Investment Advice and New Technologies: Amendment to Israeli Directive

The Israel Securities Authority (ISA) is currently amending the directive that outlines the requirements for holders of investment consulting, investment marketing, and investment portfolio management licenses to provide services using technological means. The changes are based on the insights and lessons learned since the directive was first published in 2016. The ISA has become aware that the directive’s current terms restrict the activities of service providers, leading to overload and difficulty in providing successful service to customers. This has caused customers to seek service in non-supervised arenas, reducing competition in the regulated market in Israel. To remedy this situation and facilitate the activity of service providers while also tightening the protection of investors, the ISA plans to make changes in this area.

The primary changes will focus on two areas: trading signal services and social trading. The ISA is currently considering whether to maintain the status quo, despite its problematicness, or to implement significant changes in these areas. The proposed changes may require licensees to allocate significant resources for modifying their activity in accordance with the proposed changes.

Proposed Amendments to Trading Signal Service

A trading signal service offers customers uniform investment recommendations via digital media messages (SMSs, WhatsApp, etc.). This service is considered investment advice and requires a license. The investment advice provided in this service is uniform to all customers and the service provider does not take customers’ needs and preferences into account, nor does it monitor their investment outcomes. The service is currently obligated to operate with almost no interactions between the service provider and customers. The advantage of the service is its low cost, thus allowing the general public access to the investment arena. The main disadvantage of the service, from the ISA’s perspective, is that the service is uniform. As a result, the recommendations the service offers may be unsuitable for some users of the service. Moreover, the numerous restrictions imposed on the service by the ISA have resulted in few service providers offering it. Thus, customers who could have benefited from this service seek investment advice on social networks, largely offered by unauthorized parties. In order to rectify this situation, the ISA is proposing several amendments.

Amendments to the Directive:

Definition of trading signal service

The definition will change and will constitute an “independent trading advice service” whose main characteristics are the ongoing transmission of investment recommendations to independent traders via online means, without monitoring the customers’ current investment activities. In order to protect investors, the ISA is also proposing to tailor the service to customers. Service providers will thus need to carry out a clarification process and tailor the service to customers’ needs.

Fewer restrictions on interactions

The ISA is now proposing to partially eliminate the restriction on interactions with customers and to allow licensees to interact with customers for customer acquisition and retention purposes, to provide technical support, and for routine communications. The restriction prohibiting communications concerning the actual recommendations will remain in effect (and any communications within this context must only be for the purposes of providing technical clarifications). 

The provision of two types of services concurrently

Licensees are currently unable to provide trading signal services concurrently with the provision of traditional investment advice to the same client. According to the proposal, licensees may provide both types of service to the same customer, provided there is an effective and clear differentiation between both types of service, and provided the licensee takes reasonable measures to ensure the customer is aware of the difference between the services.

Obligation to present returns on investments to customers

The ISA is proposing to obligate service providers to present to customers all previous recommendations they gave to them. Service providers must present this information in a way that enables retrospective analysis of the recommendations’ results in a fair and non-misleading manner.

Elimination of the restriction on the execution of transactions

The directive currently prohibits service providers from offering customers opportunities to execute transactions directly through the trading signal service. The ISA is now proposing to eliminate this restriction, provided security mechanisms are implemented to prevent errors during the execution of transactions and provided customers are given the option of executing transactions through more than one service provider.

Social Trading

Social trading is a service that enables less-experienced investors (called “followers”) to view the composition of the investment portfolio and the investment activity of an experienced investor (called a “followed trader”). Social trading can be carried out in the following two ways:

(1)  Followers solely view a followed trader’s activity and make their investment decisions at their own discretion. Such activity is considered investment advice.

(2) Automatic copy trading, whereby a particular followed trader’s activity is automatically copied in the follower’s account. This activity is considered investment portfolio management.

The directive permits the carrying out of social trading in these two ways. However, due to the directive’s numerous restrictions, the situation today is that authorized social trading is negligible in the Israeli capital market, unlike in other countries. Another problem in Israel is that social trading activity leaks outside the supervised realm. The ISA is proposing to make several amendments to the directive in order to strike a balance between the need to protect investors and the need to facilitate the provision of service and encourage additional competitors to enter the market.

Amendments to the Directive:

Management of a followed trader’s account

The ISA is proposing to allow licensees to operate in the social trading market also as followed traders, provided their license corresponds to the license of the platform operator. For example, a holder of an investment advice license will not be able to provide services on a platform that holds an investment marketing license. The goal is that supervised licensees possessing professional knowledge and a good reputation (which should reduce potential harm to followers) will also operate as followed traders and not just as the platform’s operators. All restrictions applying to a licensee will also apply to it as a followed trader (including restrictions regarding the licensee’s permitted investment activity). The ISA is also proposing that a licensee operating as a followed trader will not be subject to the rule whereby a followed trader may only manage one account.

The remuneration model for followed traders

Currently, the remuneration to followed traders is based solely on the number of their followers (more followers = higher remuneration from the platform owner). The ISA is proposing to expand followed traders’ remuneration options, such as remuneration based on the followed trader’s expertise (in order to encourage professionalization and specialization). However, remuneration based on the number of transactions executed by followers or based on the return on the portfolio is prohibited.  

Conflicts of interest

Currently, a platform operator must obtain the customer’s written consent before executing any transaction entailing a conflict of interest on the part of the followed trader. The ISA is proposing that platform operators must ensure the followed traders themselves covenant in the agreement not to act while in a state of conflict of interest and that platform operators must exert all efforts to prevent followed traders from executing transactions while in a state of conflict of interest.

Disclosure of the remuneration model

The platform operator must disclose its remuneration model to customers (including when the remuneration derives from quote spreads resulting from followers’ trading activities. Under such a model, the service must not be presented as a free service).

Marketing

Followed traders may not market their accounts on platforms. On the other hand, the ISA clarified that platform owners may market their service and publish the names of the followed traders operating on their platforms.

Regulation of the dialogue

The ISA is proposing to allow some dialogue between followers and followed traders within the framework of a platform’s activity. However, such dialogue is permissible only insofar as it does not reach the level of personal investment advice, it is limited to providing information about a particular asset, and the platform operator monitors and controls the dialogue.

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Barnea Jaffa Lande’s Capital Markets Department is at your service to assist with adapting services to the new amendments and to advise about other related issues.

Adv. Michal Koren is an associate in the firm’s Capital Markets Department.