A Regulator Who Rules Against Accused Every Time

The high rate of ISA decisions that end in penalties reflects the low bar of proof.

Reuters

It’s the kind of judicial record more akin to one in a police state than one where the accused are presumed innocent until proven otherwise. Over the last four years, the Israel Securities Authority’s administrative enforcement department has opened 36 investigations and launched proceedings in 24 of them. Except for six cases that it closed and six others still pending, all the rest have ended in decisions against the accused. In criminal justice terms, not one prosecuted case has ended in full acquittal. Moreover, no court has overturned a decision on appeal.

Since the Knesset approved the 2011 Administrative Enforcement Law, the ISA has been able to refer securities violations to administrative hearings rather bringing them to a full-fledged trial.

The high rate of decisions that end in penalties reflects the low bar of proof. Unlike in criminal cases, an administrative decision by the ISA can be based on negligence without any proof of intent or awareness of a violation. On the other hand, the costs and the stigma attached to a ruling are smaller. Companies can be fined up to 5 million shekels ($1.26 million) and an individual no more than 1 million shekels per violation.

But the penalties can include limits on serving in positions at publicly traded companies and other entities operating in the capital markets. It could also mean losing your securities license or paying damages.

Attorneys say the process is stacked against their clients, which is why nine cases were decided by the ISA’s enforcement panel, while 18 ended in a negotiated settlement.

This is surprising because unlike a criminal trial, which involves a long and expensive judicial process that encourages many defendants to seek a plea bargain, an administrative enforcement process takes on average a year. The accused prefer to hedge their bets by opting for a settlement because they think the process is stacked against them, said attorney Amir Scharf, a partner at Tadmor Levy, and a former assistant legal adviser at ISA.

“There’s enormous fear in the market of the results. The combination of almost absolute certainty that the process will end in penalties, and the severity of the possible penalties, creates tremendous motivation to reach agreements and hedge the risk,” he said.

Scharf represented Jerusalem Investments and two of its managers and principle shareholders, in which the enforcement committee decided in the end to withdraw the central accusation against them, which he said should ease some of the market’s concerns.

Not guilty, necessarily

Two issues impact the decision to cut deals. First, in contrast to criminal plea bargains, there is no need to admit full guilt. Second, violators must pay fines out of pocket, without insurance indemnification. Cutting a deal allows the accused to save their reputation and reduce their exposure to civil suits.

The committee encourages settlements, but often insists that the accused formally admit they violated rules. In a recent decision given in a deal with accountant Benny Mukhtar, who was accused of negligently including misleading details in an auditor’s report, the panel ruled that “it is best that arrangements that have no admission of the violator be made in exceptional instances.” But it concluded that in this case a neutral settlement, with the accused neither admitting nor denying responsibility, was acceptable.

Beyond the fear of heavy finds paid out of their own pockets, Scharf said his clients see the committee’s decision barring people from positions in publicly traded companies or the capital market as shaming. “It’s saying they’re not fit to be managers. There are cases where they are willing to pay more money and not have their vocation limited.”

Yaron Lipshes, a former legal adviser to the ISA investigations department, said that despite initial fears of a fixed game, he has been surprised for the better. He cited the example of the Israel Canada case, in which the committee ruled that controling shareholder Barak Rosen and Chief Financial Officer Guy Kenda were responsible for a misleading detail in a report, but did not hold accountable his own client, Assaf Tochmayer, Rosen’s partner, because of insufficient evidence.

“They made it hard on us, but because doubt remained, they accepted our argument,” Lipshes said. “They come prepared. They know the right questions to ask and when to be tough, both on us and on the other side.”

In contrast to the fear that the committee would be a peon of the ISA, it displays independence, but precisely in the more stringent direction. For example, it asserted in the deal with Mivtah Shamir-Tnuva-Apax and with Bank Leumi that the fine was too small relative to the wealth of the accused. In a case involving the Israel Electric Corporation, it criticized the settlement for not levying fines on the managers. And in the Jerusalem Investments case, it reprimanded the ISA for not holding responsible previous controlling shareholders who were signed onto the report, and also remarked that the ISA executed “selective enforcement” in a situation of “extreme inequality.”

The administrative enforcement process gives the ISA another way to handle cases that used to be classified as criminal. Summing up four years through 2014, 38 cases were opened in the division for criminal investigations, compared to 29 cases in the administrative department, according to the ISA’s latest report.

“That was the vision,” said attorney Zvi Gabbay, former ISA director of enforcement. “I expect the number of cases going through the administrative process to account for more than half, and the process will become a more popular tool than using the criminal process.” Gabbay believes the deterrent effect in many cases is no less than in the criminal process. “The message gets through, and the capital markets fear these processes,” he added.

Lipshes agrees regarding deterrence. “As a lawyer, I see that the moment the ISA chose the administrative process it was a relief, but I see people experiencing this emotionally,” he said. “It’s hard for them that a state body says they sinned.”

Low-cost justice

On the other side of the picture, the fear is that the administrative process will be applied to relatively light cases of innocent mistakes, in which the fine line between what is allowed and what is forbidden isn’t entirely clear. Still, the relatively low number of cases doesn’t support this fear. If five years ago, when the law passed, the fear was a flood of claims of violations, in fact the department has handled an average of fewer than 10 cases a year.

“The cost of handling an administrative case is roughly less than a third of a criminal case. So, the ISA could theoretically flood the market with administrative cases, but it hasn’t happened,” observed Scharf. “That’s because the ISA doesn’t want to make the market feel choked, so they focus on issues they view as more significant, like reporting violations of publicly traded companies, insider information, securities fraud and serious violations by investment portfolio managers.”

After two years of cases only against companies, the ISA issued its first sanctions against a functionary in November 2013, involving Africa Industries. “The gradual implementation was intentional, so as not to rock the market,” said Scharf.

Insider information violations have also seen a transition to the administrative process, which has led to sanctions in three cases. Scharf said this shift was made because of the ongoing failure of the ISA in criminal enforcement against the use of insider information, especially because of the difficulty in proving the human element. “In cases in which the ISA thinks there was criminal intent, but fears the burden of criminal proof demanded in court, they transfer the case to the administrative process,” he said. “The trend will grow, and we’ll see more and more cases of insider information in administrative processes.”

One of the cases in which the use of insider information was discovered was in early 2014, in the case of Eitan Bar Zeev, CEO of Big Shopping Centers, who bought company shares 10 days before it issued its financial report, whose details he knew. Panel members remarked in their decision that Bar Zeev acted in good faith and not out of greed, but he committed a violation because he informally and hastily consulted with workers subordinate to him, and did not ask a written and reasoned legal opinion.

Gabby thinks this kind of case should not have reached the enforcement level at all. “It is bothersome,” he said, “because we are talking about a person who consulted, but they demanded of him an external opinion. The ISA after the fact does not agree with the decisions that the company or functionary make in real time, and it opens procedures even when the actions are made in good faith. The fault is in the legislation. The ISA didn’t want this when it initiated the administrative process.”

The Bar Zeev decision caused panic in the market because functionaries theoretically always have information about upcoming reports, which on the surface prevents them from ever trading in company shares. So the ISA issued an opinion in June 2014 that backed the panel’s decision, but softened the result. According to the opinion, the ISA saw the timing of his trade, close to the report’s publication, as problematic, but indicated that it would not consider knowledge of information in the reports in every case and at every stage as insider information.