Details matter: Errors in reporting by public companies as basis for ISA enforcement proceedings
In recent years, the Israel Securities Authority (ISA) has placed significant emphasis on enforcement proceedings due to reporting violations, through:
- the ISA’s Investigations and Intelligence Department, which deals with criminal investigations, as well as administrative clarification proceedings;
- the ISA’s Administrative Enforcement Department; and
- the State Attorney’s Office – Taxation and Economics, which deals with criminal cases involving securities.
Thus, for example, the ISA more vigorously enforces:
- the failure to submit reports on time;
- the inclusion of misleading details in reports; and
- the omission of details from reports of public companies and reporting corporations.
During the years 2020-2021, the ISA opened 15 criminal investigation cases – one-third of which are in respect of violations involving reporting and misleading details. During the same period, the ISA opened 20 administrative clarification cases – three-quarters of which are in respect of violations involving reporting and misleading details (in a prospectus, in a financial statement or in an immediate report), and capital raising without a prospectus. In the years 2021-2022, decisions were rendered in 20 administrative enforcement proceedings, half of which dealt with reporting violations.
Two examples clearly demonstrate the expanding trend of enforcement in respect of reporting violations:
- the decision of the Administrative Enforcement Committee in the matter of Storage Drop Storage Technologies Ltd (formerly, Medivie Therapeutic Ltd) of October 2021; and
- the decision of the Administrative Enforcement Committee of July 2022, in the matter of Together Pharma Ltd.
Storage Drop Storage Technologies Ltd
This decision dealt with a reporting violation regarding flooding at a plant of a significant subsidiary, which gave rise to the temporary cessation of the plant’s operations. The reporting violation in that case was that the first report of the flooding incident was published by the company only one-and-a-half months after the incident.
The Administrative Enforcement Committee accepted the ISA’s position that:
- this was an unusual event which did not form part of the corporation’s normal course of business;
- the event had the potential to have a material adverse effect which, in terms of its characteristics, would be dramatic in the company’s life; and
- in real time, it had not been possible to evaluate the length of time during which the plant would be shut down.
Therefore, the committee determined that this was a material event that should have been disclosed to the investing public, and that it could affect the entirety of the decisions made by the reasonable investor.
In the framework of the administrative enforcement arrangement, an actual financial sanction of 200,000 new Israeli shekels was imposed on the company, and an additional conditional financial sanction was imposed, for an identical amount.
The company also undertook to take measures to prevent the recurrence of the violation. An actual financial sanction of 100,000 new Israeli shekels was imposed on the chief executive officer (CEO) of the company, who was also the controlling shareholder thereof, and an additional conditional financial sanction was imposed on him, for an identical amount. He was subject to a conditional prohibition from serving as an officer of a regulated entity for 12 months.
Together Pharma Ltd
The decision of the Administrative Enforcement Committee of July 2022 in the matter of Together Pharma Ltd was about the medical cannabis industry, in which Together Pharma Ltd was engaged, with respect to the publication of two immediate reports regarding the signing of memoranda of understanding with a consultant and a Chinese company.
In the first report, it was stated that the company had been informed that the regulation in China permits the sale, import and export of products that are enriched with cannabidiol (CBD) ingredients from the cannabis plant and medical cannabis products, subject to obtaining a permit and the appropriate authorisations.
The company did not specify, in the report, the content of the regulation in China. In the ISA’s opinion, this could be misleading because the report could have been interpreted to mean that it is indeed permitted to sell, import and manufacture medical cannabis products in China, even though medical cannabis (as opposed to CBD-enriched products) is not regulated in China, and its use is prohibited.
In the second report, the company stated that its Chinese partner had declared that there was no impediment according to the law or an agreement that would prevent the promotion of the joint business. This report also failed to include any reference to the fact that medical cannabis is not legal in China. According to the ISA, the report contained insufficient information and, therefore, it contained a misleading detail.
In the framework of the administrative enforcement arrangement, the officers who took part in drafting and signing the reports admitted that they had not taken all the reasonable measures to examine the medical cannabis regulation in China and, by extension, to examine the completeness of the representations that had been included in the report.
