In August 2004, the Israel Securities Authority (ISA) appointed a committee (named the Goshen Committee) to examine corporate governance in public companies in Israel. Its final recommendations were submitted in December 2006. According to a ISA February 2007 press release, the Committee placed great importance on setting proper corporate governance standards and rules that align themselves with standards adopted in leading western economies. It believes that the best way to implement these principles is through the imposition of disclosure requirements on public companies. The approach to be followed is therefore characterized as implementing the "adopt and disclose" principle, rather than following the "comply or explain" approach. In February 2007, the ISA approved a general draft law, agreed upon with the Ministry of Justice, that defines the level of disclosure which will be obligatory for companies under the Securities Law. The draft is based on the Goshen Committee recommendations. As of May 2007, the draft had not been passed into law. In November 2006, the ISA published a report summarizing the state of corporate governance in Israeli corporate and securities law as measured against the Organization for Economic Development and Cooperation's (OECD) Principles of Corporate Governance. The report indicates that Israel is moving towards compliance with the OECD Principles.

General Overview

In August 2004, the Israel Securities Authority (ISA) appointed a committee (named the Goshen Committee) to examine corporate governance in public companies in Israel. In February 2007, the ISA approved a general draft law, agreed upon with the Ministry of Justice, that defines the level of disclosure which will be obligatory for the companies under the Securities Law. The draft is meant to implement the Goshen Committee recommendations which were submitted in December 2006. According to an ISA February 2007 press release, the Committee placed great importance on setting proper corporate governance standards and rules that align themselves with standards adopted in leading western economies. It believes that the best way to implement these principles is through the imposition of disclosure requirements on public companies. The approach to be followed is therefore characterized as implementing the "adopt and disclose" principle, rather than following the "comply or explain" approach. The committee believes that based on the nature of the disclosure and experience in other countries, these explanations, particularly when they are legally mandated do not contribute material information to the investor. The key issues the Goshen Committee focused on include: (1) Independence of the Board of Directors, (2) Composition and Role of the Internal Audit Committee, (3) Approval of Transactions with Related Parties and (4) Establishment of a Court Specializing in Corporate and Securities Law.

Ben-Zion (2006) notes that following the rise in the supply of and demand for stocks, the Tel Aviv Stock Exchange (TASE) went through substantial transformation with a review of among other things of its trading rules and listing requirements and the strengthening of reporting and capital requirements of its members and the launch of an online reporting system. During this period of time, the ISA initiated legislation and regulation that enhanced the transparency of traded companies, the independence and expertise of accountants, investment advisers and portfolio managers. Now with an independent investigations department, it substantially remodeled the enforcement of the Securities Law and the supervision of the capital market. The ISA also took over corporate governance issues previously handled by the TASE, such as conflict of interest transactions with control holders, tender offers, and equal voting rights. Ben-Zion claims that "following this regulatory revolution, the Israeli capital market purportedly became the world's second most regulated market, lagging only behind its American counterpart." (Ben Zion 2006, p. 217)

In November 2006, the ISA published a report summarizing the state of corporate governance in Israeli corporate and securities law as measured against the OECD Principles of Corporate Governance. It was prepared by the Israel Securities Authority in collaboration with the Economic Department of the Ministry of Justice. The report describes Israel's practice for each principle but does not directly address compliance with the OECD Principles. It stipulates that Israel's corporate governance framework is designed to promote market integrity and development through investor protection. The framework for corporate governance is set by the corporate and securities laws, which according to the ISA report provide, contain and formally codify principles of good governance with an eye to empowering and protecting the interests of minority shareholders. Many of the common law rights of shareholders and fiduciary duties of management are explicitly articulated in Israeli law and subject to civil and in many cases possible criminal enforcement. The ISA highlighted that Israel is recognized by the World Bank as one of the highest ranked jurisdictions in terms of the provision of investor protection through the corporate governance mechanisms and disclosure requirements incorporated in its body of corporate and securities law. Furthermore, the Companies Law distinguishes between public and private firms allowing for flexibility in balancing the needs of economic freedom, capital formation and shareholder protection. Securities laws (among them the Securities Law, the Joint Investment Trust Law and the Law for the Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management) provide the basis for full and fair disclosure. (ISA 2006, p. 1)

The ISA 2006 report further explained that corporate governance provisions are formally codified and enshrined in corporate and securities law. The Companies Law 5769-1999, which covers both public and private companies contains provisions encompassing key principles of corporate governance. The Companies Law is administered by the Ministry of Justice and is enforceable through private civil legislation. Certain violations of corporate law are also subject to criminal enforcement as violations of the Penal Code and/or to administrative civil sanctions. The Securities Law is designed to ensure the protection of the investing public. Israeli securities law is based on the principle of full and fair disclosure. The Securities Law mandates the establishment of the ISA, which is charged with regulating, overseeing and enforcing the transparency of public companies and with ensuring the integrity of primary and secondary markets. In addition to articulating the rules of transparency, it establishes principles of corporate and personal accountability to the investing public. In contrast to the Companies Law, the Securities Law is criminally enforceable. (ISA 2006, p. 2)

