31.08.19 | Achai Gomeh
Recently, the Israel Securities Authority announced that it is considering introducing an innovative product to the capital market – “a trust-hedge fund” – a hybrid that combines both a trust fund and a hedge fund. The supervision over this new product will be similar to that of a trust fund – a licensed manager, a licensed trustee and regular public reports submitted to the ISA and the investors. However, it will also be similar to a hedge fund, with greater flexibility for investments, without the option of a daily redemption of the fund’s units.
Although there is still a long road ahead before launch this new project (the legislation proceeding has yet to commence), the Authority has hurried to strike a heavy and immediate blow to the hedge fund industry: Concurrent to the publishing of a call for proposals, the Authority has revealed its opinion regarding the legality of the activity of Israel’s existing hedge funds, which implies that the Authority will not allow the continued extensive fundraising for industry, rather only from wealthy investors, those with liquid assets of at least millions of shekels. One may wonder why the Authority is choosing to put its cart before the horse. Why is it choosing to rush to issue stringent restrictions on the hedge fund industry, long before the innovative product is approved?
One of the possible explanations for this is the lethal combination, which may have been identified by the Authority, between the two court rulings that were announced in recent months by the Economic Department at the Tel Aviv District Court. In the first court ruling, in the matter of Integral, in which the Authority also explicitly refers to in a public statement that it announced, the Court issued rulings that undermined the legal interpretation that was accepted in the market to that date with regard to the subjugation of the hedge funds, and called explicitly to regulate the field of hedge funds.
In the second court ruling, in the matter of uTrade, the Court issued a ruling assigning responsibility for negligence to the Securities Authority due to improper supervision of activity of a company engaged in the management of investment portfolios, without a license, and awarded the investors huge damages. Consequently, it is likely that the Securities Authority is worried that in light of the precedential decisions in the first court ruling in the matter of hedge funds, the investors in the hedge funds who lost their money will be asked to assign responsibility for the negligence that led to their damages to the Authority and demand compensation for its improper supervision. This is similar to the decisions included in the second court ruling.
In any event, there is no doubt that these two court rulings, Integral and uTrade, illustrate the famous American adage that hard cases make bad law. On the one hand, Israel’s hedge fund industry conducts itself fairly vis a vis its investors and we have not witnessed crimes or fraud, so that regulation is not necessarily required. On the other hand, the Authority’s supervision of entities engaged in investment brokerage, such as managers of portfolios, trust funds, trading floors, crowdfunding platforms, etc., is in most cases efficient and effective. At the end of the day, the damage to the market caused by the two court rulings mentioned here outweighs their benefit.
The author is an attorney, director of the capital markets, securities and venture capital department at Hamburger Evron & Co. Law Firm.