4. Case study on Israel

Abstract

This chapter on Israel describes the prevalence of company groups in the Israeli economy and among its listed companies which reached a peak a decade ago. Despite high corporate governance standards, such market structure raised concern regarding various potential risks related to pyramidal holdings, separation between the control of significant financial and non-financial corporations and other characteristics of company groups in Israel. The chapter highlights that major corporate governance reforms, along with structural reforms that addressed these risks, have dramatically decreased the size and dominance of company groups, facilitating stronger safeguards for minority shareholder protection, and enhancing enforcement, especially private.

    

Introduction

Company groups are a prevalent phenomenon in Israel, as in many other countries. Historically, a large majority of the companies listed on the Tel-Aviv Stock Exchange ("TASE") had a controlling shareholder, and major segments of the Israeli market were controlled by a relatively small number of company groups.

Company groups differ greatly in size, ownership structure, organisational structure and businesses included in the group. It should be noted that it is very common to have both listed and unlisted companies in the same group. Private companies may be holding companies or subsidiaries depending on the group structure. Company groups may have significant advantages for shareholders (“SH”) value and to the economy due to scale and cross-benefits of businesses in different sectors, but there may also be disadvantages, both on economy level (i.e. concentration and competition concerns) and on the individual company level (complex agency problems between the controlling SH and minority SH through in different companies in the group).

From a corporate governance point of view there is no single comprehensive law in Israel regarding company groups. Israeli corporate governance is mainly designed to cope with the agency and other problems characterising controlled companies. For example, the Israeli Companies Law—1999 ("ICL") deals with corporate governance issues like board composition and approval procedures for related party transactions ("RPT"), including majority of minority ("MOM") vote. The Israeli Securities Law—1968 ("ISL") deals with relevant disclosure and the accounting regime. Such provisions of course apply to company groups as well and are very important for their governance, as will be described below.

The last decade has seen major reforms in Israeli law aimed to curb the negative effects of company groups both on economy level and on corporate governance level. These reforms strengthened minority protection in public companies, mainly regarding RPTs and remuneration, curbed the size of company groups and imposed restrictions on integration of different businesses under one company group.

Structural reform

The Committee on Increasing Competitiveness in the Israeli Economy

In 2010 the Israeli Government appointed the "Committee on Increasing Competitiveness in the Israeli Economy" ("the Committee"). The Committee published an interim report in 2011 and its final report in 2012.

The Committee was concerned, regarding company groups in Israel, that an overwhelming majority (88%) of the companies publicly traded in TASE had a controlling shareholder. The committee found that there were 28 company groups, which constituted 25% of all public companies. The Committee also found that a majority of the market capitalisation of those companies was held by company groups (54%). Controlled publicly traded companies were the "building stones" of company groups and in more than a third of them, the controlling shareholder invested less than 50% of the capital. The prevalent holding structure was pyramidal—in 79% of the groups the structure contained at least two layers of publicly-traded companies. The Committee also found that 58% of the company groups had three or more pyramidal tiers—there were more than 70 companies in the third layers and above. The market value of listed companies in the third layer and above was 14% of the market value of all the companies listed in TASE and was estimated at 100 billion NIS.

Additionally, the Committee found that the average control premium in Israel was among the highest in the world—about 27%, which was more than double the global average and almost three times the OECD weighted average. The Committee found this indicative of a non-efficient control market thus raising concerns regarding minority protection. The Committee observed that agency problems become more severe as the "wedge" between the controller cash flow and voting rights increases. The committee found evidence that private benefits in Israel are high compared to international levels, indicating that agency problems and extraction of private benefits need more regulatory attention.

The Committee indicated that a pyramid structure enabled a controller to circumvent the mandatory rule of "one share one vote" applying to publicly listed companies by section 46B of the ISL, thus enabling control of subsidiaries with a relatively small capital investment.

The Committee also found that the structure of the economy in Israel, from the supra-sector aspect, was centralised, with a small number of individuals controlling a significant portion of the real and financial assets in the economy by means of business groups. The Committee noted that the complexity and the degree of leverage in business groups, in the regulatory situation and structure of the economy then existing, increased the risks at the economy level to the financial system’s robustness and to the protection of depositor or investor interests.

The Committee also observed that competition between few groups in several different markets may lead to inefficiency in the specific markets as the group may maximise profit on a group level and not on a company level, hence derogating competition in the relevant markets. This risk increases when there is a financial institution in the group as it is exposed to data from many markets as its customers and thus information symmetry is hindered and allocation of credit by such financial institutions may be inefficient. When groups are major consumers of debt and also control a financial institution, this might cause a systemic risk to market stability. It should also be noted that financial institutions play an important role in the corporate governance of listed firms as direct or indirect minority SH through customers' holdings.

