Capital Markets / Enforcement

The SEC is taking a regulation by enforcement stance toward NFTs and is creating legal uncertainty in the field. Will the Israel Securities Authority follow suit?

In corporate law, it is customary to identify three organs through which a business company operates: the shareholders, the company’s management, and the board of directors. While the duties and rules by which shareholders and company managements should act are pretty clear (albeit completely different from one another), when it comes to board members, the situation is far more complex.

Shareholders are perceived primarily as a passive organ called to act only at particular points in time or under particular circumstances, mainly by voting during a shareholders’ meeting. That being the case, it is rare for shareholders to even have to consider what actions they must take in order to be deemed as having fulfilled their duties.

On the other hand, a company’s management and especially its CEO are perceived as a highly active organ that in-effect manages the company and is directly and immediately responsible for the company’s actions. That being the case, a company’s management is obligated to fulfill its duties toward the company on a daily basis. The management is actively involved on an ongoing basis and, consequently, is held accountable for its actions and omissions.

The Unique Role of the Board of Directors

The board of directors’ role falls somewhere in between. On the one hand, it is a relatively passive organ that does not actually manage the company, is not involved in the company’s routine activities, and keeps abreast almost entirely from the information fed to it by the management. On the other hand, the board is an organ convened to take action (and sometimes to be proactive) by supervising the company’s management, formulating company policy, and passing resolutions with operative implications of the highest order. Board members therefore must contend with this precarious position. On the one hand, the law imposes obligations on the board of directors, and case law in recent years has expanded the applicability of these obligations and raises the standards of conduct expected of a reasonable director. On the other hand, board members are not involved in the company’s day-to-day management, visit the company’s offices infrequently, and their familiarity with the company, its activities, and its situation derives almost exclusively from the data and representations communicated to them by the company’s management. So what is expected from directors?

This question arises, for example, in the instance of a business failure or a transaction that is more beneficial to one party at the expense of another. In such instance, the board of directors may find itself sued by a shareholder or even by a creditor of the company. Moreover, if the company is a public company or an entity subject to regulatory supervision, the board may face scrutiny from the Israel Securities Authority or the relevant regulatory authority. In recent years, the courts and the regulatory authorities have imposed higher accountability on boards of directors, which brings the question of the appropriate and desirable standards of conduct into high focus.

When Has a Company’s Board of Directors Fulfilled Its Duties as Required?

This is a complex question, but board members need a simple answer they can implement. Therefore, when it comes to directors’ accountability, there is one rule that every director must always remember, internalize, and follow: the Business Judgement Rule (also known as "BJR"). This is a doctrine developed in United States case law, primarily by the Delaware Court of Chancery. According to this doctrine, so long as an officer’s actions fall within the parameters of three criteria, the officer will be granted immunity from liability if a plaintiff sues on the grounds the officer breached the duty of care. More specifically, courts deliberating lawsuits against officers in respect of decisions they made in their capacity as officers will rule that those officers acted properly and will refrain from intervening in their decisions if they fulfilled the following three criteria:

1. The decision was reached without any conflict of interest.
2. The decision was reached in subjective good faith.
3. The decision was reached in an informed manner, after reviewing the data and taking all relevant considerations into account.

In other words, if the board of directors appoints a forum with no personal interest or conflicting interest for the purposes of decision-making (for example, members of an audit committee or a board committee comprised exclusively of independent directors) and that forum holds an in-depth discussion on all aspects of the transaction or the resolution at hand in good faith, after consulting independent experts, then the resolution passed at the end of this process will benefit from a presumption of propriety and the court will focus on the decision-making process, while refraining from intervening in the substantive resolution or in the business action that was the subject of discussion.

To complete the picture, you should know that another rule, the “entire fairness” rule, is also in play. According to this doctrine, when company officers make decisions while in a state of conflict of interest (for example, when the company’s controlling shareholder is a party to both sides of the transaction under consideration), the defendants must prove they have fulfilled two criteria – the procedural fairness and the substantive fairness of the transaction – to convince the court to dismiss the suit.

