of customer orders. Any disruption of that link could similarly prevent the Group from completing customer trade orders. The execution of other customer orders, including foreign exchange transactions and trading in Chinese stocks, depends on the ability of its computer systems to route orders to application service providers or other brokerage firms for execution. Delays or failures in the Group's links to these third parties could prevent the Group from completing customer orders effectively or at all.
The Group's reputation could be harmed and it could lose customers if it is unable to provide its customers with the kind of market information they desire
Individual investors often obtain from their brokers market information and analysis that they desire in connection with their trading activities. The Group relies on third-party content providers to supply all of the financial information, market news, stock quotes and other market data and information that the Group offers to its customers. If the Group loses any of these existing relationships, it will need to find other content providers that can provide similar information on commercially reasonable terms and to integrate their information into its website. During this potentially time-consuming process, the Group's customers could be unable to access market information on its website and may switch some or all of their business to other brokerage firms. Additionally, if the Group's customers perceive that the quality of information being provided by other brokerage firms is superior to the information that the Group provides, they may switch some or all of their business to those competitors. These factors could result in harming the Group's reputation, loss of customers or a decrease in its ability to generate new customers, which in turn could adversely affect its financial condition and results of operations.
The Group may suffer losses if its reputation is harmed
The Group believes that its ability to attract and retain customers is linked to its reputation. As an online securities company reliant primarily on electronic communications to earn the trust of its customers, it may be particularly difficult for the Group to remedy any harm to its reputation. If it fails, or appears to fail, to deal with various issues that may give rise to reputational damage, its business prospects could be harmed. These issues include, but are not limited to, appropriately dealing with legal and regulatory requirements, potential conflicts of interest, ethical issues, money-laundering, customer privacy, record-keeping, sales and trading practices, and the proper identification of the legal, reputational, credit, liquidity and market risks related to its business. Failure to appropriately address these issues could also give rise to additional legal risk to the Group, which could, in turn, increase the size and number of claims and amount of damages asserted against it or subject it to regulatory enforcement actions, fines and penalties. This in turn could result in loss of existing customers, an inability to attract new customers, and otherwise adversely affect the Group's business.
Employee or customer fraud could subject the Group to losses
The Group is exposed to potential losses resulting from fraud and other misconduct by its employees and customers. Employees may bind the Group to transactions that exceed authorised limits or present unacceptable risks, hide from it unauthorised or unsuccessful activities or improperly use confidential information. The Group's customers may engage in fraudulent activities, including fraudulent use of customer accounts or the use of a false identity to open an account. Such types of fraud may be difficult to prevent or detect, and the Group may not be able to recover the losses caused by such activities. Its reputation may also be damaged by such activities. In particular, if customers fraudulently use the Group's accounts for money-laundering or other illegal activities, its reputation could be seriously damaged and it could become subject to significant legal liabilities and regulatory sanctions.
Growth the Group expects in the market for its services may not materialise
The market in Japan for online brokerage services is still evolving. The Group's success depends substantially on continued growth in the use of online brokerage services and increased investment in equity and other securities by individuals. If this growth does not materialise, the Group's business will suffer. Factors that could discourage Japanese individuals from investing over the internet include:
- a general decline in Japanese or international share prices or high volatility in Japanese or international securities markets;
- high minimum transaction sizes and relatively low liquidity for some Japanese shares;
- security and privacy concerns;
- legal and regulatory uncertainty concerning the use of the internet in Japan;
- inconsistent quality of service; and
- frustration with actual or perceived difficulties in using the internet to conduct brokerage and other financial transactions.
Individual investors in Japan have traditionally sought highly conservative investments, particularly after the collapse of the "bubble economy" in the early 1990s. Many Japanese invest exclusively or primarily in guaranteed bank deposits. If the overall investment culture in Japan remains comparatively conservative, the Group's growth opportunities could be more limited than it anticipates.