The Committee’s recommendations were intended to cope with these potential risks in three aspects—restriction of the height (or number of layers) of pyramidal holdings; separation of control over significant real holdings and significant financial holdings; and obligation to consider economy-wide centralisation when allocating public assets through licensing, privatisation, etc.

The recommendations were chosen to be structural due to three main reasons. First, it was observed that there is a limit to the effectiveness of corporate governance rules when agency problems and conflict of interests are severe. Secondly, market and systemic risks as opposed to company-related risks are not effectively managed by corporate governance alone. Third, regarding the size of pyramidal holding groups, structural rules are clearer to follow and enforce than rules based on the "wedge" between cash flow and voting rights, even though the rationale for limiting the size of such groups is based on its implications.

The Committee expected that implementing its recommendations will improve the efficiency of the allocation of resources, make a positive contribution to the stability of the financial system and support the growth of the economy and the welfare of the public in the middle and long term.

Enactment of LPCRC

The Law for the Promotion of Competition and Reduction of Concentration ("LPCRC") was enacted on 11 December 2013 following the Committee's recommendations. LPCRC aims to increase market competition and sectorial competition; decrease the level of market concentration; and simplify the corporate group structure and decentralise their control in the market.

LPCRC defines "a group of holders" as "a corporation, a controlling shareholder of a corporation or a corporation controlled by either of them". This definition is used to prevent evasion from the law provisions by division of the holdings among different corporations included in the group. Similarly, this law defines "control" regarding a pyramid group by attributing all the group holdings to the controlling company.

The law is divided into three main parts which will be briefly presented below.

Pyramidal holding structures

One part of the law is aimed at limiting pyramids as a means of control. Pyramidal structures were required to be dismantled to a two "layer" structure, and new pyramidal structures may not consist of more than two "layers". A "layer company" is a company which has shares or debt listed on TASE (excluding privately owned companies).

This limitation came into full effect at the end of 2019.

Separation of control over significant financial institutions and significant real companies

Another part of the LPCRC was designed to separate the ownership of significant financial institutions from significant real companies. LPCRC forbids a significant real company (whether listed or not) or its controlling entity to control any significant financial corporations (whether listed or not) or to hold more than 10% of any kind of means of control1 in such entity. In addition, a person that holds more than 5% of any kind of means of control in a significant real company cannot control significant financial corporations. Control or excess holdings in violation of these percentages must be sold and such sale may be forced by appointment of a receiver by Court at the regulator's request.

Furthermore, to prevent conflict of interest on a personal basis, the law forbids a person to be a director or an executive in both significant real and significant financial corporations, or to be nominated as a director or executive in a significant real corporation if its relative2, its partner or a person with whom he has labour relationship, business or professional relationship holds such position in a significant financial corporation (or vice versa). This applies to independent directors as well, even if the real and financial companies are not in the same company group.

This limitation came into full effect at the end of 2019.

Allocation of public assets

A third part of the law is divided into two main provisions.

The first provision deals with the obligation of a government ministry seeking to allocate public assets (licenses, contracts or shares in essential infrastructures and in the privatisation of government companies) to "concentrated entities" to take into consideration, in consultation with a specialised Committee, the level of economy-wide concentration. "Concentrated entities" are defined as significant real companies; significant financial corporations; and media groups.

The second provision of this part of the law obligates any government ministry seeking to allocate a right to a private entity, to take into consideration the “promotion of industry specific competition”. This obligation applies to rights that involve contracts or significant holdings of essential infrastructures or a license (even if it is not for an essential infrastructure) and on the condition that due to the nature of the right, its economic value or the law that applies to it, the number of operators in the relevant industry is limited.

These provisions are intended to promote competition on a multi-market level, reduce concentration of economic power in a few hands and curb potential political influence of huge company groups.

Corporate governance reform

Background

As was mentioned above, the "company group theory", where the separate personality of each company in the group is ignored and the group is treated as one economic entity— was never adopted into Israeli company law. Like in other legal systems influenced by common law, the approach of the ICL regarding corporate governance and board duties is based upon the theory of separate legal personality of the corporation. The ICL views each and every company as a separate legal entity. Directors' duties are to act in the interests of the company whose board they serve on. The interest of the company is defined to operate in accordance with business considerations to maximise its profits.

