The Israel Securities Authority provides guidance for the first time regarding the interplay between the Joint Investment Trust Law and the Securities Law
On July 17, 2019 the Israel Securities Authority (the “ISA”) issued a staff position paper (the “ISA Circular”) in which the ISA for the first time clarified its position regarding the correlation between the Israeli Securities Law, 1968 (the “Securities Law”) and the Israeli Joint Investment Trust Law, 1994 (the “Joint Investment Law”) in the context of private investment funds.
Joint Investment Law
The application of the Joint Investment Law to investment arrangements is determined by Section 2 of such law.
Section 2 (a) states that the Joint Investment Law shall apply to any arrangement, the purpose of which is the joint investment in securities (i.e., to clarify – whether listed or non- listed securities) and the joint generation of profits from holding them and from any transaction therein, which is not regulated under another statute (emphasis added). The immediately following Section 2(b) states further that the Joint Investment Law does not apply to an arrangement with said purpose, in which the number of participants does not exceed fifty and which is made without an offer to the public (emphasis added).
The Integral Fund Ruling
The ISA Circular was published a few months following the ruling of the Hon. Judge Dania Keret-Meir of the Economic Division of the Tel Aviv District Court with respect to the matter of Integral Fund L.P. (and related investment vehicles) (the “Integral Fund” and “Integral Ruling”, according to the context). In the framework of the Integral Ruling, the judge ruled that the Joint Investment Law applied to Integral Fund, because the purpose of the fund (which was a hedge fund) was a joint investment in securities and the joint profit making from them. In determining whether the conditions for an exemption under the above Section 2(b) of the Joint Investment Law were satisfied, the judge held that in less than two years of the establishment of Integral Fund the number of investors by far exceeded fifty investors (without distinguishing between accredited and non-accredited investors) and, furthermore, the principals of the Integral Fund engaged in active public marketing activities in order to solicit investors. Consequently, the court held that the aforesaid exemption was not applicable to Integral Fund and, thus, concluded that such fund was subject to the regulatory regime of the Joint Investment Law. Multiple appeals on the Integral Ruling are currently pending before the Israeli Supreme Court.
The Integral Ruling prompted several applications submitted to the ISA by various hedge funds requesting clarification as to its seemingly far-reaching effect.
Until the Integral Ruling, the issue of whether or not the Joint Investment Law applied to investment funds, hedge funds, etc., was a rather unclear topic, subject to ambiguous interpretation and altogether a murky area that was not directly addressed by neither the Israeli legislature nor by the ISA.
Section 15A of the Securities Law prescribes that certain offerings of securities shall not be considered as an offer or sale of securities to the public and shall not be subject to the prospectus requirements mandated under the Securities Law. The Securities Law provides that any legal entity offering securities to more than 35 prospective investors in any given 12 month period must first publish a prospectus, as this offering is considered an offering to the “public”. However, Addendum One of the Securities Law explicitly excludes certain categories of investors when counting such number of 35 investors, including, among other investors, institutional investors, such as – pension and provident funds, banking and financial institutions, insurance companies, as well as high net-worth investors meeting certain accreditation standards relating to their liquid assets and/or annual income (the “Qualified Investors”). Thus, the bottom line stemming from the Securities Law is that an entity is free to offer and sell securities to an unlimited number of Qualified Investors, provided, however that such entity does not engage in any public solicitation or other activities, which would otherwise constitute a public offering.
In the past, the ISA accepted an interpretation according to which a private investment fund is a unique collective investment structure, usually in the form of a limited partnership, and as such considered to be “regulated under another statute" (such as – the Israeli Partnerships Ordinance), and, therefore, exempt from the provisions of the Joint Investment Law. It was generally thought that the Securities Law ensured that the investments would not be offered to the general public, and, thus, private investment funds should only be subject to the Securities Law and not the Joint Investment Law.
The legal issue that was the subject of debate and interpretation was: (a) whether the Joint Investment Law a priori applied to private investment funds (e.g., hedge funds, venture capital funds, private equity funds, etc.) and (b) assuming the answer to (a) is yes, whether Qualified Investors should be counted for the purpose of fifty investors. Widespread opinion among legal practitioners was that the rationale behind the Securities Law, i.e., that there should be no limitation on the number of Qualified Investors to whom securities may be offered and sold (as these investors are perceived to be sophisticated and able to fend for themselves in the eyes of the law and, therefore, do not require the rights and protections afforded to non-Qualified Investors under the Securities Law) should also be mirrored and uniformly applied with respect to the provisions of Section 2 of the Joint Investment Law, to the effect that there should be no limitation on the number of Qualified Investors that are eligible to participate in a privately offered investment fund.
Evidently, prompted by the Integral Ruling, the ISA Circular puts an end to speculation and aims to clarify the legal conundrum.