The U.S. Department of Commerce in its 2007 Israel "Doing Business" report asserts that many Israeli firms are not publicly traded or are controlled through integrated holding companies. More specifically, "in the case of publicly traded firms where ownership is widely dispersed, the practice of 'cross-shareholding' and 'stable shareholder' arrangements to prevent mergers and acquisitions is common.... Hostile takeovers are a virtually unknown phenomenon in Israel, given the high concentration of ownership of most firms." (U.S. DoC 2007, p. 47)

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

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In November 2006, the Israel Securities Authority (ISA) published a report summarizing the state of corporate governance as reflected in Israeli corporate and securities law as measured against the OECD Principles of Corporate Governance. It was prepared by the Israel Securities Authority in collaboration with the Economic Department of the Ministry of Justice. According to the report governance provisions are formally codified and enshrined in corporate and securities law. The Companies Law 5769--1999, which covers both public and private companies contains provisions encompassing key principles of corporate governance. The Companies Law is administered by the Ministry of Justice and is enforceable through private civil legislation. Certain violations of corporate law are also subject to criminal enforcement as violations of the Penal Code and/or to administrative civil sanctions. The Securities Law is designed to ensure the protection of the investing public. Israeli securities law is based on the principle of full and fair disclosure. The Securities Law mandates the establishment of the Israel Securities Authority (ISA), which is charged with regulating, overseeing and enforcing the transparency of public companies and with ensuring the integrity of primary and secondary markets. In addition to articulating the rules of transparency, it establishes principles of corporate and personal accountability to the investing public. In contrast to the Companies Law, the Securities Law is criminally enforceable. (ISA 2006, p. 2) However, there is insufficient information to assign a level of compliance to this principle.

Ben-Zion (2006) notes that following the rise in the supply of and demand for stocks, the Tel Aviv Stock Exchange (TASE) went through substantial transformation with a review of among other things trading rules and listing requirements a strengthening of reporting and capital requirements of its members and launched an online reporting system. During this period of time, the ISA initiated legislation and regulation that enhanced the transparency of traded companies, the independence and expertise of accountants, investment advisers and portfolio managers. Now with an independent investigations department, it substantially remodeled the enforcement of the Securities Law and the supervision of the capital market. The ISA also took over corporate governance issues previously handled by the TASE, such as conflict of interest transactions with control holders, tender offers, and equal voting rights. Ben-Zion notes that "following this regulatory revolution, the Israeli capital market purportedly became the world's second most regulated market, lagging only behind its American counterpart." (Ben Zion 2006, p. 217)

However, in a January 2007 Selected Issues paper, focusing on financial supervision in Israel, the IMF criticized that the supervisory authorities do not all have sufficient independence. Regulation of pensions, provident funds and insurance is conducted from within the Ministry of Finance (MoF). The ISA does not have a general rule-making power that could be exercised without the consent of the MoF and the Knesset Finance Committee. The ISA and the Commissioner at the MoF do not have sufficient autonomy with respect to their budgets (even though the ISA is financed by the fees it levies on regulated entities), staff headcount, or salaries, while there are proposals to make the budget of the BoI subject to the annual approval of the Knesset. (IMF 2007a, p. 23)

The 2007 IMF report further noted that the supervisory authorities do not have sufficient resources. The resources of the ISA and, in particular, the Commissioner of Insurance are extremely limited. Neither the Commissioner nor the ISA have sufficient staff to make regular and detailed on-site visits to institutions. The ISA relies almost entirely on auditors to conduct on-site visits of mutual funds and this is a policy that carries risks. (IMF 2007a, p. 24)

Overall, the IMF paper concluded, the supervisory authorities face a serious challenge in the form of rapidly developing financial markets, inconsistent regulatory standards, and, in some respects, insufficient powers and resources to enforce compliance. There is a strong case for enhancing consistency through more formal cooperation, backed by memoranda of understanding or other agreements. (IMF 2007a, p. 24)

In the context of the 2006 Article IV consultations with the IMF, the Executive Director for Israel stated that the authorities are fully aware of the need to devise a better supervisory system of the financial sector. This consideration of supervisory architecture is still at an early stage. Therefore, staff's discussion of pros and cons of various supervisory structures, as well as the discussion of strengths and weaknesses of the existing Israeli supervisory system makes an important contribution to this process. While this process may take time, already three supervisors - the Bank of Israel, Ministry of Finance (MoF) and the ISA - coordinate the supervisory rules and procedures at the highest level as well as through ad-hoc forums at which staff of those agencies meet in order to achieve consistency in, for example, rules governing conflict of interest. The signing of a Memorandum of Understanding, the drafting of which is in its final stage, will further enhance this cooperation. (IMF 2007b, Supplementary Info, p. 4)