From a subsidiary point of view the meaning is that the board must act independently, even if the company is part of a controlled group. From a parent company point of view the subsidiary is an asset of the parent, and the parent company is expected to maximise its asset’s value. Nevertheless, the parent company cannot force the board of its subsidiary to adopt a certain policy or to make a specific decision. The ICL enables a parent company to act as a shareholder in the GM to dismiss directors (section 230(a)) or in extreme cases even to assume powers (and duties) conferred on another organ (section 50).

The ICL stresses the duty of a director to exercise independent judgment. A director who violates his duty to exercise independent judgment will be deemed as breaching his fiduciary duties. In the 2011 amendment 16 to ICL added provisions forbidding any person from performing duties of a director unless duly appointed as such, nor interfere in a director's independent judgment. Violation of this rule will expose such person to full duties and liabilities of a director (section 106). Therefore, in a group context, if directors of a parent company interfere in the management of the subsidiary, they may be seen as shadow directors who owe fiduciary duty and a duty of care to the subsidiary (section 106). Such situations can also lead a court to pierce the corporate veil, following which a Court may attribute a debt of the subsidiary to the parent company (section 6). It should be noted though that piercing the corporate veil is limited to exceptional and extreme cases, where the separate legal personality is being misused fraudulently.

An example to the application of the new provision of section 106 can be found in a recent case involving an insurance company which is part of a company group. The insurance company was a private company held by a public holding company. The parent board intended to institute a board committee that will monitor the subsidiary (the insurance company). The regulator was concerned that this is an unacceptable attempt to interfere with management of the insurance company and considered taking regulatory measures against the decision. Following the regulatory concern, as well as a private lawsuit3 filed in the matter, the parent company revised its decision and decided not to establish the aforementioned committee.

Relevant definitions

There is no single legal definition of a company group in Israeli law. There are relevant definitions regarding control and subsidiaries.

The ISL defines "control" as the ability to direct the activity of a corporation, excluding an ability deriving merely from holding an office of director or another office in the corporation. A person shall be presumed a "control holder" if he or she holds half or more of a certain type of means of control of the corporation. This definition has both a qualitative and quantitative dimension. Shareholders who are relatives or connected by a voting agreement or an agreement for the appointment of all directors may be regarded together as control holders.

A "subsidiary" is defined as a company in which another company holds 50% or more of the nominal value of its issued share capital, of the voting power therein or is entitled to appoint half or more of the directors or its general manager. Similar definitions are also included in ICL.

The ISL also defines a broader relation to a "related company", which is a company in which another company— which is not a parent company— has invested an amount equal to 25% or more of the equity of the other company; or a company in which another company— which is not a parent company— holds 25% or more of the par value of its issued share capital or of its voting power, or may appoint 25% or more of its directors.

The securities regulations stipulate that, in general, an issuer must disclose its business, including its financial information, on a group level. The term "group" is defined as including the corporation, joint project (engagement for carrying out economic activity that materially affects the corporation's profitability, its property, or obligations), and material companies that are under its control.

Minority protection in a company group environment

The ICL and ISL contain special provisions designed to address the unique challenges which derive from the Israeli market structure (concentrated holdings; companies groups; pyramids) as will be further described.

A main goal of the Israeli legal framework is to provide adequate minority protection and address agency problems between minority shareholders and the controller, which is aggravated in a company group.

As mentioned above, LPCRC provisions regarding pyramidal holding groups were aimed to prevent the use of such structures to circumvent the rule of "one share one vote" that is enacted in ISL (section 46B).

Board composition and board committees

A basic aspect of governance requirements in public companies are provisions aimed at maintaining a degree of independence at the board level, in order to strengthen its ability to effectively monitor the management. ICL requires at least two "outside directors" in a public company (sec 239).

An outside director is strongly independent from the controller. This is achieved both by independence criteria and appointment procedure. Independence criteria is examined on a group level, requiring independence not only from the company point of view but also from controller and any company controlled by him or her (sec. 240). Appointment procedure requires that an outside director be appointed by a general meeting vote requiring MOM approval for a set three-year tenure (and can be appointed by MOM approval for two consecutive tenures) (Sec 245).

In practice, a public company usually appoints at least one more independent director. An "independent director" must comply with the same independence requirements but is appointed like other directors. There is no obligation to appoint independent directors except the "outside directors" and directors qualifying for board committees (see below). But in 2011 a recommended corporate governance provision was added to the ICL stating that in a company in which there is a controlling shareholder at least one third of the directors shall be independent directors (when there is no controlling SH the recommendation is for a majority of independent directors).

The composition of the mandatory board committees is designed to preserve their independence.

