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Internal Control System

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Internal Control system is a system or an environment to enable activities in companies to ensure appropriateness of business.

Contents

Overview of Internal Control System

Companies are required to execute Internal Control to ensure credibility of financial documents and effectiveness and efficiency of business. The system to enable the effective execution of Internal Control is Internal Control system. For example, a system that "records the access logs concerning financial information" is one example of this.

By establishing Internal Control system, we can appropriately execute Internal Control.

Subjects that are supposed to establish Internal Control system and systems to be established as Internal Control systems are defined in Companies Act and Companies Act Enforcement Regulations.

Things to Be Established as Internal Control System

Companies Act does not refer to Internal Control system by explicitly using the term Internal Control system, but the following mentioned in Companies Act is generally considered as Internal Control system.

"The development of systems necessary to ensure that the execution of the duties by the directors complies with the laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company"

The systems to be established as "systems necessary to ensure that the execution of the duties by the directors complies with the laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company" are defined in Article 98 and Article 100. Article 98 refers to systems in companies without board of directors while Article 100 refers to systems in companies with board of directors. Systems to be established are basically the same for both of them, and the following 9 systems are included.

  1. Systems regarding the management and storage of information related to task execution of executive officers
  2. Regulations and other systems concerning the risk management about loss
  3. Systems to ensure the effective task execution of executive officers
  4. Systems to ensure that employees' task execution complies with laws and statutes
  5. Systems to ensure the appropriateness of business of the business group comprised of the corresponding stock company, its parent companies, and its subsidiaries
  6. Terms regarding employees supporting the tasks of auditors in case such employees are required by auditors
  7. Terms regarding independence of employees, which are mentioned in the previous item, from executive officers
  8. Systems to be used when executive officers and employees report to auditors and other systems related to reporting to auditors
  9. Systems to ensure that other audits by auditors are effectively done

<Article 98 of Companies Act Enforcement Regulations>

  1. Systems prescribed by the applicable Ordinance of the Ministry of Justice written in item 4 of Article 348(3) of Companies Act include the following.
    1. Systems regarding the management and storage of information related to task execution of executive officers
    2. Regulations and other systems concerning the risk management about loss
    3. Systems to ensure the effective task execution of executive officers
    4. Systems to ensure that employees' task execution complies with laws and statutes
    5. Systems to ensure the appropriateness of business of the business group comprised of the corresponding stock company, its parent companies, and its subsidiaries
  2. In case of stock companies with more than one executive officer, the systems defined in the previous paragraph include systems to ensure appropriate business decisions.
  3. Regarding stock companies except for companies with auditors, the systems defined in the first paragraph include systems that are used by executive officers to report matters to be reported to stock holders.
  4. In case of companies with auditors, including stock companies whose statutes limit the range of audit by auditors to matters related to accounting, the systems defined in the first paragraph shall include the following systems.
    1. Terms regarding employees supporting the tasks of auditors in case such employees are required by auditors
    2. Terms regarding independence of employees, which are mentioned in the previous item, from executive officers
    3. Systems to be used when executive officers and employees report to auditors and other systems related to reporting to auditors
    4. Systems to ensure that other audits by auditors are effectively done


<Article 100 of Companies Act Enforcement Regulations>

  1. Systems prescribed by the applicable Ordinance of the Ministry of Justice written in item 6 of Article 362(4) of Companies Act include the following.
    1. Systems regarding the management and storage of information related to task execution of executive officers
    2. Regulations and other systems concerning the risk management about loss
    3. Systems to ensure the effective task execution of executive officers
    4. Systems to ensure that employees' task execution complies with laws and statutes
    5. Systems to ensure the appropriateness of business of the business group comprised of the corresponding stock company, its parent companies, and its subsidiaries
  2. Regarding stock companies except for companies with auditors, the systems defined in the previous paragraph include systems that are used by executive officers to report matters to be reported to stock holders.
  3. In case of companies with auditors, including stock companies whose statutes limit the range of audit by auditors to matters related to accounting, the systems defined in the first paragraph shall include the following systems.
    1. Terms regarding employees supporting the tasks of auditors in case such employees are required by auditors
    2. Terms regarding independence of employees, which are mentioned in the previous item, from executive officers
    3. Systems to be used when executive officers and employees report to auditors and other systems related to reporting to auditors
    4. Systems to ensure that other audits by auditors are effectively done
What is an Employee?
Employees are those who belong to a specific business owner with a employment contract and support the business owner's business.


