A Japanese district court ordered the government to pay 670 million yen ($5.66M) in compensation to victims of fraud by failed mortgage securities firm Daiwa Toshi Kanzai on Wednesday.

Daiwa, and its group companies, was accused of falsely telling investors that its products were safe and would bring high interest returns. It subsequently cost almost 111.2 billion yen ($934M) in losses to 17,000 investors, however.

After determining that Daiwa had excessive debt, the Finance Ministry’s local bureau initiated bankruptcy proceedings in April of 2001. Daiwa president Hiromoto Toyonaga was indicted for fraud charges in November of the same year. He was later sentenced to 12 years in prison.

Presiding judge Tomoichiro Nishikawa concluded that the state did not exercise proper oversight of the industry. He indicated that it had been the local bureau’s mistake for approving the company’s application for a renewed business registration in December 1997, calling it “extremely irrational”.

The bureau could have easily anticipated at that time that there was a pressing danger of Daiwa going into bankruptcy, the judge said.

The local bureau approved the registration renewal three times from 1991 through 1997.

A total of 721 plaintiffs had sued the state to be compensated 3.99 billion yen ($33.5M) that they had lost from the mistake.

But the court mentioned that the investors also should have noticed the risk of purchasing mortgage securities with high interest rates, so it ruled that the state should pay only 60 percent of the amount requested.

It ordered the state to pay almost 670 million yen ($5.6M) to 260 investors who have purchased mortgage securities from the company since 1998.

Wednesday’s ruling marked the first time the state should have responsibility for damages involving personal assets of so many investors, according to defense lawyers.

Daiwa started issuing mortgage securities in 1985 by giving a golf course owned by an affiliate and other assets as collateral.

Although Daiwa's financial statement for the fiscal year ending in March 1997 didn’t show red ink, each of six Daiwa-affiliated companies that borrowed money from the company were suffering seriously from accumulated debt, according to the ruling.

Therefore, Daiwa couldn’t collect more than 1.3 billion yen ($10.9M) it loaned to those companies. As a result, Daiwa lost the financial foundation for it to get registration renewal.

The court recognized that the local bureau should have noticed the fact that Daiwa and its affiliated companies had operated as a single entity and that the Daiwa group had a capital deficit over 10 billion yen ($8.4M) in 1996.

“The local bureau should have realized the company was actually operating on a scanty budget. There is no way to look at the case but regard the bureau falsely processed the application for registration renewal,” the judge said.