It is worth noting the following points highlighted by the ISA in the ISA Circular:
What’s in a name? That which we call a rose by any other name would smell as sweet.
The name of the investment entity has no relevancy in terms of the applicability of the Joint Investment Law or the Securities Law. To clarify, it is of no relevance if the investment entity is called a "hedge fund", an "investment fund", an “investment track" or goes by any other term. An investment entity cannot avoid the application of either law simply by naming the entity one name or another.
- Manner and Place of Incorporation
Section 2 of the Joint Investment Law determines, inter alia, that the law is applicable to any arrangement with the purpose of joint investment in securities and joint profit making from its holdings and transactions in such securities, which “is not regulated under another statute”, meaning – a specific law which embodies a comprehensive and specific investment arrangement, delineating the features of its investment activity and its supervision, in such manner that is distinct from an investment according to the Joint Investment Law.
The ISA stresses that the legal form of an entity (whether it is a company, limited partnership or any other type of legal entity) should not be considered a factor in determining whether either the Securities Law or the Joint Investment Law is applicable. The same holds true with respect to the jurisdiction of organization of an investment entity (whether it be – Israel, the Cayman Islands, Delaware, etc.). Both the Joint Investment Law and the Securities Law are territorial laws and relate to the offering of securities to the public in Israel and raising funds from the same. It does not make any difference if the entity that raises funds from investors in Israel was registered in Israel or abroad, or whether it is regulated under non-Israeli legal regimes.
In short, the type of an investment arrangement according to a particular law, or the formation of an investment vehicle abroad subject to a foreign law, do not constitute “regulation under another statute” for purposes of the Joint Investment Law and, thus, do not automatically trigger the exemption thereunder.
- Separate Legal Entities
The purpose of the Joint Investment Law and the Securities Law is to prevent instances where the offering of securities to the public is not subject to regulation and scrutiny by virtue of these laws, including the various duties and obligations emanating therefrom for the purpose of safeguarding the interests of public investors. Therefore, an artificial separation into different legal entities, as was the case in the Integral Ruling according to the findings of the court, cannot be used to circumvent the provisions of the law, and in particular to avoid adhering to the legal requirement regarding the maximum number of investors. The ISA clarified that the number of investors in these cases should be aggregated with respect to all the relevant legal entities comprising an investment arrangement.
- Offer to the Public
Both the Joint Investment Law and the Securities Law prohibit an unregulated solicitation and offer of securities to the general public. The Integral Ruling enumerates a non-exhaustive list of various marketing activities which might constitute an offer to the public. These activities are broad and include, but are not limited to, telephone calls, email inquiries, written or oral publications, publications to the general public or specific publications targeted to a particular group of people, publications on the internet or social networks, presentations and brochures, investor conferences, inquiries through intermediaries, word-of-mouth inquiries, and so on and so forth.
- Qualified Investors and the number of Investors in an arrangement
Section 2 (b) of the Joint Investment Law stipulates two conditions in order for an investment arrangement to qualify for an exemption from the law. The law shall not apply to an investment arrangement (i) if the number of participating investors does not exceed fifty and (ii) was not made via an offer to the public. The ISA Circular states loud and clear that, in accordance with the purpose of this law, Qualified Investors shall not be taken into account, when determining the number of participating investors. Accordingly, a private offer made by an investment fund solely to Qualified Investors will not be considered as an offer to the public. However, the number of non-Qualifying Investors may not exceed 50 at any point in time.
The ISA's stance as reflected in the ISA Circular provides long awaited guidance, by supporting and acknowledging the view adopted by most legal practitioners in the private equity industry, whereby the number of Qualified Investors in a private equity fund should not be limited. However, approaching or on-boarding 35 non-accredited investors on a continuous basis during any given 12 month period (thus, tripping the maximum number of 50 non-Qualified Investors) is not permissible under the Joint Investment Law, contrary to the provisions of the Securities Law. With respect to private equity funds and venture capital funds, which are closed-end investment vehicles whose fundraising period is in any event limited and which normally target only institutional investors or high net worth individuals with large amounts of cash (i.e., Qualified Investors) the ISA Circular undoubtedly stated the obvious. Conversely, with respect to hedge funds, which are open-ended funds admitting investors on an ongoing and periodic basis, the ISA Circular might be viewed as having a detrimental effect by limiting the absolute number of retail investors and public access to hedge funds.
Going forward it remains to be seen whether the Israeli legislative body will follow in the footsteps of the ISA and enact an amendment to the Joint Investment Law in alignment with the ISA Circular position. In addition, we will be on the lookout for the opinion of the Israeli Supreme Court and the final outcome of the pending appeals on the Integral Ruling, particularly, in view of the ISA Circular.
This article is intended to serve as a general overview and does not constitute a replacement for specific legal advice on the matters discussed herein.