The audit committee is responsible for reviewing flaws in the management of the company, supervising the internal auditor, overviewing whistle-blower protection and approving several aspects of RPTs. The committee must include all the "outside directors" and a majority of independent directors. The rest of the members must comply with independence criteria to make sure they are not affiliated to the group: "The following shall not serve as members of an audit committee: The chairman of the board of directors and any director employed by the company or employed by the controlling shareholder thereof or by a corporation controlled by such controlling shareholder, a director providing services, on a regular basis, to the company or to a corporation controlled by a controlling shareholder as aforementioned, as well as a director whose primary income is dependent on the controlling shareholder" (sec. 115). This requirement is referred to in the market as "light independence".

The financial statements committee must be headed by an "outside director" and the rest of its members need to qualify for "light independence". Other requirements deal with financial literacy and will not be discussed here (Regulations according to sec. 171(E)).

The remuneration committee should include a majority of outside directors, and its other members must qualify for "light independence" and be remunerated according to the limitations regarding "outside directors" (Sec 118A).

It should be noted that law reforms in 2011 made the independence criteria more stringent (sec 240(B) and (F)); enhanced the independence of the audit committee (sec 115) and established the even more independent remuneration committee (sec 118A).

Separation of CEO and chairperson positions

The ICL stipulates that the CEO and his or her relative may not be appointed as the chairperson of the board and an individual, who is subordinate to the CEO, directly or indirectly, may not be appointed as the chairperson unless approved by a MOM vote.

The chairperson or his or her relative may also not be assigned duties of the CEO or of a subordinate of the CEO. The chairperson of the board in a public company may not serve in any position in the company or a company controlled by it, except director or chairperson of the board in the controlled company.

Before amendment 16 to the ICL in 2011 this rule applied only to the CEO himself.

MOM approval

The main protection to minority SHs in ICL is by requiring certain transactions or issues to be approved, inter alia, by a majority of SH that includes a majority of the minority shareholders, excluding any minority votes held by a SH related to the controller (MOM approval as defined above):

1. 1. Transactions with a controlling shareholder which is extraordinary (sec. 270 (4)). The provisions regarding RPTs are discussed below.

2. 2. Remuneration—the company's remuneration policy is set by the remuneration committee and should be approved by MOM approval (Sec. 267A, 272). In addition, any remuneration agreement that is not in accordance with that policy and any remuneration agreement with the CEO must be approved by MOM as well as the CEO remuneration. The vote on those matters is not binding, with the exception of remuneration of a director or for the controller who serves as a director or executive. The amendment to ICL regarding remuneration policy and transactions was enacted in 2013 and will not be described in detail in this paper.

3. 3. Merger—a merger between a public company and another company controlled by the same controller (i.e. in the same group) requires, inter alia, MOM approval (sec 320).

4. 4. Appointment of "Outside Directors" as described above.

Related party transactions

RPTs may in some cases be beneficial to the company, but in other cases may be abusive at the expense of the minority SHs. RPTs involve conflict of interest, or agency problem, and therefore require approval processes stipulated in the ICL.

An entire chapter in the ICL is dedicated to the approval processes of different types of RPTs involving directors, managers or controlling shareholders. The ICL requires a mandatory approval process in advance (ex-ante). A precondition for the approval of an RPT is that the transaction is in the company's interest, and is not valid unless approved according to the requirements in the law. Other requirements in the ICL as well as case law imply that the conditions of an RPT transaction should be fair and when relevant, in similar terms to a parallel transaction between unrelated parties, as will be further discussed below.

In the context of company groups the main focus of ICL is on transactions with the controlling SH, or with a third party if the controlling SH has a personal interest in it. Such transactions include remuneration agreements (section 270 (4)).

For the purpose of transactions with interested parties, the definition of 'controlling shareholder' has been expanded and it also includes a holder of 25% or more of the voting rights in the company's general meeting if there is no other person holding more than 50% of the voting rights in the company (section 268).

It should be noted that this provision is interpreted as also including transactions of a private subsidiary with the controller of the public company. Such transactions will require the same approval in the public company as if it entered it itself, in order not to circumvent legislative purpose.

The audit committee is required to classify every RPT (or class of RPTs) as either an extraordinary transaction, non-extraordinary or negligible (sec. 117(1A)). A transaction is defined as extraordinary if it is either not in the company’s regular course of business; not undertaken in market conditions; or if it is likely to materially influence the profitability of the company, its property or liabilities (Section 1).

Approval of extraordinary RPTs requires three stages: first approval by the audit committee; then the board of directors; and at last the GM in a majority vote requiring also MOM4 (Section 275).

