By Shmuel Rosenblum
Between 2014 and 2018 inclusive, American real estate corporations issued an astronomical number of bonds in Israel—to the value of 25 billion NIS—and the Israeli public pounced on the opportunity to invest their pension and provident funds in what looked like their lucky break. But daily reports in the financial press are exposing scandal after scandal, involving these corporations. Bond values are plummeting and leaving much drama in their wake.
Let’s take a brief look at what happened.
Who’s Who in the Shareholder Zoo
Usually these US-based, corporations are managed by a majority shareholder who has a controlling stake in the business. They own dozens of multi-family housing complexes or other income-producing real estate, throughout New York and other cities in the US. At the top of these corporations’ food chain is a majority shareholder, followed by his family (spouse, children, sons-in-law, etc.) and a number of employees whose salary and employment terms are determined by the majority shareholder himself (mainly through a management company also controlled by the very same majority shareholder!). Each real estate company (LLC) is incorporated under a parent company, and all are controlled—yes, you guessed it—by the head of the food chain. These companies have financial obligations that tie them to the banks who enabled their acquisition of assets—obligations that precede and necessitate the issuing of bonds.
Why Issue in Israel?
Many of these controlling shareholders caught wind of an attractive phenomenon in Israel—much lower interest rates on bonds than those levied by US banks. And so began the movement of eager-beaver corporations who crossed the Atlantic, and began to generously dish out bonds that would cost them much less to issue than the expensive commitments they had to cover back home. This movement managed to raise a whopping 25 billion NIS from the Israeli public’s pocket.
What’s in a bond? The following is a breakdown of a corporation’s shareholder composition—before and after its IPO:
And the management?
Mr. Levi, Brother-in-Law, Son-in-Law, Mrs. Levi, Mr. Levi Jr. etc.
And the management?
Just the same.
Usually, when they issue bonds, majority shareholders such as Mr. Levi don’t part with all of their assets for the greater good of the public. After launching IPOs on some of their companies, they most often still retain private ownership of numerous housing complexes and real estate contracts!! Consequently, Mr. Levi’s managing company must then provide service and human resources to both his private assets and his new public corporation.
While this article won’t address the issue of legalities and taxes, it does address the complexity of an IPO for novice companies from abroad.
ISA Regulations in Israel
It sounds like a dream come true. Finance your properties by listing your company in a low-interest rate market!! However, along with the tempting rewards come the ISA’s mandatory regulations that apply to all public corporations. And this is where the trouble begins.
Most of these majority shareholders have no experience managing a public company! They have no experience with compliance to regulations of full disclosure. Until their first IPO, they simply ran a family business! Everything was always handled by family and selected employees, under the full authority and discretion of the majority shareholder. Business transactions were often the topic of discussion at the family dinner table, and many important management decisions were made—albeit with scrupulous business ethics—after the main course, while waiting for Mom’s famous apple crumble in the familiar comfort and privacy of the home, far from the public eye.
Now hear this: Israel’s ISA regulations stipulate that public companies are required to retain an accountant (no such obligation exists in the US), as well as an internal auditor, three Israeli managing directors, a trustee in Israel for debenture holders, and a local team of legal advisors. These companies must present quarterly financial statements to the relevant authorities, maintain full transparency including cash flow reports to enable the public repayment of bonds, and an immediate report to the public in the event of any fundamental changes or a crucial matter. Transactions that involve a potentially biased party must be performed under supervision. Documentation must be presented with accurate Hebrew translations.
If you’ve never gone public, you and your company could face a catastrophic ending. The necessary about-turn in business and private conduct is sometimes an insurmountable challenge for some companies.
What Are Israelis Saying?
Important note: The reports here are presented as they appear in the press, or as expressed by experts in the field. They are in no way an accusation, judgement or attempt to discredit the shareholders in question, their integrity or the financial stability of their corporations.
The following is an excerpt from an article in Israel’s Calcalist newspaper (January 24, 2019) on one such company’s IPO in Israel, which issued bonds to the total value of approximately 2.4 billion NIS:
“The American real estate company, which is currently examining funds that it says were ‘inadvertently transferred to the controlling shareholders account, suddenly found a loan that was not reported to the audit committee and the board of directors. This loan of $4.85 million with an interest rate of 4.1% was used to finance three properties—two belonging to the public company, and one privately owned by the corporation’s majority shareholder.”
In recent months, many similar incidents have been reported and there’s unease in financial circles, as they ponder and pinpoint the pitfalls:
* There is a risk of exposure for family businesses that have no experience in running a public company.
* When the majority shareholder is the hand that feeds a company’s employees, experts question the staff’s ability to maintain public integrity. Similarly, it should be mandatory that any transaction or business decision (such as purchase of property, renovation or sale) that involves a biased party—in this case employees who receive their salary from the majority shareholder (through his management company)—should be supervised and subject to special regulations.
* Some professional opinions stipulate that because of the inability to monitor conflicts of interest, controlling shareholders of a public company should be prohibited from owning and managing similar private companies “on the side”.
* An idea is circulating on how to convey to foreign corporations what a public company entails. The idea suggests that the management of any foreign corporation with no prior experience in public management undergo a mandatory training course in Israel.
Conclusions: Israel is not an IPO paradise, nor a golden egg. Full compliance with Israeli law involves heavy costs and pretty serious sanctions! Israeli authorities are clamping down and fully enforcing the regulations. Interestingly, for some there is a pot of gold on the opposite end of the IPO forecast. Some very successful companies who issued bonds in Israel with proper conduct and the right channels are enjoying enviable stability.