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Protecting the Investor in a Public Company
A Comparative View
Sunlight is said to be the best of disinfectants,
electric light the most efficient policeman.
Brandeis, Other People’s Money’
I. Introduction
Over sixty years ago and many years ahead of his time, United
States Supreme Court Justice Louis Brandeis propounded his
theories in his book, Other People’s Money. The period which he
spoke of then exists now. Today, vast fortunes are entrusted to
corporations and managed by corporate directors. This phenomenon
has a number of important ramifications: the first being that the
centre of financial and economic power is shifting. Private accumula-
tions of wealth are fast disappearing into the hands of incorporated
bodies. This stems from the proliferation of corporations and the
enlarged scope of their activities, as well as from the heavy duties
and taxes imposed on capital and its transfer, on income, and on
estates. Secondly, the increased sphere of corporate activity has
widened the gap between the shareholders who own the company and
the directors who manage it. Thirdly, widespread international
transactions and the need to command large sums of money have
prompted companies to turn to the public for necessary financing.
The publicly-owned corporation
is thus today characterized by
great concentrations of capital representing thousands of investors,
with the result that the interest of any one investor is very small
and there is no direct supervision of directors by interested share-
holders. Ultimately it is the duty of the government to protect such
investors. Finally, these developments have bred a new generation
of professional directors who own either no shares in the company
or a very small percentage only. Their goals need not always coin-
cide with those of the company and its shareholders; they may be
personally motivated and consequently engage in prestigious trans-
actions, or even hide unlawful or unsuccessful activities.
In these circumstances, how can the public be protected against
the exploitation of its good faith? The right to raise money from
the public is a privilege which the state grants to specific bodies. So
long as securities are held by the public, the state must therefore
supervise these bodies, both at the stage of raising the money as
1 (1914), ch.15.
19781
COMMENTS – COMMENTAIRES
well as during later periods. Those who wish to make use of the
public’s money should inform the public at large of all the material
facts needed for the formation of intelligent investment decisions.
Nevertheless, most countries have refrained from direct control
over the capital market, for fear that it might crumble under super-
vision. The United States was the first nation to activate govern-
ment control as part of President Roosevelt’s New Deal policies,
following the economic crisis of 1929? Canada was influenced by
American policies and legislation in this regard and, following the
1965 Report of the Attorney General’s Committee of Securities
Legislation in Ontario,3
the various provinces adopted securities
statutes similar to the American legislation.4 Ontario implemented
the proposals of the Kimber Report almost in their entirety in
The Securities Act of 1966. 5 Substantially uniform statutes have
since been adopted in most of the other provinces.6
Israel also followed the American example. In 1963, the Yadin
Commission 7 recommended changes in methods of regulatory con-
trol, and, five years later, a system of government control over the
floatation of securities was enacted by the Israeli Parliament: The
Israel Securities Law, 1968.8 The new Israeli securities law was
transplanted into a system of company law which is essentially
copied from the English Companies Act, 1929.9 The only material
2The Securities Act of 1933, 15 U.S.C. 77a et seq. (1976) and the Securities
Exchange Act of 1934, 15 U.S.C. 77b et seq. (1976). The various States have
their own laws. See Loss and Cowett, Blue Sky Law (1958).
3Hereinafter referred to as the Kimber Report (1965).
4For discussion of securities
in Canada, see: Williamson,
Securities Regulation in Canada (1960) and Supplement (1966); Bray, “Recent
Development in Securities Administration in Ontario” in Ziegel (ed.), Studies
in Canadian Company Law (1967), vol.1, ch.14;
(1973), vol.2, ch.8.
regulations
5R.S.O. 1970, c.426, as am. by S.O. 1971, cc.1, 31; and S.O. 1973, c.l1. The
current securities legislation has just undergone revision before the Ontario
Legislature. The Securities Act, 1978, Bill 7, (1978), 2d Sess., 31st Leg. (Ont.)
was introduced on Feb. 28, 1978 and passed through third reading on June
23, 1978. Numerous areas ir the Act have been altered to ensure increased
investor protection. The most important changes include increased require-
ments for detailed rules concerning take-over bids, timely disclosure of
material information and a new pattern of exemptions from prospectus
filing requirements.
