Consider the following case – The CEO of a public company trading on the Tel-Aviv Stock Exchange (“TASE”) runs into an old friend who expresses interest in purchasing a very large quantity of the company's products. The two exchange business cards, promise to stay in touch and schedule a meeting to further discuss and possibly seal a deal. Now, ask yourself this; does the CEO already at that point in time possess material inside information? Is she/he now prohibited from trading in the company's securities, unless such information is made public?
The recent ruling of the Economic Division of the Tel-Aviv District Court in the case of Africa Industries Ltd et al. v. The Israel Securities Authority et al ("Africa Ruling") may shed light on the issues raised in the above hypothetical scenario and may assist in answering various other similar fact patterns that relate to questions concerning information obtained at the negotiations stage of a deal and whether use of such information constitutes insider trading.
What is clear though is that it would be advisable for the prudent businessman operating in Israel to become familiar with the Africa Ruling and apply the Magnitude/Probability test (set out below) when making any investment decisions in a public company trading on the TASE after having been exposed to information obtained during negotiations regarding any potential developments or deals concerning that company.
The facts of the Africa Ruling were as follows. Africa Industries Ltd. ("Africa") held 90% of the share capital of Negev Ceramics Ltd. ("Negev"), a public company trading on the TASE, while the remaining share capital was held by the public. During the year 2011, Negev and Olympia Tile-International Inc. ("Olympia"), a Canadian company which purchased Negev's products from time to time, had engaged in discussions and negotiations in respect of a potential large scale distribution transaction covering Negev's products ("Negotiations").
In January 2012, Africa published a tender offer to purchase the remaining 10% of shares of Negev. The Negotiations were neither mentioned in Africa's tender offer nor disclosed to the public by Negev. Africa's tender offer was accepted in full and Negev became a wholly owned subsidiary of Africa.
Several months later, at the end of May 2012, a distribution agreement was signed between Negev and Olympia covering Negev's products in North America. It should be noted that the first draft between the parties had only been exchanged at the beginning of May 2012, after the tender offer was published.
The Israel Securities Authority ("ISA") found out about the Negotiations and in late August 2013, the Administrative Enforcement Committee of the ISA ("Committee") determined, among other things, that the Negotiations were material and should have been disclosed at the time of the tender offer. It held that by failing to disclose the existence of the Negotiations to the public, Africa and its office holders had committed "insider trading" (as defined in the Securities Law, 1968 ("Securities Law")). In addition, the Committee held that Africa and a number of its office holders had negligently misled the ISA in presenting that the Negotiations had commenced during May 2012. Thus, the Committee imposed a monetary sanction on Africa in the amount NIS 5 million (US$1.25 million) as well as monetary sanctions on each of the above office holders amounting to hundreds of thousands of Israeli shekels ("Decision"). It should be noted that the Committee was established in 2011 and has the power and authority, among other things, to investigate administrative violations of the Securities Law and impose monetary and other sanctions.
In November 2013, Africa appealed and filed an administrative petition to the Economic Division of the Tel-Aviv District Court. After considering the arguments raised by Africa, in late January 2015, the Court rejected the petition and confirmed the findings of the Decision. In doing so, it set a precedential ruling in determining the test relating to inside information within the context of negotiations. Prior to the Africa Ruling, two main tests were used by the Israeli courts in determining the materiality of information pertaining to negotiations; however their implementation has not been uniform:
- The Agreement-in-Principle Test: Under this test, negotiations regarding a future transaction are considered material only after the parties have reached an agreement in principle as to the price and structure of the transaction; and
- The Magnitude/Probability Test (adopted in the US 1988 decision in Basic Inc. v Levinson): Under this test, materiality depends on a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.
In the Africa Ruling (being the first time the Committee's rulings were subject to judicial review), the court determined that the Magnitude/Probability Test should be the test used to examine the materiality of information. The general rationale is that even without an agreement with regard to the price and structure of the transaction and even at very early stages of negotiations, the information pertaining to the negotiations may be relevant for the investors’ investment decision and may therefore be considered material information.
When applying the test, the court, accordingly, found that at the time of the tender offer the information regarding the Negotiations was material primarily due to the fact that: (a) the transaction's magnitude was considerable since the transaction was of paramount strategic significance to Negev (allowing it to enter the American market); and (b) there was a relatively high probability that the transaction would occur since the Negotiations were included in a number of presentations that were made before Negev's management and Africa's chairman and were also used to support a request for a Government grant.
In evaluating the decision, the Africa Ruling is an enlightening one for several reasons. First, it is reasonable to assume that the decision will strengthen the ISA's resolve to deal with inside information violations by way of administrative proceedings rather than criminal proceedings (as the burden of proof in administrative proceedings is lower and the legal procedure is quicker). Second, it is now clear that the ISA, the Committee, and the Economic Division of the Tel-Aviv District Court are all of the opinion that the Magnitude/Probability test is the one that should be adopted and applied. The application of the Magnitude/Probability test, however, both within a company and by the Courts, may be problematic as by nature negotiations are dynamic. In this respect, persons should err on the side of caution. Lastly, but no less important, is that in considering the materiality of information obtained in the negotiations, a quantitative analysis alone is not sufficient, rather a qualitative analysis should be implemented as well, such as considering if the negotiations concern a company entering into new areas of operation or how the negotiations are presented to the management.
It will be interesting to see how the Magnitude/Probability test is actually implemented, and if the Africa Ruling causes an increase in companies reporting to its shareholders regarding any developments that are in the very early stages of negotiations.