The Doctrine in Israel

In Israel, directors who fail to fulfill their fiduciary duties and duties of care may find themselves sued in civil proceedings and, in some instances, even criminal proceedings. A concrete example of this is the Peled-Givony Group case. Uncovered during an investigation conducted by the Israel Securities Authority that began in the summer of 2002, this scandal ended with a Supreme Court ruling in 2016.

A Legal Imbroglio that Dragged on for 14 Years

In this case, the former police commissioner, Rafi Peled, who engaged in a business venture with several partners, was convicted of fraud and corporate breach of trust and of reporting offenses with the intent to mislead. Peled’s accomplices were sentenced to prison terms, and Peled himself was sentenced to community service and fined ILS 200,000. In Peled’s case, the district court ruled as follows:

“Although Rafi Peled did not steal money from public companies and did not embezzle these funds, he colossally failed to fulfill his duties as chairman of the board of directors, as a controlling shareholder, and as a member of the control group. He failed to exercise his own judgment and conceded to others; he allowed Jaegerman (a financial advisor to the company, Z.G.) to do as he pleased with these companies; he knew about Jaegerman’s actions and tactics, but did nothing to oppose them; and he heard warnings from Shenhav, Istrik, and others and chose to ignore them or perhaps hoped they were resolvable problems. In so doing, Peled committed a breach of trust of the public companies he headed and also of the public of investors.”

Basically, Peled’s sin was that he did not properly supervise the actions of others. It is even possible Peled acted in subjective good faith. However, he was in a state of conflict of interest by virtue of his being the chairman of the board and a member of the control group, and he definitely failed to scrutinize, consider, or criticize in an “informed” manner the actions ultimately cited in the indictment. Had Peled been diligent about adhering to the three criteria of the BJR, he could have spared himself 14 years of legal imbroglio.

Elovitch and the Leveraged Acquisition

Another example of the importance of adhering to the business judgment rule is the 2016 Supreme Court ruling in the Vardnikov v. Elovitch case. In that case, the plaintiff attacked the resolutions of Bezeq’s board of directors to distribute dividends, raise debt capital, and reduce capital in a way that enabled Shaul Elovitch to finance the leveraged acquisition of the company’s control core. The Supreme Court explicitly applied the Business Judgment Rule and determined the board of directors had fulfilled the three requisite criteria: it was not in a state of conflict of interest, it acted in good faith, and it passed an informed professional resolution after weighing all relevant considerations. In that case, the court also added an interim test and left ample room (too much room, in my humble opinion) for judicial discretion and intervention in the board’s resolution. However, as stated, the court defended the resolution by Bezeq’s board of directors, notwithstanding Elovitch’s clear interest in the capital reduction that would enable a dividend distribution.

Better Place

The Supreme Court again addressed the question of applying the Business Judgment Rule in its February 2022 ruling in the Better Place Israel v. Shai Agassi case. In that case, the plaintiffs alleged, inter alia, that the board of directors was negligent in managing the company and argued that the BJR does not apply when a company is in an “insolvency environment” or when the directors failed to exercise independent judgment, because the board of directors of a parent company passed the resolution. Interestingly, the General Attorney submitted his position on the issue at hand. He argued, inter alia, based on a Delaware court ruling, that the fact a company is facing insolvency does not affect the obligations imposed on officers and does not place them in an inherent state of conflict of interest, which would deny them any ability to rely on the BJR in the first place. The Supreme Court cited its ruling in the Bezeq case with regard to the interim test, ruled that it must be careful not to make automatic analogies between the issue at hand and the issue that was presented before the court in Bezeq, and decided to remand the case to the district court for adjudication. That being said, what is important for our purposes is that the Supreme Court has, in fact, strengthened the application of the Business Judgment Rule in Israeli law. Moreover, it has also opined that the rule can substantiate a motion to dismiss of a claim against an officer already at the preliminary stage of the proceeding.