O See, e.g., R.S.A. 1970, c.333; R.S.B.C. 1967, c.45; R.S.M. 1970, c.S-50; R.S.N.S.
1967, c.280; R.S.Q. 1964, c.274 as am. by S.Q. 1966-67, c.82; S.Q. 1971, c.77; S.Q.
1973, c.67.
7 The Committee on Floatation of Securities, appointed on Marcn 14, 1962.
8 Sefer Ha-Chukkim No.541 (1968), 234.
9 Companies Act, 1929, 19 & 20 Geo. V, c.23.
McGILL LAW JOURNAL
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change in this law over a period of fifty years has been the new
law on securities.’ Thus the Israeli experiment, as the first of its
kind outside North America and Japan,” constitutes an interesting
example for the understanding and application of a new, modern
approach to the securities market.
Even in England there are those who favour abandoning the
existing system and establishing greater government control over
publicly held corporations. Professor Gower states that it is now
widely acknowledged that continued reliance on private agencies
will not suffice:
The trouble is that Queensberry rules not subject to legal sanctions are
inadequate to preserve a code of conduct, at any rate in the heat of a
take-over battle. No rules for disclosure, however all-embracing, no City
code, however olearly drafted, and no Panel, however prestigious, can
really be an adequate substitute for a single authority with statutory
powers over the whole field of securities regulation.12
He concludes:
What seems to be needed is a statutory body –
a smaller (poor man’s)
S.E.C. … and which would be provided with a staff adequate to lay
down rules and to police them, and be armed with powers to co-
ordinate and supervise the activities of the private agencies.’ 3
II. Participation of the public in corporate capitalization
and the importance of suitable legislation
A. The importance of the capital market to the economy
Today, problems of public financing are of primary concern in
modern economics on both the national and international levels.
The trend which characterizes the capital market in the Western
world is toward multiplication of companies seeking capital from
the public, on the one hand, and an increase in the number of invest-
ors prepared to invest in such companies, on the other. The op-
portunity to raise money from a large segment of the population,
by means of companies with limited liability has created important
sources for financing company activities. This point was rightly
1o Sefer Ha-Chukkim No.541 (1968), 234.
1 Japan enacted the Securities Exchange Law of 1948 which is modelled on
the U.S. securities acts of 1933 and 1934, 15 U.S.C. 77a et seq. (1976), 15
U.S.C. 7T et seq. (1976).
12 Gower, Principles of Modern Company Law 3d ed. (1969), 310. See also
the Green paper published by the U.K. Labour Party on The Community and
the Company (1974), 19, para.4: “We do not believe that, left to its own devices,
the Stock Exchange can operate effectively and fairly”.
13 Ibid.
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COMMENTS – COMMENTAIRES
stressed in the Command Paper on Company Law Reform presented
to the English Parliament:
In this free enterprise system, it is the limited liability company that
provides the framework through which the savings of individual citizens
are channelled both directly, and indirectly through institutions such as
pension funds and banks, into the industry and commerce of the country.
It enables capital to be accumulated and invested in risk-taking enter-
prises, which create economic expansion, provide jobs and produce goods
and services.1 4
The “Securities Industry” has become a sign of modern economy
in capitalist countries. Execution of giant projects in industry and
commerce would be impossible but for the ability of large companies
to raise sums of capital from a multitude of investors. The creation
of the corporation as a device for the large-scale raising of public
funds, the investors being guarded against personal liability, is the
largest and most ingenious contribution of law to the world of
economics.
B. The importance of the capital market to the investor
The existence of a central market for securities, mainly through
the stock exchange or over-the-counter market, assures regular
two-way traffic between buyers and sellers, and thus attracts invest-
ors. The investor is able to go from one investment to another
speedily and with minimal costs. From the point of view of liquidity
there is no investment like traded-securities, for on any given busi-
ness day the investor may materialize his investment, in whole or
in part, and receive its value in cash, subject to certain limitations
which exist in every stock exchange.
