Israel Securities Authority – What Constitutes Securities Fraud?
The Israel Securities Authority has published an updated legal staff position paper on securities fraud. In it, the ISA seeks to detail indicators which the ISA believes point to suspicions of securities fraud that justify opening a criminal investigation.
The law prohibits influence of stock prices by the use “fraudulent means”. However, the legislature has never defined the term “fraudulent means.” Over the years, courts have interpreted and given this term substance. It was held, inter alia, that fraudulent means are not limited to artificial transactions alone, such as self-dealing between two different accounts owned by the same person. Rather, it is possible that fraudulent means exist in real transactions, too, i.e., sales or purchases with random parties in the market.
As a rule, fraud is characterized by setting the security’s rate as a goal of the trade activity, at times, by creating the appearance that the transaction is influenced by market forces alone.
Now, the ISA wishes to warn capital market players against trade activity it may deem suspicious as fraudulent means of trade, as follows:
- Self-Dealing– the simultaneous purchase and sale of the same security, by the same person or anyone on his behalf, which influences the security’s rate on the stock exchange.
- Matched orders– the purchase and sale of the same security, by two or more people, through advance coordination between parties, which influences the security’s rate on the stock exchange.
- Conducting transactions by means of false representation– conducting transactions in trade while influencing the rate of the security, whether coordinated or not, which creates a false representation as to the existence of active trade in the security or changes in the rate of the security.
- Giving directions without intention to perform– causing a flow of directions for trade and rescinding them before performance in order to create the impression of real supply or demand in the rates limits, and thus influence the rate of the security.
- Influencing the closing rates– giving instructions for sale or purchase with the intention of influencing the rate of the security at the time of closing (Marking the Close).
- Securities takeover intended to influence the rate– causing a flow of directions and/or performing transactions by one or several parties, with cooperation, in an attempt to create a surplus of demand or a surplus of supply of the security, in order to directly or indirectly influence and fix the purchase or sale rates of that security.
- Influencing the security’s minimum rate– causing a flow of directions or performing transactions intended to prevent a rate decrease, in order to prevent negative outcomes to the issuing party, the controlling party, or a different interested party in the security.
- Influencing the rate for purposes of valuation – influencing the security’s sale or purchase, in proximity to the end of the reporting period or a deadline, so to improve the value of the assets, portfolio, or income of the reporting party. (Window dressing)
- Trading activity intended to influence the outcome of a material event– giving purchase or sale instructions for a security in order to influence its rate in proximity to an important event, when the rate may impact the outcome of that important event (such as expiration date for options in the derivatives market, tender exchange, series expansions, entrance or exit from indexes, etc.)
- Influencing the security with the intention of influencing a related security– this may include a derivative, a security on the same income curve, etc., or influencing a security in one trading platform in order to influence its rate in another trading platform.
- Exploitation of stock exchange trade mechanisms to influence the security’s rate– giving a purchase or sale order for the purpose of influencing the rate and thus operate stock exchange trade mechanisms, while exploiting the mechanisms to produce profits.
In addition, the ISA presents an open list of indicators that may be relevant to how it applies its discretion on the existence of securities fraud. According to the ISA, each of the indicators may be independent or examined along with others. The indicators listed include, inter alia, the scope of the directions or transactions by the same party; the extent to which these transactions influenced the security’s rate; the absence of financial reason in executing the transactions; executing the transactions in proximity to an important event when the security was used as the basis for an asset value, such as valuations, arrangements, indexes, issuances, etc.; and the existence of direct or indirect interest in influencing the rate or the value of the security or a derivative thereof.
In effect, there is no real novelty to the ISA’s legal staff update compared to the one published about six years ago, in 2014. In fact, the two legal staff positions are almost identical.
We believe this raises some questions in light of the dramatic changes in trading activity in the markets since 2014. In recent years, advance technologies were developed and sophisticated entities began using them. Today, machines perform the vast majority of trade, without any human involvement. Nevertheless, the ISA’s latest update completely overlooks the influence of new trade techniques on the crime of fraud, such as algorithmic trade or high frequency trade (sale or purchase of securities at a higher speed using advanced computers that can give and execute a huge volume of commands in microseconds).
It is possible the ISA thought it fitting to refresh its old update on fraud because of the data on the high flow of small investors to the market during the COVID-19 pandemic. However, this new update’s level of relevancy for the vast majority of securities trade is minor. Sophisticated parties currently conduct securities trade on the Tel Aviv Stock Exchange (and around the world) without human involvement, as well as with massive investments in advanced technologies in order to minimize risk and uncertainty. Thus, while the ISA is occupied fighting yesterday’s war, the gaps between sophisticated investors and small investors have never been greater.
Adv. Hadar Israeli represents individuals and companies in a wide range of criminal and administrative enforcement proceedings, as well as complex commercial litigation, in Israel and the US. Adv. Eran Elharar represents companies and individuals in a wide range of legal proceedings in the fields of criminal and administrative enforcement.