Regulation of Broker-Dealer Activity
Earlier this month, the Israel Securities Authority published a legislative memorandum aimed at regulating the broker dealer field in Israel. While the activity of most financial intermediaries is regulated and supervised (e.g., portfolio managers, investment advisors, underwriters, and distributors), the activity of brokerages and dealers is not supervised or subject to specific regulation.
This situation created a regulatory gap, and the goal of the new memorandum, and the regulatory provisions included therein, is to bridge this gap.
“Broker-Dealer Activity”
The statutory definition of “broker-dealer activity” includes the following:
- Executing security transaction orders for clients.
- Receiving and conveying orders in order to execute transactions for clients.
- Selling or purchasing securities to one’s own account by executing clients’ orders.
While the first two actions relate to a brokerage’s activity, the third relates to a dealer’s activity.
The legislative memorandum proposes only entities granted a license from the ISA be able to perform broker-dealer activities. At the same time, it holds several activities and entities exempt from the license requirement, primarily because their activity is already supervised and regulated. These include portfolio managers, underwriters and distributors, banks, crowdfunding platforms, and trading platforms.
In addition, the ISA suggests exempting from the license requirement those entities holding foreign licenses for broker-dealer activities and operating in Israel only with “sophisticated investors.” However, such entities still need to register in a designated registry.
Licensing Requirements
The conditions to receive a license include, inter alia, operating through a company registered in Israel, or one registered in Israel as a foreign company; the control of business activities and management are conducted in Israel, or if not conducted in Israel, the corporation must show it is able to follow all provisions and effective enforcement can be performed on it; possessing qualifications and means suitable for the broker-dealer activity; restrictions on other activities performed by the license holder; and holding self-capital and insurance.
In addition, the entity controlling the license applicant must obtain a “controlling permit” from the ISA.
Organizational Duties and Corporate Governance
The legislative memorandum proposes the licensee be required to meet corporate governance rules. These include the duty to appoint a minimum number of directors and independent directors, corporate eligibility requirements for the directors, various audit and supervision duties by the board of directors over the licensee’s activities, the duty to establish an audit committee, the duty to set protocols, the duty to prevent conflicts of interests, etc.
The legislative memorandum also authorizes the ISA to establish a duty on the licensee to appoint officers appointed by the internal audit mechanism and the internal enforcement plan, as well as a duty to appoint officers charged with risk management, fulfillment of duties, and credit supervision.
Duties toward Clients
A licensee’s duties toward its clients were also determined. These include the duty of trust and care; provisions in terms of conflicts of interest; eligibility requirements for the licensee’s employees; restrictions on the licensee receiving incentives from third parties; the duty to disclose information to the client prior to commencement of activity; the duty to provide ongoing reports; prohibitions on misleading clients; the duty to fit the service to the client (in terms of his understanding of the risks and rewards involved in the activity); the duty to execute the best possible deal; and the duties involved in handling the client’s funds and securities, such as the duty to hold client funds separate from the licensee’s assets.
The legislative memorandum also proposes regulatory incentives for entities that establish a platform for technology-based brokerage services for retail clients in Israel. Such incentives will be established later within the regulations and provisions.
Additionally, it is proposed the ISA be entitled to exempt certain licensees from the self-capital, corporate governance, and organizational duties requirements, at its own discretion. This would apply to the following instances: (1) the licensee is subject to a foreign law that regulates such duties, (2) the scope of the licensee’s activity is small or there are few clients, or (3) the licensee provides its services only to eligible clients. We note this is not a total exemption from the requirement for an Israeli broker-dealer license, but rather an exemption from specific duties.
To view the legislative memorandum on the Ministry of Justice’s website
***
Our Capital Markets Department is at your service if you need any advice or guidance in this regard.