Finally, Israel's Tycoons Need to Watch Their Step

The IDB saga shows that the country now has institutional investors willing to confront the big guys.

Two weeks ago the focus was on Bank Leumi's plan to forgive personal debts owed by Nochi Dankner, but last week it was on the Tel Aviv District Court. At issue was a plan by IDB Development's bondholders for a revamp and debt write-off that would transfer control of the company from Dankner to IDB Development's creditors.

At this stage, Judge Eitan Orenstin decided not to rule on the main issues, so the discussions on IDB Development's situation and the valuations presented by all the sides haven't  begun in earnest.

But Orenstin did decide on a precedent for Israel: Appointing not one but two outside observers at the company on behalf of the court. He appointed Chagai Ulman to oversee the board's activities and Eyal Gabbai to serve as a financial adviser to the court. Even at this stage, before deliberations on whether IDB Development should be declared insolvent, this is an impressive achievement for the bondholders, led by York Capital Management and Psagot Investment House.

For perhaps the first time in Israel, institutional investors and mutual funds got tough on a company in which they hold securities.They didn't hesitate to confront the company in court. But the success of IDB Development's bondholders raises another question: Where were the representatives of IDB Holding's bondholders?

If IDB Development's viability is in question, then IDB Holding's viability is even more doubtful. IDB Holding is on top of IDB Development in the pyramid; the assets are held by IDB Development, with IDB Holding just an administrative company sitting on top.

In other words, the success of IDB Development's bondholders in court exposes the fecklessness of IDB Holding's bondholder representatives; they didn't turn to the court even though their claims could have been several times stronger than their counterparts' at IDB Development.

So from now on the capital market is split in two: the institutions that are willing to confront the tycoons and those that aren't.

As with the Bank Leumi episode, the people can be expected to vote with their feet in favor of institutions that stand up for their rights. The upshot: Investment firms are discovering the PR benefits of corporate activism – and tycoons and defaulters will find the going tougher.

Who needs a director untainted by conflicts of interest?

Business mavens mention the following play on words on the term "conflict of interest": "I have no interest if there is no conflict."

In fact, what does a controlling owner managing the public's money need with a director untainted by a conflict of interest? Such a director couldn't enjoy any side income and couldn't set his children up with jobs. He would be too independent, ask too many hard questions, cast dissenting votes and, who knows, might even resign in protest over something. Who needs it?

Some directors in the IDB group and many other institutions are tainted by conflicts of interest – anything from personal connections to conflicts of interest among the various boards they sit on. In fact, that's why they're there.

But last week, following developments in Orenstin's courtroom, IDB Development's new court representative was instructed to replace directors suspected of having conflicts of interest. This is a clear message to other controlling owners: From now on more regulators and investors will pay attention to boards' activities and episodes where boards don’t act strictly for the company's good.

The Bank of Israel will investigate

Tycoons are used to being subjected to criticism or investigations after receiving credit. But last week Orenstin instructed the Bank of Israel to investigate how the banks granted loans to IDB Development.

The examination will obviously focus on the lenders, but the borrowers also have reason to worry. If unreasonable procedures are discovered, questions will arise as to what the people at the bank got from IDB Development for giving it preferential terms. Orenstin didn't issue the same call to the Israel Securities Authority or the Finance Ministry department supervising the capital market, but these institutions can't ignore what he said.

The court decided that there's concern over failures in IDB Development's corporate governance, so this also constitutes a call for the ISA and the treasury's capital-market supervisors to put their houses in order. They're the ones ensuring that the public's savings remain in safe hands.

A loss of faith in valuations

The finding by accountant Shlomi Shuv that IDB Development's management presented two entirely different valuations for the same company at the same date should completely undermine the little remaining faith in valuations provided by listed companies. Orenstin's hearing was a farce when it came to valuations. Several sides presented appraisals and analyses, but none in accordance with the method used in Israel's courts.

This too is bad news for tycoons because nobody will take seriously a valuation that a company presents. Tycoons will find it harder to obtain authorization for interested-party transactions, which could be a good thing.

The battle over stability

The Bank of Israel, the supervision of the capital market, and certainly the tycoons and their suppliers of services in the top 0.1% tend to glorify the value of "stability." The central bank is concerned about shocks to the banking system, the treasury is worried about shocks to the insurance companies, and the tycoons warn about shocks, crises and other apocalyptic scenarios if the government adopts recommendations from its committee investigating concentration in the economy.

The problem is that claims about the sanctity of stability are spin: The haircuts, the surreal loans that banks have given tycoons, and the help the tycoons have received from the insurance companies are the causes of shocks and instability, as proved over the last five years. To build a more stable financial system, we need a more competitive structure. When that happens, the only thing lacking stability will be the guaranteed profits of tycoons and their cronies.

Moti Milrod
Tomer Appelbaum