The court has ruled: Israel Securities Authority was negligent in supervising UTrade and will have to compensate investors

Investors who lost money claimed that already in early 2015, the Authority ought to have verified that UTrade had ceased its activities and issued an explicit public warning • Justice Ruth Ronen rejected the Authority’s claim that if it were to be held responsible for the loss of investors’ money, it would not be able to function properly and investors would be hurt

07.07.19 | Efrat Neumann

The Israel Securities Authority was negligent in supervising UTrade, and it bears responsibility for the losses of investors who fell victim to the company’s fraud – thus recently ruled Justice Ruth Ronen, Head of the Economic Department at Tel Aviv District Court. The ruling required the Authority to compensate four plaintiffs for a total sum of ILS 1 million (after interest and linkage).

Between 2012 and 2015, UTrade raised 27 million dollars from 600 customers for purpose of investing in algorithmic trading – trading on stock exchange  based on computer software. After the event, it became apparent that the procedure for recruiting customers, under the responsibility of owner Aviv Talmor, was based on false presentations and concealment of information. It further became apparent that at a certain point, UTrade operated according to a “pyramid’ networking marketing method, meaning that it used money raised from new customers to finance withdrawal requests from its old customers. The matter exploded at the end of 2015.

Six investors filed lawsuits against the Israel Securities Authority (hearing of the cases was consolidated) on the grounds that it failed in its function as supervisor of activity in the capital market and did not prevent UTrade’s activity. Justice Ronen, who accepted the suit of four of them, ruled that the Authority was negligent in not stopping UTrade’s activity and in that it did not issue a public warning that would have prevented investor losses.

The Head of the Capital Market, Securities and Venture Capital Department at law firm Hamburger Evron & Co. (who was not involved in the case), Adv. Achai Gomeh, says that the novelty lies in the fact that the Court went into the scope of the enforcement and supervision activities of the Authority and criticized the way in which it operates. “The Court has put an end to claims of the Authority that it is not liable for damages caused by an entity that is not under its supervision. The hope is that the Authority will now focus less on non-substantive checks of supervised entities and focus its activity outside its comfort zone – namely, in catching those who actually break the law, and not those who are on the margins of the law”.

Gomeh adds that the ruling prepares the way for the Authority to publish warnings – as happens abroad – in respect of certain entities, and this is good news for citizens. “In so doing, the Court makes it clear that publishing notices that warn in a general manner of investments in non-supervised entities, without naming them, is not effective for inexperienced investors”.

Clear indications of breach of commitment

The claim filed by the investors related to client portfolio management activity by UTrade, which requires a license. In March 2015, the Authority wrote a letter to UTrade demanding that it cease its operations, after having informed the company at the beginning of the year that its activities appeared to require a license. In consequence, in May 2015, the company undertook to cease recruiting new customers and to take steps  in order to stop managing the portfolios of existing customers by the end of the month.

In June 2015, UTrade customers began to encounter difficulties in withdrawing their money, and complaints about this were even received by the Authority, but only at the end of that year did the Authority file an application for an injunction against UTrade. The company was issued with an injunction, a liquidator was appointed, and the process of liquidating the company commenced, with a criminal proceeding subsequently being instituted against Talmor.

The plaintiffs argued that as early as the beginning of 2015, the Authority should have conducted an inspection, to ensure that UTrade had ceased its activity, and it should have explicitly warned existing and potential customers.

The Authority claimed that only under the most exceptional circumstances – which do not exist here, can tortious liability be imposed on state authorities in respect of enforcement failures. According to the Authority, there is a huge number of entities that are not supervised by it, and it is difficult to identify and supervise them. It also argued that investors take upon themselves a known risk. The Authority added that if it were to be held liable in instances where investors lost money in the capital market, it would not be able to function properly since its resources were limited, and investors would suffer injury as a result. It further argued that at the heart of the matter, it operated as an Authority in a reasonable manner and within a reasonable time frame.

In April 2019, at the height of the UTrade hearing, a Supreme Court ruling was published in the fraud case of businessman Gregory Lerner. In this case, a claim filed against the Israel Securities Authority and the Police was rejected. Justice Ronen distinguished between the two cases and noted that contrary to the Lerner case, where it was determined that the Authority had no basis for suspecting an act of fraud, in the UTrade case, it had indications of a breach of obligations.

Ronen noted that in exceptional and fitting circumstances, it is possible to compel the Authority, and the fact that it is not the main perpetrator in the story does not relieve it of its obligations to persons injured in the event of negligence.

According to the Judge, UTrade engaged in activity that is supervised by the Authority – portfolio management – and this supervision is intended among other things to protect inexperienced investors, who do not know how to take the measure of the entity with which they are contracting. “Since UTrade’s activity required receiving a license from the Authority, the Authority was authorized and required to supervise that it operate under a license, and it therefore owes a duty of caution to anyone harmed by breach of this obligation. The Authority (as indeed any other potential causer of harm) needs to use preventative measures whose cost is lower than the span of damage that could occur if not for the prevention.”

Ronen determined that until May 2015, the Authority had acted in a reasonable manner vis-à-vis UTrade, but as of the month of June, despite the commitment it had by then received from UTrade, and complaints received that the company was continuing to operate, it should have checked whether UTrade was in breach of its commitment. “If the Authority had conducted such an inspection at an earlier time, it would have discovered already then what was finally discovered in the December 2015 inspection”, she said. Therefore, according to Ronen, the Israel Securities Authority was negligent in preventing illegal activity and also in not publishing a warning towards the end of May on the risk inherent in managing money through UTrade.

In the next stage, the court examined whether the prosecution was able to prove the existence of a causal link between the negligence of the Authority and between their investment. In other words, the plaintiffs had to prove that if the Authority had acted properly, their damage would have been avoided. Ronen found such a causal link in four of the cases that were heard. However, she said that due to ignoring red lights and not checking whether the entity they were investing in had a license, the plaintiffs do have a share in the blame – which she quantified at 30%.

 “The plaintiffs were negligent when they did not carry out an investigation into UTrade’s licensing situation and the need for a license despite the existence of warning lights. Blame must be placed on the investors too since such a ruling would give other investors the message that they too – and not only the Authority – bear responsibility for investing in an informed and responsible manner, that they should check into the nature of the entity in which they choose to invest their money, and verify they have a license as required.”

After deducting the plaintiffs’ guilt, it was determined that the Authority would pay them a total sum of ILS 1 million, each according to the damage they suffered.