White & Case llp recently completed a study of the exemptions that Israeli companies take from the corporate governance requirements that apply to US domestic issuers. In total, we reviewed filings by the 65 Israeli companies listed on the Nasdaq Stock Market and the three Israeli companies listed on the New York Stock Exchange (NYSE.)1 We believe that this study will assist listed Israeli companies and those conducting IPOs in determining the appropriate governance practices to adopt.
We believe that the results of this study are of interest for the following reasons:
- After Canada (whose companies benefit from a special US Securities and Exchange Commission (SEC) registration and reporting regime), Israel is the foreign country with the largest number of companies listed in the United States. Although the number of UK listings by Israeli companies has grown recently, the United States continues to be the destination of choice for Israeli companies conducting IPOs.
- Almost all Israeli companies that are publicly traded in the United States are listed on Nasdaq. Nasdaq amended its rules in January 2005 to provide that foreign private issuers can receive an automatic exemption from its corporate governance requirements that apply to US companies, provided that the foreign company discloses the particular exemption in its annual report or on its website.
- Most Israeli companies are listed only in the United States. Those companies also listed on a non-US securities exchange are generally listed on the Tel Aviv Stock Exchange. Since the US listing represents the substantial majority of trading and US shareholders represent the majority of shareholders, the application of US corporate governance requirements is of particular interest.
The following is a summary of the results of the survey:
- Twenty percent of Israeli companies listed on Nasdaq take no exemption from Nasdaq listing requirements. This number increases to 29 percent when Israeli companies whose only exemption relates to quorum requirements are included. Put differently, over two-thirds of Israeli companies take an exemption from one or more substantive Nasdaq corporate governance requirements.
- Forty-two percent of Israeli companies listed on Nasdaq take an exemption from Nasdaq’s requirement of shareholder approval for the establishment or amendment of an equity compensation plan. Almost half of the Israeli companies claiming this exemption have done so since filing their 2006 annual report. This exemption allows the establishment of new equity compensation plans without shareholder approval and also generally enables outstanding options to be repriced without shareholder approval. Only 14 percent of Israeli companies have taken an exemption from Nasdaq’s other shareholder approval requirements regarding the issuance of shares in certain M&A transactions with related parties, or in certain private placements in connection with M&A transactions or involving below market issuance prices.
- Seventeen percent of Israeli companies listed on Nasdaq take an exemption from the requirement of majority-board independence (this is in addition to a small number of Israeli companies that are exempt from this requirement because they are “controlled companies.”) The result of this exemption is that audit committee members are generally the only directors that are required to be independent (for example, two directors meeting Israeli independence requirements and all directors meeting SEC and Nasdaq independence requirements).
- Only three percent of Israeli companies take an exemption from Nasdaq’s audit committee requirements. The low number of Israeli companies taking advantage of this exemption reflects the importance that is attributed to the audit committee and the fact that the Israeli Companies Law has its own relatively robust audit committee requirements. There is consequently little benefit to be gained by an exemption from Nasdaq’s requirements.
- Only three Israeli companies are listed on the NYSE. As a result, there is a limited sample for analysis. Each of the three NYSE-listed companies takes exemptions from most of the NYSE requirements other than exemptions related to audit committees. One of the companies is a controlled company.
- The largest company in Israel—Teva Pharmaceuticals Ltd.— has taken no exemptions to Nasdaq’s corporate governance requirements. The other members of the Tel Aviv Stock Exchange 25 Index that are traded in the United States have taken various exemptions, but none of them take a blanket exemption.2
Analysis and Recommendations
Just under one-fifth of Israeli companies have taken an exemption from Nasdaq’s and the NYSE’s majority independence requirements. Compliance with the technical independence requirements can be challenging and the majority independence requirement is more stringent than the standards adopted by many non-US exchanges.3 Nevertheless, the standard reflects a belief that significant independent director representation leads to more robust management oversight and is something that many US investors now expect. If the full majority independence rules are not followed, we still believe that Israeli companies should limit the number of executive officers and other individuals with significant non-stock ties to the company that serve on the board. In addition, while the audit committee requirements of the Israeli Companies Law are robust, we believe that there are compelling reasons for Israeli companies to continue to adopt Nasdaq’s and the NYSE’s audit committee requirements. These include, for example, the requirement that there be three independent members of a listed company’s audit committee (not just two as required under Israeli law) and stricter independence requirements than those imposed by Israeli law. The survey indicates that almost all Israeli companies follow this approach with respect to audit committees.
Approximately one-fifth of Israeli companies have taken an exemption from Nasdaq’s and the NYSE’s nominating committee requirements and one-tenth of Israeli companies have taken an exemption from Nasdaq’s and the NYSE’s compensation committee requirements. We believe that the existence of a nominating committee is beneficial only when it conducts an annual review of the board’s overall skill set (actual and desired), as well as a review of each director’s contributions to the board (objectively and through self evaluations), thereby being in a better position to determine an optimal slate of director nominees. This is a challenging mandate to fulfill. Nevertheless, a nominating committee is the ideal forum to carry out this mandate, unless the board itself can fulfill this role. We also believe that a functioning compensation committee is critical for all public companies, notwithstanding the fact that foreign private issuers are exempt from the SEC’s enhanced compensation disclosure requirements. We therefore see strong reasons for Israeli companies to follow Nasdaq’s and the NYSE’s compensation committee requirements, and the survey indicates that almost all Israeli companies do so.
The topic of shareholder approval is more complex. There is a growing trend for Israeli companies to exempt themselves from the requirement of shareholder approval for the adoption or material amendment of an equity compensation plan. (By contrast, the number of Israeli companies taking an exemption from the requirement of shareholder approval for the issuance of shares in private placements with related parties or at below market prices is currently less.) We think this reflects the fact that adoption of, and amendments to, equity compensation plans are a more frequent occurrence than extraordinary issuances of shares in related-party, M&A and private transactions. Current economic conditions are only likely to expand the need to increase the number of shares available under existing plans or to reprice outstanding options. We believe that the board of directors of each company should make an individual determination regarding use of this exemption in light of the potential dilution that it can cause to existing shareholders without affording such shareholders the opportunity to vote.
Finally, companies that may in the future make use of the Nasdaq and NYSE exemptions should include appropriate disclosure in their annual reports or on their websites advising of the potential availability of these exemptions. If it is known that a particular exemption is likely to be used in the future—particularly an exemption from shareholder approval requirements—we believe it is advisable to inform the market sufficiently in advance of using the exemption so that investors will not be surprised.
Background to the Exemptions
In January 2005, Nasdaq Marketplace Rule 4350 was amended to allow foreign private issuers to follow their home country corporate governance practices without requesting a specific exemption from Nasdaq. Nasdaq-listed foreign private issuers must disclose in their annual reports or on their websites the particular requirement of Rule 4350 that they do not follow, together with an explanation of the home country practice, if any, followed in lieu of the requirement.4 The amendment generally conformed Nasdaq’s practices to those of the NYSE with respect to corporate governance requirements for foreign private issuers.
The new exemption for foreign private issuers represented a significant change from prior rules because foreign private issuers previously had to show that a particular Nasdaq corporate governance requirement was contrary to law or generally accepted business practices of their home country. In addition, under prior rules, FPIs were required to disclose any corporate governance rules that they were not following in their annual report filed with the SEC. This requirement raised timing issues for issuers that wished to follow home country practices at a time when the filing of their annual report was not proximate. The amendment to the rule addressed both of these issues.