New Restrictions on Hedge Funds in Israel
The Israel Securities Authority recently published a staff position that has material implications on the hedge fund sector in Israel and on the investor public.
This position was issued against the backdrop of a judgment handed down by the Tel Aviv District Court in the Integral Fund case – a hedge fund that caused heavy losses to the hundreds of investors who invested in it. In this case, the court ruled that the provisions of the Joint Investment Trust Law apply to the fund and therefore Integral Fund breached the regulatory obligations that apply to it.
In its position, the ISA provided clarifications about some of the topics addressed in the court ruling. According to the ISA staff position, hedge funds (or any investment fund) that meet particular criteria are subject to the Joint Investment Trust Law and to the stringent regulations that apply by virtue of this law.
Two important clarifications in the ISA staff position addressed the mode of incorporation of hedge funds and the limit on the number of investors in a fund:
Mode and place of incorporation
Section 2(a) of the Joint Investment Trust Law exempts an investment arrangement if that arrangement is regulated under another law. Prior to the publication of the ISA staff position, the prevailing interpretation was that hedge funds incorporated as limited partnerships are regulated under the Partnership Ordinance, and therefore the Joint Investment Trust Law does not apply to them.
It was further clarified that the mode of incorporation (whether under the Companies Law or the Partnership Ordinance), and the place of incorporation (in Israel or abroad), do not constitute a comprehensive designated arrangement that suffices to exempt a hedge fund from application of the Joint Investment Trust Law. This determination is also true if the fund’s activities are regulated under foreign law. Therefore, the mode of incorporation or the fact that the arrangement is regulated abroad will not be considered a factor when determining whether the Joint Investment Trust Law applies to the hedge fund.
The maximum number of investors
Section 2(b) of the Joint Investment Trust Law exempts investment arrangements if the number of participants in the fund does not exceed 50 investors and no offer was made to the public.
It was further clarified that, when counting the number of participants in the investment arrangement, classified investors, as defined in the Israel Securities Law, should not be counted. (Those that meet the criteria specified in the First Addendum to the Israel Securities Law are also deemed sophisticated investors).
Another clarification, which is perhaps the most significant, is that a new hedge fund will be precluded from contacting more than 50 investors or offerees (not including classified investors), while existing hedge funds with more than 50 investors will, from now on, be able to publicize offers to invest in the fund solely to classified investors.
Additional clarifications presented in the ISA staff position are as follows:
(1) Moniker of the fundraising entity
The name or moniker of the fundraising entity has no bearing on which law or regulation applies to it. The applicable law will be determined according to the characteristics of the entity or the investment.
In other words, the Joint Investment Trust Law will not apply solely to entities called a “mutual fund” and can also apply to entities called “hedge fund,” “investment fund,” etc.
(2) Artificial splits
Various investment arrangements have tried to circumvent the limit of 35 offerees in a public offer pursuant to the Israel Securities Law, by artificially splitting the investment arrangement into a number of disparate investment arrangements and counting the offerees in each arrangement separately instead of aggregately.
The ISA staff clarified in its position statement that artificially splitting funds into separate legal entities cannot serve to circumvent the provisions of the Israel Securities Law or the Joint Investment Trust Law as they pertain to the maximum number of offerees and investors.
(3) Contacting and publicizing offers to the public
The Joint Investment Trust Law and the Israel Securities Law prohibit funds from contacting the public and publicizing any investment offer to them that is not supervised (i.e. without a prospectus).
The ISA clarifies that “contacting” the public and “publicizing offers” to the public encompass an open list of the various ways potential investors may be contacted—by telephone, email, written and oral advertisements, advertisements on social networks, presentations and brochures, “word of mouth,” etc.—all of which are prohibited.