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Last update - 01:40 22/12/2003

The Unprotected Investors in Dual-Listed Stocks

By Uri Ronnen

What would you say if you found the Health Ministry sampled fewer cold cuts imported from America than it did Israeli produced ones, even if they carried the same risk of failing to meet standards?

What would you say if the ministry defended its policy by saying "American Health Department supervision is among the most stringent in the world" -- although the U.S. regulator barely checks cold cuts exported to Israel?

You would probably say the Health Ministry was sacrificing consumers' safety to importers' profits.

This scenario is purely fictitious. But if you substitute the ISA (Israel Securities Authority) for the Health Ministry and the financial reports of dual-listed companies for cold cuts, you would move from fiction to fact.

This worrying situation exists because the ISA has declared it does not check financial reports of dual-listed companies as stringently as it does for companies traded only in Israel -- even though the American SEC (Securities and Exchange Commission) doesn't properly oversee reports of dual-listed companies either.

Every year since 2000 the ISA has said in its annual report to the Finance Minister and the Chair of the Knesset Finance Committee that although the ISA's authority over the dual-listed companies and other publicly traded companies is identical, the ISA "takes it into consideration that these [dual-listed] companies are already supervised by SEC, whose level of supervision is among the highest in the world."

This is an outrageous statement because the ISA chooses to ignore the fact that two types of companies are traded on U.S. stock exchanges -- domestic and foreign stock issuers. All the dual-listed companies on the Tel Aviv Stock Exchange are foreign issuers in America. Everyone who knows a bit about the enforcement policy of the SEC -- analyst, lawyer, journalist, accountant or academic researcher -- is aware that the SEC knowingly neglects enforcement on foreign issuers.

True, the level of SEC supervision is indeed "the highest in the world" -- but only for domestic issuers. In a December 2001 Forbes magazine article, Elizabeth MacDonald, one of its senior editors, highlighted serious problems in the financial reports of a few foreign issuers, and then warned: "Don't count on the SEC to monitor this situation closely. The agency is preoccupied with domestic problems."

MacDonald said that "while the agency says it's on guard, the SEC Web site shows just two accounting enforcement actions since 1998 against foreign companies that trade as ADRs, as opposed to 388 filed against U.S.-based companies."

Urban Myth

Dr. Amir Licht of the Interdisciplinary Center in Herzliya, one of the world's experts in dual listing, says the ISA's attitude is based on an urban myth. In an article in "Mishpatim," the Hebrew University's legal journal, that cast doubt on the ISA's assumption, Licht cites a study conducted by Prof. Jordan Siegel of the Harvard Business School, indicating that "the SEC tends to refrain from regulating non-American issuers."

Siegel first examined the enforcement regarding Mexican companies that are registered in the United States, where it was public knowledge that some companies were guilty of serious fraud. Siegel found, however, that no steps were taken against them or against their controlling shareholders. A broader survey conducted by Siegel regarding all the foreign issuers revealed a similar situation. Licht says the findings were confirmed by senior SEC officials whom Siegel interviewed.

Siegal's research confirms what Israeli investors have suspected for a long time -- the SEC neglects them. This is how they felt, for example, when the SEC ignored the class action suits filed against Israeli companies such as ECI Telecom, Nice Technologies and Commtouch, for inflating revenues -- and which ended in compromises in which the companies agreed to compensate investors. If those companies had been local issuers the SEC would certainly have opened its own investigations.

Commtouch case is particularly interesting, since it and its U.S. competitor Critical Path have restated revenues that were manipulated more or less in the same quarters and by the same tricks. The SEC filed and settled a civil fraud action against the American company but ignored the Israeli company.

Prof. Eli Amir of the London Business School says there are several instances of Israeli companies registered for trade in the U.S. and applying accounting practices a local company would never dream of using.

"Every time I see this, I am surprised all over again, especially when one considers the stiff regulatory environment in the U.S.," Amir said. "Then I met an investment banker at HSBC, who explained that the SEC cannot justify the allocation of limited resources for enforcement against companies whose shareholders are mostly not Americans."

The SEC also avoids investigating suspicious reports by foreign companies, due to the high costs involved in gathering evidence in foreign countries, and the difficulties in obtaining the cooperation of accountants and foreign supervisory bodies.

Insult to Injury

The ISA's declaration that it relies on American supervision is reflected too in the field. For example, the ISA has a good record of successfully forcing companies to disclose the financial covenants to which they were committed in financial agreements. But when asked why it did not demand similar disclosure in the financial reports of the leveraged Koor conglomerate, an ISA official said Koor is a dual-listed company and cited ISA's enforcement policy declaration.

Does that ISA official truly believe that Koor's shares are of any more interest to the SEC than the snow that fell in Tel Aviv in 1951? The ISA's disregard for the SEC's dismal enforcement on foreign issuers makes matters even worse: a 2000 amendment to the Securities Law, approved under pressure from the TASE and the Association of Publicly Traded Companies, allows Israeli companies that are traded in the U.S. to register for trade in Israel on the sole basis of sparse reports they file in the U.S. as foreign issuers.

Last week it became known that Alvarion, a dual-listed company that provides even less quarterly disclosure than other foreign issuers, will be joining the prestigious Tel Aviv 25 Index next week. A few weeks ago, for the first time and without a public debate, the ISA granted its approval to dual-listed Sapiens Software Systems to raise capital in Israel based solely on its scanty reports as a foreign issuer in the U.S.

Given these two instances, we asked the ISA last week whether the time had not come to desist from granting enforcement discounts to dual-listed companies. "These are companies that issue according to American law," responded the ISA's spokesman. This statement ignores the fact that the U.S. has different disclosure regimes for domestic and foreign issuers, and gives no hint of the gap between the written law and the reality of the SEC's non-enforcement on foreign issuers. One has to wonder if by the end of the day, the ISA has adopted the Association of Publicly Traded Companies' propaganda as its official policy.

"The ISA's assumption that the SEC is overseeing dual-listed companies is erroneous," said Amir, who has been chairman of the Israel Accounting Standards Board. "This is liable to cause serious harm to Israeli investors, particularly because the scope of their quarterly financial reports is substantially narrower than that required from Israeli companies."

Licht says the ISA must recognize the reality documented in the academic studies and calls for a reexamination of ISA policy. He suggests the ISA should first attempt to put into use the memorandum of understanding it signed with the SEC. And if that doesn't work, the ISA itself will have to enforce the rules and regulations.