Until 2011 (amendment 16 to the ICL) the MOM vote required only 1/3 of the minority vote. Another reform in 2011 required that a transaction with a controlling shareholder for a period of over three years should be re-approved every three years (Section 275).5 These new provisions had a huge effect on approval of RPTs and gave greater power to minority SHs to review and approve the terms of the transaction periodically. This may be seen together with new research described below that indicates decline of control premium in Israel as indication to further enhance and improve minority protection in Israel.

In 2013 amendment 22 to the ICL prescribed that the audit committee set forth a procedure for entering a RPT which should include a competitive procedure or a different procedure to be conducted prior to engaging in the transaction. This requirement is intended to approximate market terms or to ensure that the transaction is in the benefit of the company (Section 275).

MOM approval does not prevent judicial review ex-post if a transaction is later contested in court. Generally, courts reviewing RPTs will uphold them to entire fairness standard (See: C.A 2718/09 Gadish Kranot Tagmulim v. Elsint (Nevo, 28.5.2012); Cls. Act. 26809-01-11 Kahana v. Machteshim Agan Taasiyot (Nevo, 15.5.2011)). However, in some cases where the board appointed an independent committee to negotiate the transaction, and if the negotiations were real and honest and on a fully informed basis, the court may uphold the contested transaction to the Israeli version of the Business Judgement Rule (BJR) (See for instance: Cls. Act.43859-08-13 Segal Levy Yizum and Nekhasim v. Kur Taasiyot (Nevo, 9.1.2014)). The practice that has been established following those rulings is to institute such committees to negotiate major RPTs. This practice was not included in the ICL.

The judicial review may result in practice the courts declaring the transaction or parts of it void or determining the 'fair value' of the consideration. It can also result in holding executives and directors in breach of their fiduciary duties or duty of care.

Approval of a non-extraordinary RPT: the audit committee is required to determine an adequate approval procedure inside the company. Such procedure should include a competitive procedure or a different procedure to be conducted prior to engaging in the transaction. This requirement is intended to approximate market terms or to ensure that the transaction is in the benefit of the company (Section 117 (1B); Section 117 (2A)).

Negligible RPTs do not require special approval procedures but are subject to accumulative disclosure. The audit committee must determine the manner of approval of transactions that are not negligible, including determining types of transactions that will require the approval of the audit committee. The audit committee may decide on such classification for a type of transaction, according to criteria to be determined once a year in advance.

Another condition for approval of an RPT is that the audit committee and the board check whether the transaction includes distribution of dividend or self-purchase of shares. In such cases the rules regarding distribution of profits apply as well.

Enforcement

An additional layer of minority SH protection is administrative and private enforcement mechanisms. Private enforcement will lead to judicial review, inter alia, of RPT and many other issues, mainly in form of class action or a derivative suit. In the last decade such enforcement rose dramatically, much of it attributed to the establishment of a specialised court as described below.

With regard to company groups it should be mentioned that in 2014 the Israeli Supreme Court recognised the right of a shareholder in a public company to file a multi-derivative suit, i.e. on behalf of a subsidiary or a subsidiary of a subsidiary, under the same chain of control.6

In 2010 legislation introduced new specialised judicial forums—the Economic Department of the Tel Aviv District Court (which was practically established in 2011) for corporate and securities litigation, as well as the Administrative Enforcement Committee, which facilitated enhanced administrative enforcement by ISA of both ICL corporate governance rules and securities law.

Enhanced enforcement and specialised court decisions both made significant contributions to company group governance through better enforcement of RPT requirements. The ISA and the Attorney General take an active role providing expert opinions to the courts and funding selected SH suits.

Relevant case law—Fiduciary duties

Fiduciary duties of the board of directors in group context were contested more than once in Israeli courts, usually during derivative suits or class actions. Here are several main examples from case law.

In Der. Act. 10466-09-12 Ostrovski v. DIC (9.8.2015), a derivative suit was filed against the board of directors of DIC, a public holding company which was then a third tier in a multi-tier group. The major claim was that the board has breached its duty of care by approving an acquisition sought by the controller of Maariv, a media company, as well as extension of credit to Maariv following the acquisition. This investment ended up in huge losses and the plaintiff argued it was made as per the request of the controller without sufficient information and examination. The derivative suit ended in a settlement.

In C.A 773/14 Vardenikov v. Alovich (30.11.2015) a derivative suit was filed against the board of Bezek (a public telecom company) claiming that the company's distribution and debt financing policies were not in the company's interest but rather the controller's interest to pay his personal debts after a LBO of the company. The board invoked the BJR and the court accepted and dismissed the case.