Pursuant to the arrangement, a financial sanction of 250,000 new Israeli shekels was imposed on the company, and the company undertook to take actions to prevent the recurrence of the violation. Personal financial sanctions of 100,000 new Israeli shekels and 175,000 new Israeli shekels were imposed on the officers.
In both of these cases, failure to comply with the reporting standard, which can only be learned retroactively from the ISA’s decisions, led to the imposition of significant means of enforcement on the companies and on their officers. Thus, for example, in the second example, the ISA subjected the pharma company to the obligation of conducting an examination of the law in China, at the time of joining forces with entities in that country, and of presenting the examination, in its entirety, in the report, while indicating that it is not sufficient to rely upon relevant representations.
There are many other examples of the serious manner in which the ISA treats and deals with incidents of reporting violations by public companies and reporting corporations.
The ISA was set up in accordance with the Israeli Securities Law 1968, which determines that “its role will be to protect the interests of the public investing in securities”. Therefore, one of its key duties is to maintain a fair capital market. In a fair capital market, the market players rely upon the credibility and integrity of the trading, and they believe that the possibility of maximising profits from investments is not confined only to people in the know. The principle of full disclosure has been recognised as a fundamental principle by the ISA and by the courts, and its purpose, among others, is to protect the investing public.
In the field of securities, the duty of disclosure and reporting requires reporting corporations to release periodic reports and immediate reports to the public upon the occurrence of various events, including due to “any event or matter that deviates from the corporation’s ordinary course of business”.
The reporting corporations are required to draft their reports with due care and to include therein all the relevant information, in such a manner that they will not contain any “misleading detail”.
The subject of the reports for the public preoccupies the officers involved in this task on an almost daily basis. They must consider questions including:
- Is it necessary to make a report?
- What should be the date of the report that is required?
- What should the contents of the report be?
According to the law, reporting violations can take place even without the officers of the company having any malicious intent or any intent to mislead, as well as in cases in which the company or the officers do not stand to gain any clear economic benefit as a result of the violation.
Reporting violations are examined retroactively, for the most part, only after additional information that is relevant to the need to report and to the manner of drafting of the report has become known. This is usually information that was not necessarily clearly known previously, so that at times, the enforcement in this field constitutes, to a certain degree, “wisdom with hindsight”.
It is the role of the officers involved in this task, aided by the internal and external legal advisers, to make the best and most appropriate decisions despite the lack of certainty and time pressure.
The ISA can implement a number of different means, which vary in terms of severity, stringency and cost, against anyone who, in its opinion, commits violations of the securities laws, including reporting violations.
The most stringent of all is the criminal proceeding in respect of the commission of criminal offences, which is conducted in the courts. Such proceedings take a long time and are likely to lead to a criminal conviction and to prison sentences or a fine.
Administrative enforcement proceeding
In the enforcement landscape, next in line is the administrative enforcement proceeding, through which the ISA has been channelling most of its enforcement efforts in recent years with respect to reporting violations by public companies.
This is a rapid and efficient proceeding that is taken against corporations, officers and other individuals (eg, external consultants such as accountants and attorneys) mainly in respect of violations constituting negligence.
The administrative enforcement proceeding is conducted before a professional panel of three of the members of the Administrative Enforcement Committee, who are based at the ISA. The procedures in the administrative proceeding are less rigid than the procedures conducted in the courts and, therefore, they allow the proceeding to be conducted rapidly and efficiently. In the framework of the proceeding, various means of enforcement can be imposed, including:
- a financial penalty for the company;
- a financial penalty for the officers, to be levied on the individual (with no reimbursement from the company or from an insurance company);
- payment to the party injured by the violation;
- actions to remedy the violation and to prevent it from recurring;
- a prohibition on serving as an officer at a regulated entity; and
- the cancellation or suspension of a licence.
The least stringent penalty that can be imposed is the “simple” financial sanction, which is taken against corporations, primarily in respect of technical violations, such as failing to file a report on time.
