Capital Markets - What Every Business Owner and Investor Must Know Before Entering

1. Any person who has “inside information” about a public company – material information that has not yet been disclosed to the public – is prohibited from trading in the company’s shares based on that information. This applies to a junior employee who overheard a conversation in the hallway, not just to the CEO.
2. Stock manipulation – buying and selling shares designed to create a false impression of active trading activity – is a serious criminal offense punishable by up to five years’ imprisonment.
3. A public company must publish an “immediate report” on any material event as soon as it occurs. Anyone who delays, conceals, or distorts such information is exposed to criminal and civil liability.
4. A class action in the field of securities is a real tool. An investor whose rights have been violated along with thousands of others can file a lawsuit that will cover them all.
5. The Israel Securities Authority is an enforcement body with teeth. It is authorized to investigate, demand documents, impose financial sanctions, and file indictments.

Why the capital market is not just a matter for public company owners

Even a private business owner planning to raise capital, an investor purchasing bonds, or a supplier selling to a public company – all may find themselves in conflict with capital market regulations. A supplier who receives material information from a public company that is his client and then trades in its shares may find himself under investigation for insider trading. An investor who purchased ETFs and discovers that the entity managing them acted in conflict of interest can file a class action.

Three main prohibitions established by the Securities Law

Insider trading – Section 52(g) of the Securities Law, 5728-1968, prohibits anyone who has material information that has not been disclosed to the public from trading in the securities of that company. “Material” information is information to which a reasonable investor would attach importance in deciding whether to buy or sell. Acquisition of a company, appointment of a new CEO, results of a clinical trial – all of these, before publication, constitute inside information.

Stock manipulation and market manipulation – Section 54 of the Law prohibits influencing securities price fluctuations through fraudulent means. This includes not only coordinated fictitious transactions, but also real transactions whose sole purpose is to influence the price – not based on honest economic considerations. Case law has established that the mental element – intent – is what makes a trading activity illegal.

Disclosure obligation – A public company is required to maintain full transparency. Immediate reporting on material events, annual and quarterly financial statements, reporting on changes in control and on transactions with interested parties. Concealing material information from the public – even without intent to profit from it – constitutes a violation.

The case that resonated throughout the capital market – Dankner v. State of Israel

In CrimA 220/17 Nochi Dankner v. State of Israel, which concluded with a Supreme Court judgment dated August 29, 2018, one of the most serious economic fraud cases ever tried in Israel was adjudicated.

Background: In February 2012, IDB Corporation, in which Nochi Dankner was the controlling shareholder, faced a critical public offering to raise approximately NIS 321 million. The capital market did not believe in the company – the stock declined. Dankner feared the offering would fail.

What happened: According to the court’s determination, Dankner and his colleague, Itay Strum, coordinated between them that the latter would execute massive purchases of IDB shares on the stock exchange – in the amount of approximately NIS 42 million – in order to create artificial demand, raise the price, and signal to the public that there are external parties who believe in the company. Dankner even called Bank Hapoalim and requested that they approve exceptional credit for Strum without collateral. The offering succeeded – the public purchased shares at a price influenced by the manipulation.

The outcome: Dankner was convicted of stock manipulation, inducing the public to purchase securities by fraud, and additional offenses. The District Court sentenced him to two years’ imprisonment. The Supreme Court, following the State’s appeal, increased the sentence to three years, and Strum’s sentence to two years.

Justice Mintz stated in the judgment: “Artificial interference with market forces through fraudulent acts undermines public trust and increases suspicion that the prices of traded securities do not accurately reflect the economic activity in the company and in the market.”

Subsequently, a civil class action was also approved on behalf of investors who purchased the shares during the manipulation period – in an amount of up to approximately NIS 50 million.

What this means for a business seeking to raise capital in the capital market

Raising capital in the capital market – whether through a stock exchange listing or through a bond issuance – requires an entire framework of procedures: preparation of a prospectus, obtaining approval from the Israel Securities Authority, valuation reviews, legal opinions, ongoing reports following the offering. A company entering the capital market transitions from “private” to “public” status – and assumes transparency and compliance obligations that did not previously exist.

Directors in a public company owe fiduciary duties to the company and to the public shareholders. An audit committee and compensation committee are not bureaucracy – they protect the directors and the company from allegations of conflict of interest.

The private investor – what remedies are available

An investor who feels harmed by a public company – that information was presented misleadingly in a prospectus, that a material report was delayed, that a policy was chosen designed to enrich the controlling shareholders at the expense of the minority – can file a class action. This is the most effective tool for the private investor, as it aggregates small injuries to thousands of individuals into one significant lawsuit.

Conversely – an investor who receives a “tip” from someone close to the company, who exploits information that should not have reached him, who buys shares the day before an announcement of a transaction – may discover that he is a party to an insider trading investigation.

A point worth remembering also in the context of investor lawsuits: not every underperformance of an investment portfolio establishes a cause of action. In a case represented by our firm (CA 63767-07-20 – Richani v. Quantum Capital Markets Ltd. et al.), an investor sought compensation of NIS 6.4 million for “lost opportunities” – the claim that he would have earned more had his funds been invested in the S&P index. The court rejected the claim entirely, ruling that the securities market is not an insurance policy. A return that is not high in itself does not constitute negligence – as long as no actual breach of management duties has been proven. The claim was dismissed, and Richani was ordered to pay NIS 90,000 in costs. The appeal to the Supreme Court was also dismissed.

Considering an offering, investing in a public company, or received a notice from the Israel Securities Authority? This is the area where one mistake can result in criminal proceedings.

© Tidhar Tzur Law Firm | This article is for general information purposes only and does not constitute individual legal advice.