New Court Ruling Clarifies Legal Boundaries for Offering of Foreign Investments in Israel

The Tel Aviv District Court handed down an important ruling recently regulating the activities of entities distributing alternative investments in Israel. In many instances, the distribution activities are accompanied by conversations and correspondence with potential investors, which constitute investment advice, and this is where matters become complicated. When foreign distributors are seeking Israeli investors to invest in foreign funds and financial instruments, matters become even more complicated.

The Tel Aviv Economic Court ruled that, in such a complicated case, investment advice was, in fact, provided in Israel which, under Israeli law, required a license from the Israel Securities Authority, and that the foreign distributor’s visits to Israel imposed Israeli law on it, despite the fact that the agreement it signed with its Israeli clients included a foreign jurisdiction clause. The court further ruled that when a distributor receives a commission from the entity that issued the fund or financial instrument, the distributor must fully disclose that commission to potential investors.

Specifically, the ruling involved an Israeli investor who lost his investment in American real estate investment trusts (REITs). The investor sued the Israeli family office “Olympus Economic Solutions,” which referred him to an American investment advisory firm that proposed to the investor that he should invest in the REITs. The investment advisory firm acted here as a distributor and received commissions from the American broker in respect of the investments in the REITs made in the client’s account being managed by the American broker. The family office also received part of the commissions transferred from the broker in consideration of the referral to the investment advisory firm.

During the first part of its ruling, the court examined the territorial scope of the law in this case. Given its dramatic impact on this specific case, this is a very important issue in our view. As mentioned above, the foreign investment advisory firm – which is supervised by the relevant US regulatory authorities – signed an agreement with its clients that explicitly stipulated that disputes arising from the agreement would be resolved in the United States and under US law, and that the actual investments in US REITs were made through an American broker.

Nevertheless, the Israeli court decided to give greater weight to the fact that the investor resides in Israel and that the meetings were held in Israel, with the Israeli family office brokering between the investor and the advisory firm, and ruled that, under these circumstances, Israeli law applies. Had the case at bar been adjudicated in a US court, it is quite possible that the outcome would have been entirely different.

In the second part of its ruling, the court analyzed the specific circumstances of the case and its legal implications. The ruling stated that the advisory firm and the advisor on its behalf had provided “investment advice” pursuant to the Israeli Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management Law of 1995 (the “Advice Law”), which requires a license from the Israel Securities Authority or, alternatively, must be provided in conformity with one of the exemptions from the licensing requirement defined in the Advice Law.

The court further ruled that the family office and its owners had violated the Advice Law by referring their clients to an unlicensed advisory firm.

Conflicts of interest

Another issue that the court addressed is the concern of prima facie conflicts of interest between distributors and advisors and their clients. This is one of the most important issues influencing financial regulation in Israel and abroad, which derives from the fact that, in many instances, such as the case adjudicated in this ruling, distributors and advisors receive commissions from issuers or from entities related in one way or another to the financial instrument in which the client is investing. For example: pursuant to the Advice Law, when a service-provider has an interest in a financial asset, it is deemed a “marketer” and not an “advisor” – semantics that serve to inform the client that the service-provider may be reaping additional financial incentives beyond the management fee that the client is paying. It is important to note that “marketers” are also obligated to prioritize the client’s best interests and provide professional service tailored to the client’s needs, but they are also allowed to recommend financial assets in which they have an interest, provided that they still prioritize the client’s best interests and issue due disclosure to the client. 

In its ruling, the court ruled that the client did not receive due disclosure of the commissions to which the distributor was entitled. As stated, there is nothing wrong with receiving a commission, but the court emphasized the importance of due disclosure to the client, and based its ruling, inter alia, on those commissions in order to determine the liability of the family office and the advisory firm.

We believe that this ruling should be seen as a link in a chain that includes investors’ lawsuits against advisors and distributors, enforcement proceedings initiated by financial regulatory authorities in such situations, and the growing trend on the part of the courts and the regulatory authorities to strengthen their protection of the public in relation to all matters pertaining to financial activities, even when at issue are ostensibly engagements in the free market that are regulated by contractual agreements between the parties.

It is our position – without expressing an opinion about the outcomes of this ruling – that not every distribution and marketing of alternative investment products will require an investment advice or marketing license, and that it will depend on the specific circumstances of each case.

We recommend seeking legal advice in order to ascertain whether your activities are subject to regulatory obligations that you might not be aware of, and we are at your service to assist you in this regard.

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Barnea Jaffa Lande Law Firm is at your service for legal advice on the subject of regulation in Israel and Abroad, and any other legal matters.