<Article 348(3) of Companies Act>

(3)In the case provided for in the preceding paragraph, the directors may not delegate the decisions on the following matters to individual directors:

  1. The election or dismissal of managers;
  2. The establishment, relocation and abolition of branch offices;
  3. The matters listed in each item of Article 298(1) (including the cases where such items are applied mutatis mutandis under Article 325);
  4. The development of systems necessary to ensure that the execution of the duties by the directors complies with the laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company; or
  5. Exemption from the liability under Article 423(1) pursuant to the provisions of the articles of incorporation under the provisions of Article 426(1).


<Article 362(4) of Companies Act>

(4)Board of directors may not delegate the decision on the execution of important operations such as the following matters to directors:

  1. The disposal of and acceptance of assignment of important assets;
  2. Borrowing in a significant amount;
  3. The election and dismissal of a important employee including managers;
  4. The establishment, changes or abolition of important structures including branch offices;
  5. Matters prescribed by the applicable Ordinance of the Ministry of Justice as important matters regarding the solicitation of persons who subscribe for Bonds such as the matters listed in item 1 of Article 676;
  6. The development of systems necessary to ensure that the execution of duties by directors complies with laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company; or
  7. Exemption from liability under Article 423(1) pursuant to provisions of the articles of incorporation under the provisions of Article 426(1).

Compliance with Internal Control System Establishment

Companies Act only enumerates items to be established as Internal Control systems and does not define the levels of establishment and measures for execution. Thus, as for the levels of establishment and measures for execution, Internal Control systems in Corporation with Committees, which was required in Commercial Law Enforcement Regulations, in advance of the enforcement of Companies Act, to establish Internal Control for the sake of audits by audit committees, should be referred.

Systems regarding the management and storage of information related to task execution of executive officers

The logs recording how executive officers are involved in business execution are necessary. Therefore, we must clarify the participants in charge of creation of document management standards, creation, storage, and management of meeting minutes and approval documents, and so forth.

Regulations and other systems concerning the risk management about loss

There exist external risks, such as changes in trends of the market, and internal factors, including mistakes in paperwork, system down, and so on, in company activities. Thus, we need to establish systems to respond to these risks. To do that, creation of in-house standards, such as standards about all kinds of trades, profit standards, etc., and creation of RCM, which summarizes countermeasures against risks are required.

Systems to ensure the effective task execution of executive officers

Tasks of executive officers that control the company administration must be done efficiently. Thus, reexamination of business plans and creation of standards on administrative authority are to be executed.

Systems to ensure that employees' task execution complies with laws and statutes

Employees that are engaged in business execution must comply with laws and regulations to execute business. So, creation of compliance manuals, establishment of the dedicated department to monitor Internal Control, etc. are indispensable.

Systems to ensure the appropriateness of business of the business group comprised of the corresponding stock company, its parent companies, and its subsidiaries

In case the business is executed with group companies and subsidiaries, the appropriateness of business execution including group companies and subsidiaries must be ensured. Therefore, we need to establish the management and audit of group companies, to maintain organizational systems, and so forth.

Terms regarding employees supporting the tasks of auditors in case such employees are required by auditors

Auditors that evaluate Internal Control must be able to sufficiently execute their tasks. Therefore, establishment of an auditor office, auditor room, etc. are required.

Terms regarding independence of employees, which are mentioned in the previous item, from executive officers

In addition to auditors, employees supporting auditors must be independent of executive officers to execute the tasks appropriately. Thus, auditors' privileges regarding the employee evaluation, employee movement, etc. are to be established.

Systems to be used when executive officers and employees report to auditors and other systems related to reporting to auditors

To make auditors work effectively, executive officers and employees must report the matters concerning business. So, execution of reporting meetings concerning important decisions is required.

Systems to ensure that other audits by auditors are effectively done

Auditors that evaluate Internal Control must be functioning. Therefore, appointment of external advisors through regular meetings with the internal audit department or audit corporations or auditor meetings is necessary.