The Group must continue to adapt to rapid technological and other changes in the online retail financial services industry in order to remain competitive
The online retail financial services industry in Japan is characterised by rapid technological change, changes in customer requirements, frequent service and product introductions and evolving industry standards. The Group's future success will depend in part on its ability to enhance its existing services or to develop new services that address investors' increasingly sophisticated and varied needs, meet evolving industry standards and reflect technological developments in a timely and cost-effective manner. Possible future developments to which the Group may need to respond include the widespread acceptance of electronic commerce networks, proprietary trading systems or other new trading markets that offer payment for order flow, lower usage costs or other benefits to investors or brokerages. Adapting to these changes may require significant capital or operating expenditures. Failure to adapt to these developments could have a material and adverse effect on the Group's business, growth prospects and operating results.
The Group operates in a highly regulated industry and new regulations could adversely affect its business
The securities industry in Japan is highly regulated and the Group could face sanctions for any compliance failures. There can be no assurance that any new regulations would not adversely affect the Group's business by imposing additional costs, exposing the Group to increased liability or otherwise. On 24 March 2009, Monex received from the Financial Services Agency in Japan (i) an order to suspend business requiring the cessation of new business services (aside from those approved by the Financial Services Agency) which involve the use of new system developments for the period between 1 April 2009 and 30 June 2009 and (ii) a business improvement order. The Financial Services Agency has issued such orders as "the management of the electronic data processing system related to financial product transactions is not satisfactory". Monex is conducting strategic improvements to reform its organisation and raise awareness within the company so that similar acts will not be repeated. As the order for business suspension is limited to new business services which involve the use of new system developments, Monex believes that, at this time, the suspension order has not and in the future will not have a significant effect on the Group's business. However any further suspension orders or any other orders from relevant authorities may have an adverse impact on the Group's reputation as well as its business and results of operations.
The Group is required to comply with stringent minimum capital requirements
Japanese laws and regulations require the Group and other securities companies to meet strict capital adequacy requirements. If the Group fails to maintain the required levels of capital, it could temporarily or permanently lose permission to conduct its business. Increases in the aggregate principal amount of margin loans the Group extends to its customers decrease its capital adequacy ratio. It may therefore need additional capital in order to keep its capital adequacy ratio above levels mandated by regulations if the value of margin trades executed through the Group continues to increase. Similarly, engaging in foreign exchange and securities lending businesses also serves to increase the Group's need for capital. There can be no assurance that the Group will be able to obtain additional capital on favourable terms or at all. If it fails to obtain additional capital, it may have to limit margin loans to its customers. It may also have to limit the expansion of its foreign exchange, securities lending and other businesses requiring minimum capital, which could adversely affect its earnings and growth potential.
The Group's membership in the Japan Investor Protection Fund may compel the Group to inject substantial sums into the fund should other securities companies become insolvent
Monex is a member of the Japan Investor Protection Fund, which was established to protect retail investors' assets in the event that securities companies become insolvent. Securities companies in Japan are required by regulation to segregate client assets from their own assets. Nevertheless, if a major securities company that did not segregate client assets becomes insolvent and the fund has insufficient resources to compensate the firm's clients, the fund's members may be required to contribute substantial additional funds to help compensate investors. In addition, the Group is also a member of the National Futures Protection Fund, established by firms in Japan that facilitate commodity trading of their customers, and the Group could similarly be required to provide significant amounts to this fund if another firm engaged in commodity trading were to become insolvent.
The Group and third parties may infringe on each other's intellectual property, and the Group could suffer litigation or licensing expenses as a result
The Issuer believes the software and systems used by the Group do not infringe upon the intellectual property of third parties. However, there is no assurance that there is no current infringement, including due to actions by its third-party service providers, or that in the future its operations will not violate the intellectual property of others. Any litigation brought against the Group in the future may result in damages being awarded against it, orders to pay for the use of previously unrecognised third-party intellectual property or injunctions against continuing aspects of its business. Conversely, despite any precautions the Group has taken to protect its intellectual property rights, third parties may infringe them. In such cases, the Group may take legal action against the violating parties or take other steps to stop the infringement or seek compensation for any ensuing loss, with no assurance of success.