In the past two years, more than 100 companies that completed initial public offerings have joined the Tel Aviv Stock Exchange (TASE). This wave of initial public offerings on the TASE has brought about the situation whereby many new players have joined the TASE, some of whom have encountered, for the very first time, the reporting requirements and mechanisms that exist at public companies. They have also had to deal with the transition from being a private company to a public one, which a fortiori creates the need for the officers and the employees to adjust the work processes and the organisational culture so as to be consistent with standards that are appropriate for public companies.
Ophectra Real Estate & Investments Ltd
The decision of the Administrative Enforcement Committee with respect to an officer of Ophectra Real Estate & Investments Ltd, which was rendered in March 2022, is a good example of a situation in which proceedings that were performed during the period when the company was a private company are no longer suitable for a public company.
In that case, an administrative enforcement proceeding was conducted against the CEO of the company, due to the inclusion of a misleading detail in two immediate reports that the company had released, and in two periodic financial statements, which incorporated a reference to the immediate reports. The immediate reports pertained to two agreements for the construction of a gas station and a commercial centre on the land of a Moshav. After a while, it became apparent that the Moshav did not have any rights in the land and, consequently, the two agreements did not take effect. The reports also failed to include a stipulation that had appeared in the agreements, according to which the approval of the Moshav’s general meeting was a prerequisite for the validity of the agreements.
According to the ISA, the CEO had acted negligently by failing to conduct an adequate examination with respect to the Moshav’s rights in the land, and, as a consequence of this omission, the public was misled by the misleading detail in the company’s reports, alleging that the agreements were valid between the parties. One interesting point in this regard is that during his investigation, the CEO stated that he had also signed agreements of this kind in the past, without obtaining certification of the rights of the owners of the land. However, he confirmed that the signing in those cases had taken place before the company had gone public.
The Administrative Enforcement Committee determined that the CEO had included a misleading detail in the company’s reports, and it imposed on him:
- a personal financial sanction of 100,000 new Israeli shekels;
- a conditional financial sanction of 100,000 new Israeli shekels; and
- a prohibition from serving as an officer of a regulated entity for a period of four months.
This shows the standard of conduct that the ISA imposes on public companies and their officers, which is different from the standard to which they were accustomed during their ordinary course of work as private companies.
The ISA has previously declared that it intends to adopt a lenient policy with respect to officers of companies that have implemented an initial public offering, who had not served in a senior position at a reporting corporation prior to the offering. It would appear that with the passing of time, since the last wave of initial public offerings, the impact of this lenient policy will be gradually diminished, so that, in the coming years, there will be additional enforcement proceedings also against the new companies on the TASE and their officers.
The great importance that the ISA attaches to reports is given expression in the normal course of business of public companies, as well as at the critical point of transition from a private company to a public company. The ISA has invested extensive resources in regularly monitoring the field of immediate reports and in examining the periodic reports and the interim reports of these companies. This also includes monitoring events that must be reported in real time in the framework of an immediate report.
Therefore, it is recommended to the officers of any company whose securities are traded on the TASE to be attentive and aware of the complex reporting requirements of the ISA and the changes made thereto. The officers should also enlist the aid of legal advisors and consult with them on a regular basis and in real-time.
These advisers should have the expertise and understanding of the reporting and enforcement worlds in relation to securities, with respect to:
- the need per se for immediate reports (and indeed any reports);
- the various ways of reporting;
- the drafting of the reports; and
- the date on which they must be released.
In addition, it will often be prudent practice for public companies and reporting corporations to adopt an effective internal enforcement plan in the field of securities, which is likely, “in times of trouble”, to assist the company and its officers in their dealings with the ISA and with the enforcement proceedings directed against them. This includes the possible benefits entailed in the ISA opting for a less stringent enforcement track – for example:
- an administrative proceeding instead of a criminal one;
- lessening the possibility of proceedings being initiated against managers, as well as against the company itself; and
- a requirement for less severe sanctions.
Finally, it is very important to provide a professional and rapid response to inquiries made by the ISA staff in the course of administrative clarification proceedings or an investigation. Relevant parties should seek legal assistance, without delay, from attorneys with expertise in the enforcement proceedings of the ISA.