In Der. Act. 37473-09-12 Ben Israel v. Dankner (18.11.2015) a derivative suit was filed against both the board of directors and the controller, according to which they were in conflict of interest when approving an acquisition of another company from a private company held by the controller. Following the contested acquisition, the controller was relieved from financial obligations to the purchased company. The transaction was claimed to be in the interest of the controller and other companies at his control but not in the interest of the acquiring public company. Proceedings ended on a settlement.

Another line of cases which are related to fiduciary duties deals with allocation of business opportunities. Courts held that director's fiduciary duties forbid them from taking advantage of business opportunities related to the company's business, even if the company is not in a position to take advantage of that opportunity itself (see in re 25351-01-12 Hatahana Hamerkazit Be Tel Aviv v. Nitzba Hakhzakot (22.8.2017); Der.Act 20136-09-12 Biton v. Pangaya Nadlan (21.10.2013)).

Relevant case law—Company groups

Several examples from rich case law demonstrate how corporate governance flaws in company groups are addressed.

The case of Melisron LTD (Criminal Appeal 99/14) dealt with a company group were the defendants served as officers in several companies in the group, both private and public. The Supreme Court determined that if a person serves as an organ in several companies in a company group, and the entire company groups acted as one economic unit and had a uniform economic purpose then each company may be convicted on the basis of the organ's actions.

In Shahar Hamillenium LTD case (Criminal Appeal 5836/16, 6210/16) a public company and the controller were convicted of fraud and reporting offenses due to cash withdrawal by a controlling public company from its public subsidiary was concealed from the board and the public by the controller and the CFO and not duly approved.

Administrative Enforcement by ISA dealt, inter alia, with cases where financial statements of subsidiaries where not consolidated into the parent company’s statements (Administrative Case 1/12 Mivtach Shamir LTD7) and failure to report a delay in payment of a loan given to the controller (Administrative‎ Case‎ 3/13 ‎Inventech ‎Central ‎Hotels‎ LTD8).

Disclosure and the right to information

The ICL defines a strong right of SHs to information relevant to any issue discussed in the GM (Section 184-186). In public companies this right is usually realised through disclosure under ISL.

The ISL requires a public company to disclose any material information regarding its activity to the ISA and to the public. This rule also applies to information regarding a private company that is considered to be of material importance to the public company (where both companies belong to the same group).

This is further reinforced by IAS 24 disclosure requirements applying to related parties within company groups. Contractual agreements between a public company or its subsidiaries and affiliated companies in the group, that are substantial for the public company, must be disclosed in detail.

In addition, the regulatory framework addresses disclosure of more aspects of ownership and control in company groups.

The Securities Regulations (Periodic and Immediate Reports) 1970, provide a list of events which require immediate disclosure9. These are events deemed material by the legislator in every reporting corporation, for example:

1. 1. Changes in the holdings of certain interested parties: Immediate disclosure regarding a person who has ceased or has become an interested party in the corporation, as well as changes in his holdings. The disclosing obligation also applies to the interested party whose holdings have undergone a reportable change.

2. 2. "An interested party in a corporation" is defined as (1) A person who holds 5% or more of the issued share capital of the corporation or of the voting rights therein, whoever is entitled to appoint one or more directors of the corporation or its general manager, whoever serves as a director of the corporation or its general manager, or a corporation in which such person holds 25% or more of its issued share capital or of the voting power therein, or may appoint 25% or more of its directors; (2) a subsidiary of a corporation, except a registration company.

3. 3. In addition, a corporation is required to publish the existence of voting agreements and other agreements relating to the holding of the corporation's securities.

4. 4. Disclosure of specific transactions: several regulations focus on disclosure relating to specific transactions, such as: a private placement of securities, a transaction between a company and the controlling shareholder, a tender offer, a merger, and offering of securities to the public.

5. 5. Remuneration: disclosure should be provided regarding all components of the terms of office of directors, officers and controlling shareholders who serve as office holder in the company, which require approval of the general meeting, even in cases that such approval is not required due to a specific relief in Regulations (i.e. due to minor changes).

6. 6. Details of remuneration should also be disclosed for: (a) five highest remuneration among officers and directors of the corporation or its subsidiary; (b) three senior officers with the highest remuneration in the corporation if not included in (a) above; (c) any interested party in the corporation not listed in paragraphs (a) or (b).

In the annual report10, a corporation is required to mention the name of its controlling shareholder, if control was transferred during the period described in the report and the name of the person who was the controlling shareholder of the corporation during that period.

In addition, the report must mention the shares and other securities that each interested party in the corporation holds in the corporation on the date of the report or on a date as close to it as possible, detailing the name of each interested party, the rate at which he holds the shares and each of the other securities of the corporation which the corporation undertook to sell to him.

