Japanese pension funds face a tricky situation. On one side is an investment environment of near-zero yields, declining real estate values, and a stock market that is down 75% from its peak in 1989. On the other side is a ballooning retirement-age population who enjoys the longest life expectancy in the world. But these investments have to fulfill the promises made to current and future retirees, however impossible that may be. So the one thing they don’t need is pension fund assets evaporating from an asset management firm.

Given the importance of age in Japan, the Ministry of Health released a slew of statistics just before “Respect for the Aged Day,” a national holiday in September—the Japanese might not have a lot of vacation, but they do have a lot of holidays. A record-breaking 30% of the Japanese are 65 or older. A record 47,756 were at least 100 years old, the oldest two being 114. Due to the scandals in 2010 when some of the oldest people turned up as mummified bodies or didn’t turn up at all—pension fraud!—the ministry announced that this survey had been conducted more carefully. And despite the March 11 tsunami, whose victims were mostly elderly, the number of centenarians rose by 3,300 over last year.

These statistics are the envy of any other nation—but they’re a nightmare for pension funds. And so it’s no surprise that 22% of the 119 Japanese pension funds sought “alternative investments” in the current fiscal year, according to a survey by JPMorgan Chase. And AIJ Investment Advisors Co., an asset management firm based in Tokyo, enchanted these yield-hungry pension fund managers with “alternative investments” that had stable but high yields, even when markets were crashing, as during the financial crisis or after March 11.

Pension fund managers were also lured by the pedigree of AIJ’s management team. President Kazuhiko Asakawa, a “breezy and confident talker,” was a former manager at Nomura Holdings, Japan’s largest securities company. Chief investment officer Shimpei Matsuki also hailed from Nomura. But there was a detail they didn’t tell their clients: Matsuki had a suspended prison sentence on his record; he’d paid off a guy who’d threatened to cause havoc at the shareholder meeting in 1995. It’s a common form of corporate extortion in Japan.

In a newsletter, AIJ bragged about one of its funds that had made 241% since its inception in May 2002 by trading Nikkei options. “The aim is to secure absolute returns regardless of the market directions,” said the newsletter, of which Bloomberg News obtained a copy.

It appears that 84 corporate pension funds swallowed AIJ’s bait, hook, line, and sinker. And they handed what is now believed to be ¥210 billion ($2.6 billion) to the firm. Alas, most of the money is gone, regulators suspended the firm on February 24, authorities are investigating, and rumors are flying.

Prosecutors allege that the company lied to its clients about fund performance and supplied them with fictitious financial reports. AIJ officials told the investigating Securities and Exchange Surveillance Commission (SESC) that they invested most of the money in funds registered in the Cayman Islands. Sources said that the money was then transferred to a European bank in Hong Kong from where it was used for futures trading in Japan; and that only ­¥20 billion ($250 million) remained.

Then on March 2, sources revealed that the SESC would “consider, if necessary, raiding the company’s offices to seize documents and other materials that would shed light on AIJ’s investment operations.” (You mean they haven’t done that yet?)

Worried that other pension fund assets have evaporated as well, regulators initiated the first steps of a nationwide probe of all 263 asset management firms, the most expansive fund probe in Japan’s history. And the ruling Democratic Party is planning to propose changes to the Financial Instruments and Exchange Law to prevent this kind of fiasco in the future—because, stunningly, that law doesn’t require closely held asset management firms to hire independent auditors. Bernie Madoff at least had to pay for one. Which made a heck of a lot of difference.

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