Principle II: The Rights of Shareholders and Key Ownership Function

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According to the 2006 ISA report, Shareholders in Israeli public companies have all the rights regarding 1) secure methods of ownership registration; 2) convey or transfer shares; 3) obtain relevant and material information on the corporation on a timely and regular basis; 4) participate and vote in general shareholder meetings; 5) elect and remove members of the board; and 6) share in the profits of the corporation. These rights are provided in the Companies and Securities Laws. However, there is insufficient information to assign a level of compliance to this principle.

The report goes on to state that the right of shareholders in public companies to be informed of all material developments as they occur is absolute, unqualified, and enforced. The Israel Securities Law, requires disclosure in current reports (called immediate reports) of all material developments rather than on a closed set of issues as is customary in some jurisdictions. At the same time, shareholders in public companies have the right to participate in most decisions concerning fundamental corporate changes, including the amendment of statutes, articles of incorporation or bylaws and authorization of additional shares. Decisions pertaining to all these issues require shareholder approval. (ISA 2006, p. 5)

Shareholders have an unqualified right to be fully informed about general meetings. The disclosure of details concerning general shareholders meetings to shareholders in public companies is anchored in both the Companies Law and the Securities Law. The meeting must be announced and agenda made public at least 21 days in advance. In addition, the company must file a current report, which is disseminated to the public on the ISA website. (ISA 2006, p. 6)

The Companies Law confers shareholders the right and responsibility of appointing directors at the annual general shareholders meeting (unless otherwise indicated in the company's bylaws). It also stipulates that independent directors be appointed by shareholders, a responsibility which cannot be delegated to another party. A special majority which gives additional weight to votes of minority shareholders is required. In addition, within the framework of shareholder rights to propose resolutions at shareholders meetings, they can propose to either replace or nominate directors. Remuneration (including equity components) of board members must be approved by shareholders at the general meeting. Remuneration and the other employment conditions of senior executives must be approved by the board of directors, and if an executive also serves on the board of directors or is a controlling shareholder, by the shareholders as well. Such approval requires a special majority as applicable for all transactions to which a controlling shareholder is party. (ISA 2006, p. 7)

The ISA report claims that the rules and procedures governing the acquisition of corporate control in capital markets are codified and transparent. Israel's Companies Law governs the practices and minority shareholder rights regarding the transfer of control. It sets three thresholds which necessitate the issuance of a tender offer. (ISA 2006, pp. 8, 9)

With respect to mergers, according to the ISA report, both the Companies Law and Securities Law mandate transparency and accountability to minority/public shareholders. Mergers which entail an effective transfer of ownership are subject to the approval of the shareholders of both of the two merging parties. Mandatory shareholder approval is waived only if the target company is a wholly-owned subsidiary of the acquiring company. (ISA 2006, p. 9)

Principle III: The Equitable Treatment of Shareholders

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According to the 2006 ISA report, the Securities Law requires that all TASE-listed companies have one class of shares with equal voting rights. Veteran firms (prior to 1991) that have more than one class of shares are required to fully disclose all rights attached to all series and classes of shares. This information is publicly available through the ISA's online electronic filing database. These disclosure requirements pertain to all reporting companies and not just those listed on the TASE. (ISA 2006, p. 12) However, there is insufficient information to assign a level of compliance to this principle.

The report further states that Israel's Companies Law provides safeguards and civil remedies for minority shareholders from abuse by controlling shareholders. The Companies Law protects minority shareholders from majority abuse in several manners. It stipulates that shareholders have a duty to act in good faith towards the company and other shareholders, specifically when voting for certain key issues. Controlling shareholders, any shareholder holding the critical vote or having a right to nominate or veto a nomination of an officer are required to act fairly. Related-party transactions between a company and controlling shareholders must be approved by a special majority favoring minority shareholders. (ISA 2006, p. 12)

Chapter 8A of Israel's Securities Law, which originally came into force in 1981, is dedicated to the prohibition of the "use of inside information". This prohibition is not restricted to insiders alone and relates to the use of inside information by any party. The rules and penalties regarding the use of inside information are stricter for insiders, primarily for senior executives, who under certain circumstances may be required to positively prove non-use to avoid conviction. In addition, criminal penalties are heavier for insiders than for others. The ISA claims that is has successfully enforced its insider trading provision. (ISA 2006, p. 14)