Furthermore, in the annual report a corporation is required to report all its transactions with the controlling shareholder or in which the controlling shareholder has a personal interest during the last two years, or which are in effect at the date of the report.

However, a company is not obligated to report transactions that are considered negligible, as long as the company has determined the types and characteristics of negligible transactions. In practice, a "best practice" was created for this matter, according to which companies approved in advance a procedure for classifying negligible transactions while determining the relevant parameters according to the type of transaction, both qualitatively and quantitatively.

In addition, the annual report must include a list of the corporation's financial position in each of the subsidiaries and affiliates companies and specify the changes in the corporation's investments in the reporting year in each subsidiary and in its affiliated company, including the dates of the changes and the main terms of the transactions related to these changes. The specification should also relate to changes in a company that became a subsidiary or affiliate, or ceased to be such a company in the reporting year.

Moreover, a corporation is required to disclose any material legal proceeding in which any of the directors, office-holders, related companies or interested parties are a counter-party to the corporation or who have an interest in that proceeding which is contrary to the interest of the corporation.

Control premium

As mentioned above, a high control premium in Israel was seen as a major indicator for market concentration and corporate governance deficiencies in the country.

It is interesting to see the change in control premium in Israel a decade later, mainly attributed by researchers to the effect of the LPCRC and the amendments to ICL, especially the requirement that a transaction with a controlling shareholder for a period of over three years should be re-approved every three years.

A famous study by Dyck & Zingales examined the average level of the control premium in 39 developed countries by estimating how much a new controlling shareholder pays above market price in control transactions. The study examined control transactions between 1990 and 2000. According to this study, Israel's average control premium rate was one of the highest in the world, about 27%, almost twice as high as the global average of 14%.11 In the most advanced capital markets such as the United States and the United Kingdom, the control premium rate was even lower and stood at 3% or less.

These studies have greatly influenced the decision makers in Israel and led to a long list of reforms in the Companies Law and the Securities Law. The main reforms are described above. They were intended, inter alia, to reduce the negative effects reflected in the high control premium in Israel.

New research conducted by Professor Sharon Hannes and Mr. Eylon Blum had initial data published that might indicate a major change in control premium. The initial data from this research includes control transactions in the highest listing segment in TASE during 2006-2014. The study included 13 transactions, in which the average control premium was only 4.6%— a significant decrease in two decades. Moreover, the weighted average calculated according to the size of the transactions was a premium of only 1.2%. In five out of the 13 transactions examined there was a negative premium. But the median control premium in transactions with a positive premium was 10.3%.12

These initial research findings may indicate a significant change of trend in control premium. These findings should be looked at together with several recent occasions where controllers decided to dissolve their control and sell their controlling shares in the company in the stock exchange (Paz, Discount Bank, Poalim Bank, etc.). Therefore, at the same time, and probably not coincidentally, we are experiencing a decline in the proportion of companies that have controlling shareholders towards more decentralised control structures.

This trend of companies with decentralised ownership has also changed the regulatory concerns in MOJ and ISA with respect to governance and duties of board in company groups. Historically and as mentioned above, the major concerns were regarding controlling shareholder, RPTs and board independence. Today, regulatory concerns shift also to board effectiveness, board–management relationship and the implications on institutional investors' engagement. In companies where there is no controlling SH, it is important to have an independent, strong and professional board of directors, with an active supervisory circle of caring and involved shareholders. MOJ is currently conducting research aimed to amend the ICL and add provisions relevant to non-controlled companies.

Recent data on company groups in Israel

By the end of 2017, four years after the enactment of LPCRC and two years before it comes to full effect, and six years after major reforms regarding RPTs in the ICL the share of controlled companies in TASE declined from 88% to 80%. The number of company groups declined mildly to 26 company groups, which include 23% of all public companies, and their share in market capitalisation declined from 54% to 35% of the value of the stock exchange market. In the end of 2018, only eight companies remain in the third tier of pyramidal groups, and the market value of these eight companies is only 3.7% of market capitalisation (estimated at 26 billion NIS). The company groups including these companies were required to comply with the two-layer rule of LPCRC by December 2019.

It should also be mentioned that three out of the five largest banks in Israel, were part of a company group comprising of both significant financial banking activities and significant real holdings. To date, no bank is part of such group.

In addition, the two last insurance companies that were still part of company groups with both significant real and financial holdings have ceased such status before December 2019— in one case by acquisition by a different controller and in another case by dissolving control and selling the controlling shares to the public.