The Director’s Best Friend

This shows how important it is for every director to know the Business Judgment Rule. Different companies operate in different industries, develop unique expertise, and are motivated by different people under dynamic circumstances. Consequently, it is very difficult to compare the decisions of one board of directors against the decisions of another board of directors. Nevertheless, a board of directors must act according to particular standards of conduct, and deviating from those standards may be deemed a breach of fiduciary duties and the duties of care imposed on directors. In light of this diversity, it is clear that judges cannot re-evaluate every board decision submitted to them. For this reason, the Business Judgment Rule was developed. It essentially focuses on the decision-making process and releases the court from having to scrutinize the minutiae of each decision. This insight is of critical importance to directors, because the BJR is straightforward: implement an orderly, fair, informed, and prudent process, and you will likely be protected. For this reason, it is clear why the Business Judgment Rule is a director’s best friend.

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Barnea Jaffa Lande's Capital Markets department is at your service regarding corporate governance, public companies and board of directors related questions.

Dr. Zvi Gabbay heads the firm's Capital Markets Department.

The trend of tightening enforcement measures against corruption crimes has intensified over the past year, and increasing the punishment of these criminals has become a global effort. Israeli courts and the State Attorney General’s Office have also adopted this trend. However, the latest legislative initiatives of the Israeli government could adversely affect Israel’s ranking in the Corruption Perceptions Index (CPI). This could prompt foreign countries to increase their law enforcement efforts against Israeli companies and individuals.

Israel

1. Israeli legislation that restricts law enforcement and control capabilities against elected officials

During the brief period since its election, the Israeli government has initiated a legislative blitz whose main goal is to protect elected officials from law enforcement or control measures against them. Among other draft bills on the government’s agenda are the following:

• An amendment to the Gifts Law, which will allow civil servants to raise funds for themselves or for their relatives to finance legal or medical proceedings.
• An amendment to the Basic Law: The Government, whereby declaring the prime minister unfit for office will only be possible on the grounds of the prime minister’s physical or mental incapacity to perform his role.1.3
• An amendment to the Basic Law: The Government, so that a person with a criminal record may serve as a minister in the government (also known as the “Deri 2 Law”).
• A draft proposal of the “French Law,” which prohibits the investigation of an incumbent prime minister. Additionally, a draft bill that would subordinate the department for the investigation of police officers directly to the Ministry of Justice and give it powers to investigate prosecutors from the State Attorney General’s Office.
• A draft bill that will grant immunity from arrest to heads of authorities and to heads of regional councils, unless they are caught in the act of committing a crime involving the use of force, disturbing the peace, or treason.

The government is advancing these legislative proposals, despite the strong objection of Israel’s Attorney General, Adv. Gali Baharav-Miara.

2. Transparency International’s Corruption Perceptions Index

Transparency International’s Corruption Perceptions Index ranks 180 countries and territories around the world by their perceived levels of public sector corruption, ranking them on a scale of 0 (highly corrupt) to 100 (very clean).

The latest index, published in January 2023, gave Israel a score of 63 points for 2022, a four-point increase from its score in 2021. Thus, Israel’s rank rose from 29th place to 31st place in 2022.

However, Transparency International issued an alert that it has identified a downtrend in the number of investigations and indictments of corruption cases in Israel. As a result, it lowered Israel’s ranking in enforcement measures against corruption from “active enforcement” to “moderate enforcement.” This is an important warning, since a downtrend in Israel’s ranking could have repercussions on its legal and political relations in the international arena.

3. Consideration of criminal record as a precondition for participation in tenders

The Finance and Economy Directive, published by the Ministry of Finance’s Accountant General at the end of 2022, prescribes that government ministries must examine criminal information during their procurement processes through tenders. The directive states that bidders must submit an affidavit attesting to no criminal record. Additionally, bidders must issue their consent to the disclosure of information from the Criminal Register (which was prohibited until the directive came into effect). Tender committees may consider refusing an engagement based on criminal information issued to it.