Subjects Supposed to Establish Internal Control System

What is Large Company?
A company whose capital is more than 500,000,000 yen or a company whose debt is more than 20,000,000,000 yen.

In Old Commercial Law, companies with committees are required to establish Internal Control system. However, in Companies Act, the following entities are required to establish Internal Control system.

  • Large companies (See Article 348(4) and Article 362(5) of Companies Act)
  • Companies with committees (See Article 416(2) of Companies Act)
Regarding the responsibility for establishing actual Internal Control system in large companies and companies with committees, Companies Act defines the following.
What is a Company with Committees?
A company in which authorities of audit, human resource, and compensation are separated in board of directors. Shifts to companies with committees in which authorities are separated in terms of governance are desired. In the old law, it is named "Companies with Committees etc." However, under Companies Act, it is called "Companies with Committees" owing to the revision.
Executive Officers and Board of Directors
Executive officers are in charge of business execution and are regarded as representatives of a company by external parties. Board of directors is comprised of executive officers. Public companies, companies with auditors, and companies with committees are required to establish the board of directors, but it is optional for other companies.
  • Rights and obligations of executive officers (Execution of Operations: Article 348)
  • Rights and obligations of board of directors (Authority of Board of Directors: Article 362)

"The development of systems necessary to ensure that the execution of duties by directors complies with laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company," which corresponds to Internal Control system, is supposed to be determined "by all executive officers at the board of directors.

Thereby, all executive officers are responsible for the establishment of Internal Control system.


<Article 348(3) and (4) of Companies Act>

(3)In the case provided for in the preceding paragraph, the directors may not delegate the decisions on the following matters to individual directors:

  1. The election or dismissal of managers;
  2. The establishment, relocation and abolition of branch offices;
  3. The matters listed in each item of Article 298(1) (including the cases where such items are applied mutatis mutandis under Article 325);
  4. The development of systems necessary to ensure that the execution of the duties by the directors complies with the laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company; or
  5. Exemption from the liability under Article 423(1) pursuant to the provisions of the articles of incorporation under the provisions of Article 426(1).

(4)At a Large Company, the directors shall decide the matters listed in item 6 of the preceding paragraph.


<Article 362(4) and (5) of Companies Act>

(4)Board of directors may not delegate the decision on the execution of important operations such as the following matters to directors:

  1. The disposal of and acceptance of assignment of important assets;
  2. Borrowing in a significant amount;
  3. The election and dismissal of a important employee including managers;
  4. The establishment, changes or abolition of important structures including branch offices;
  5. Matters prescribed by the applicable Ordinance of the Ministry of Justice as important matters regarding the solicitation of persons who subscribe for Bonds such as the matters listed in item 1 of Article 676;
  6. The development of systems necessary to ensure that the execution of duties by directors complies with laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company; or
  7. Exemption from liability under Article 423(1) pursuant to provisions of the articles of incorporation under the provisions of Article 426(1).

(5)A Company with Board of Directors that is a Large Company shall decide the matters listed in item 6 of the preceding paragraph.


<Article 416 of Companies Act>

(1)The board of directors of a Company with Committees shall perform the following duties notwithstanding the provisions of Article 362:

  1. Deciding on the following matters and on the execution of other operations of the Company with Committees:
    (a)Basic management policy;
    (b)The matters prescribed by the applicable Ordinance of the Ministry of Justice as those necessary for the execution of the duties of the audit committee;
    (c)In cases where there are two or more executive officers, matters regarding the interrelationship between executive officers including the division of duties between executive officers and hierarchy of commands of executive officers;
    (d)The directors to receive requests for the calling of board of directors meeting pursuant to the provisions of paragraph 2 of the following article; or
    (e)The development of systems necessary to ensure that the execution of duties by executive officers complies with laws and regulations and the articles of incorporation, and other systems prescribed by the applicable Ordinance of the Ministry of Justice as systems necessary to ensure the properness of operations of a Stock Company.
  2. The supervision of the execution of duties by executive officers, etc.

(2)The board of directors of a Company with Committees shall decide the matters listed in item 1.(a) through item 1.(e) of the preceding paragraph.

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