Conclusions

In the last decade Israel enacted several reforms which had dramatic influence on company groups and corporate governance in controlled companies.

These reforms aimed to promote competitiveness and efficient allocation of capital and to minimise systemic risks deriving from the structure of the market at that time. These reforms also aimed to protect investors in public companies and minimise agency problems in controlled companies.

It is early to assess the impact of all these reforms but even now some significant trends can be noted – decrease in the size and dominance of company groups in the Israeli market; enhanced enforcement, especially private, which contributes to higher standards of corporate governance and a decrease of control premium that may indicate more effective investor protection and fewer opportunities to extract private benefits of control. In addition, several recent cases where controllers decided to dissolve their control may indicate an initial trend of more companies with decentralised control structures.

References

OECD (2015), G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, https://doi.org/10.1787/9789264236882-en.

Blum, Eylon and Hannes, Sharon (2016), Does Law Matter? Private Benefits of the Controlling Shareholder Following Legal Reform, http://web.law.columbia.edu/sites/default/files/microsites/law-economics-studies/control_premiun_cls.pdf

Notes

← 1. For this purpose, "Means of control" are broadly defined as any of the following: (1) the right to vote at a general meeting of a company or of a parallel body of another body corporate; (2) The right to appoint a director in a corporation; (3) the right to participate in the profits of the corporation; (4) the right to the balance of the corporation's assets upon its liquidation after the discharge of its liabilities.

← 2. "Relative": a spouse, brother, parent, descendant, descendant of the spouse, and spouse of any of the above.

← 3. The lawsuit was filed by one of the shareholders in the public holding company. The shareholder claimed, against the two companies and the three directors who were appointed to be members of the committee, that the institution of the committee should not be permitted. The shareholder asked the court for declaratory reliefs according to which there is no legal or corporate validity for the institution of the board of directors committee, and also that the board of directors committee is not entitled to instruct or guide officers in the insurance company and accordingly officers in the insurance company are not permitted to act in accordance with its instructions or guidance.

← 4. The transaction will be approved, even without MOM approval, if shareholders voting against the transaction represent less than 2% of the voting SHs.

← 5. A relief in regulations allows a company which offers its securities to the public for the first time (IPO) re-approve such a transaction only five years after the IPO if it was duly described in the offering prospectus.

← 6. See: C.A.R. 2903/13 Iterkoloni Hashkaot v. Shmuel Shkedi (Nevo, 27.08.2014).

← 7. Mivtach Shamir is a public company that, together with Apax funds, acquired 76% of the shares of the Tnuva Group, a private company. Mivtach Shamir was required by ISA to describe its investment in Tnuva in the periodic reports, as required by the Securities Regulations, and to attach the reports of the holding corporation and the Tnuva Group's reports. The Administrative Enforcement Committee approved an enforcement arrangement, and stated that a private corporation, held by a public corporation is obligated to disclose information to the holding parent company as if it was its own obligations.

← 8. Despite the fact that the controlling shareholder did not repay the loan on time, the Company did not report it. Later the controlling shareholder demanded that the Company return part of the repayment amount and, in fact, received a new loan from the company. This transaction was also not reported to the public. The Administrative Enforcement Committee regarded the case as a severe flaw in corporate governance, and regarded the company officers' actions as breach of duties and action in conflict of interest.

← 9. The immediate reports are published upon the occurrence of a material event on the day such event occurred or on the first trading day following the occurrence of such event (depending on the time such material information relating to its affairs becomes known to the corporation).

← 10. An annual report is submitted once a year and describes the operations of the corporation during previous year. The annual report is submitted within three months as of its reporting year-end.

← 11. A. Dyck, & L. Zingales Private benefits of control: An international comparison. Journal of Finance 59, 537-600 (2004). In another study by Lauterbach & Ronen, the control premium was calculated for transfer of control transactions in 1993-2005. Their findings revealed a similar picture, according to which the control premium in Israel was 31.5% (B. Lauterbach, & B. Ronen Estimating the private benefits of control from block trades: methodology and evidence, EFA 2007 Ljubljana Meetings Paper (2007)). The Economic Department of the Israel Securities Authority, examined the control premium between 2006-2010, and found that the average control premium ranged between 19%-30%.

← 12. http://web.law.columbia.edu/sites/default/files/microsites/law-economics-studies/control_premiun_cls.pdf. This study has subsequently been updated and expanded to cover a larger selection of companies and transactions from 2001 -2019, and is available in Hebrew on the Tel Aviv University website (Eylon Blum, Sharon Hannes, Beni Lauterbach and Revital Yoseph, 2020).