4. Supreme Court: the punishment for crimes of bribery will be incarceration

The Supreme Court recently increased the punishment of Natan Foreman, a former executive of Egged Transportation (the largest public bus company in Israel), who was convicted of soliciting a bribe totaling EUR 1 million. The district court sentenced Foreman to nine months of community service, considering his age (73) and the time that elapsed since he committed the crime (18 years). The Supreme Court overturned the district court’s ruling and sentenced him to incarceration. This decision issued a clear message that, notwithstanding the significant extenuating circumstances, the price for corruption and bribery is imprisonment behind bars.

5. The filing of a derivative civil lawsuit against former minister Faina Kirschenbaum

After former minister Faina Kirschenbaum was convicted of accepting bribes, the State filed a civil suit demanding the return of ILS 6 million it claims Kirschenbaum and other defendants unlawfully took from the State’s coffers. The filing of this lawsuit constitutes another significant demonstration of the State Attorney General Office’s policy in recent years. This policy aims to enforce punishment for corruption crimes through economic means and nullify any economic benefit a convicted person may still retain.

6. Covert investigation of bribery and corruption and of rigging Ministry of Defense tenders at an alleged value of ILS 1 billion led to arrests

Dozens of suspects were detained for questioning last month on suspicion of grave economic corruption. The Israel Police and the Director of Security of the Defense Establishment arrested the suspects, including contractors and employees of the Engineering and Construction Division of the Ministry of Defense. They were arrested on suspicion of operating a massive cartel of dozens of companies and of rigging hundreds of tenders estimated to total ILS 1 billion. The suspicion is that the cartel has been operating for quite some time and bribed officials inside the Ministry of Defense and in the IDF.

USA

7. US Deputy Attorney General’s memo orders prosecution of cross-border corporate crimes when the foreign country where the crime was committed does not take adequate and effective law enforcement measures

US Deputy Attorney General Lisa Monaco issued a memo instructing US prosecutors to take action against crimes by international corporations that occur in foreign countries in instances where the foreign law enforcement officials procrastinate in domestic law enforcement. This is a dramatic change in US policy. As a result, greater intervention by US law enforcement authorities in relation to foreign corporations is likely, even in cases where the main crime scene is not in the United States.

8. Lenient enforcement against corporations cooperating with the authorities

The US Department of Justice has adopted lenient law enforcement policies in relation to cooperating corporations, particularly in instances where the corporation issues voluntary disclosure at its own initiative. Accordingly, the US Criminal Division published an update of its law enforcement policy. The update includes an expansion of the leniency policy in relation to all offenses under its purview (and not only for violations of the Foreign Corrupt Practices Act). The update also specifies the criteria for various leniencies in law enforcement. Similarly, the US Attorney’s Office published a policy document instructing prosecutors to take into account corporations’ voluntary and immediate disclosures of various violations.

9. US Department of Justice’s decision not to prosecute Safran for bribery in light of its voluntary disclosure and proactive cooperation

The US Department of Justice decided not to prosecute the French aerospace corporation Safran in respect of bribes given by employees of its American and German subsidiaries. This was despite findings that officers of the corporation’s subsidiaries paid bribes to Chinese government officials. The DOJ made this decision in light of the fact that Safran proactively cooperated with the investigation, issued disclosures to the authorities, and agreed to forfeit about USD 17 million.

Europe

10. Summary of anti-corruption activities in first year of European Public Prosecutor’s Office (EPPO)

The EPPO recently published a summary report of its activities in 2022. Established in June 2021, this independent body has been granted powers to investigate and prosecute cross-border crimes (particularly organized crime) against the European Union’s economic interests. The report states that during 2022, the EPPO opened about 865 investigations of suspected acts of corruption by public figures throughout the European Union.

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Barnea Jaffe Landa and Advs. Hadar Israeli, Anat Shubat, Eran Elharer and Shir Rosenzweig are at your disposal for any question in the areas of white collar, enforcement and compliance.