Finally, the report notes that all corporate officers and controlling shareholders are required to immediately disclose to the company any material interest they have in a given transaction. Interested directors in a transaction are not allowed to vote on it in the board of directors meeting. In addition, shareholder approval is required for certain related party transactions. In public companies, extraordinary transactions with controlling shareholders require shareholder approval under special majority conditions which enables disinterested shareholders to block approval of the transaction. Related party transactions must be immediately disclosed to the public. (ISA 2006, pp. 14, 15)

Principle IV: The Role of Stakeholders in Corporate Governance

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According to the 2006 ISA report, the rights of stakeholders are respected, regardless if they are mandated by law or the result of private contracting. Stakeholders have the opportunity to redress violation of rights through individual or class action. Employee option plans as well as other schemes for employee profit-sharing are well developed in Israel, and the ISA online filing system MAGNA, guarantees access to relevant, sufficient and reliable information to the entire public. (ISA 2006, p. 16) However, there is insufficient information to assign a level of compliance to this principle.

The Employee's Protection Act (Exposure of Violations, Misconduct, or Administrative Impropriety) 5757 - 1997 prohibits employers from dismissing or adversely affecting the working conditions of employees that have submitted or aided others to submit complaints against the employer or a fellow employee. The burden of proof in such cases is placed on the employer. (ISA 2006, p. 16)

The Companies Law and the Bankruptcy Ordinance comprise the framework for insolvency proceedings and creditor rights. Israeli bankruptcy law articulates the kind of claims a creditor can place on debt obligations, due process in debt recovering, foreclosure procedures, waiver of liens on assets and the division of assets under receivership. These regulations also categorize and prioritize creditor rights in cases of insolvency. This framework is transparent, efficient and enforceable under civil law. (ISA 2006, p. 17)

Principle V: Disclosure and Transparency

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According to the 2006 ISA report, Israel's Securities Law has established a disclosure regime which is recognized as conforming to the highest international standards. The scope, quality and timeliness of disclosure regulation, the efficiency of the supervision and enforcement of disclosure requirements, and the immediacy and equity of public dissemination provide the information infrastructure required to promote market efficiency and integrity. Furthermore, Israel has officially adopted International Financial Reporting Standards (IFRS) for public companies, to be fully implemented by January 2008. Major companies have already opted for early adoption of these international standards. Israel's disclosure regime for public companies requires the disclosure of all financial and non-financial information material to the process of investment decision making. (ISA 2006, pp.18, 21) However, there is insufficient information to assign a level of compliance to this principle.

Principle VI: The Responsibilities of the Board

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According to the 2006 ISA report, the Companies Law stipulates that the all corporate officers, i.e. directors and executives, must act in good faith and care to the benefit of the company. They must avoid undertaking activities bearing potential conflicts of interest or which compete with the company's activities. They can approve activities in which there is an apparent conflict of interest or corporate opportunity only if it is deemed that the officer acted in good faith and that the activity is not harmful to the company, and only if the officer disclosed his/her interest in advance. (ISA 2006, p. 23) However, there is insufficient information to assign a level of compliance to this principle.

According to the Companies Law, the board of directors is vested with the authority to outline company policy and set a company's action plan, as well as the method of financing its implementation. It is charged with monitoring the company's financial situation and in determining the financial leverage the company will undertake. The board of director audit committee, (the appointment of which is compulsory for public companies) is charged with addressing deficiencies in the management of the company's business, which could be interpreted to include governance practices. (ISA 2006, p. 23)

Regarding the board nomination and election process, the conditions and qualifications for nominating and electing board members are articulated in the Companies Laws, including provisions applicable to public companies, which require the appointment of independent directors and the appointment of directors with expertise in finance and/or accounting. In public companies, the board is required to set the minimum number of directors that must possess financial expertise. (ISA 2006, p. 23)

The Companies Law stipulates that public companies appoint at least two independent directors, at least one of which must have expertise in accounting and/or finance. In addition, all independent directors must also be members of the board's audit committee (the appointment of which is compulsory for public companies). The Companies Law empowers the board of directors to establish committees as it deems fit, unless the company's bylaws stipulate otherwise. The Law prohibits the board from delegating some of its responsibilities to a committee and stipulates that if a certain responsibility is delegated to committee, all members of that committee must be board members and at least one member is an independent (external) director. Public companies are compelled to appoint an audit committee. The composition, responsibilities and procedures for audit committee meetings are stipulated in the Companies Law. The Law further mandates that the board of directors of public companies meet at least once every three months. There are no limitations on the number of other positions a director may have. At the same time, the duty of care mandated by the Companies Law requires him to act at a level of expertise that a reasonable corporate officer in the same position and facing equivalent circumstances would act and to take reasonable measures to obtain information regarding the activity under approval. (ISA 2006, pp. 25, 26)