The securities quoted daily in the newspapers enable the investor
to keep track of the value of his investments and furnish up-to-date
information to guide him. There are, in addition, periodic and im-
mediate reports which,- by providing information on companies
issuing securities, allow the investor to examine the desirability of
acquiring or selling securities.
It is in the interest of every state and every stock exchange to
preserve rules of proper business conduct for securities transactions.
Thus, even a person lacking expertise in financial matters may join
the large investing public without it being necessary for him to
examine independently the financial situation of the company in
which he is investing. The exposure of companies to public scrutiny,
through the duty of disclosure in prospectuses and reports, and
14 Cmnd no.5391
(1973), 5.
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the comparison between the publicly-traded securities of various
companies of the same type, tend to cause proper pricing and to
discourage companies without a sound economic base from turning
to the public.
C. Considerations in protecting the investor
As the circle of investors broadens, and additional capital from
hundreds of thousands of investors streams into the securities
market, the demand for investor protection and the need for
cautious, precise reports on company activities increases. The object
of all securities legislation is to create confidence, and therefore the
main point in securities legislation must revolve around the protec-
tion of the investor.’5 The machinery to provide full information to
the investor and the creation of a marketplace free of manipulation
are the immediate objectives of the legislation and its administra-
tion.’
The fear does exist, however, that emphasis on the principle of
investor protection may hamper the company’s business and, in so
doing, eventually damage the shareholder too. For example, detailed
reports are necessary to help the investors make intelligent choices,
but total disclosure to all may reveal the company’s business secrets,
hinder its transactions and thus place it in a position inferior to
its competitors. However, these two aspects need not always con-
flict.
The securities market relies upon public confidence and this
confidence, in turn, is based upon information as to the financial
status of the company. As confidence grows, the public increases
its investments and the company profits. This consideration holds
true both as regards the primary market for new capital to finance
new economic activity and
the secondary market for resale
and revaluation of outstanding securities. Although
two
markets fulfil separate and distinct functions, if there were no
reliable information and continuous reports in the trading market,
the public would cease to place its confidence in it and thus the
primary market would be adversely affected.
the
To the extent that the legislation emphasizes the principle of
“protecting the investor”, public confidence in the securities market
increases and is strengthened. As was stated in the Kimber Report,
“[o]nly
in the institutions of both
through public confidence
15 This, in turn, facilitates the flow of capital to all areas of the economy.
16 See Bray, supra, note 4.
19781
COMMENTS – COMMENTAIRES
markets will capital be readily raised to finance the vital economic,
developments of the nation”.17
III. Basic principles in supervision of the capital market
The quality of securities offered to the public depends upon the
financial strength of the issuing company. The investor receives a
proprietary certificate which bears no relation to the company’s
financial condition. The company, its directors and promoters, have
all the pertinent information; they have the opportunity to clarify
and verify all relevant facts which may shed light on the company’s
financial status. It is only fair to require the company and its
directors to disclose this information to the public, to whom the
securities are being offered.
Thus, the concept underlying all modern securities legislation
is full disclosure by the company, so that the future investor may
be furnished with all relevant facts when considering whether or
not to invest in the securities offered. In bringing the Securities Act
of 193318 before the United States Congress for approval, President
Roosevelt said:
There is … an obligation upon us to insist that every issue of new
securities … shall be accompanied by full publicity and information,
and that no essentially important element attending the issue shall be
concealed from the buying public.
This proposal adds to the ancient rule of caveat emptor, the further
doctrine, “let the seller also beware”. It puts the burden of telling the
whole truth on the seller. It should give impetus to honest dealing in
securities and thereby bring back public confidence.’ 9
This view has been adopted as the basic rule of the securities
market. The famous Special Study of Securities Markets in the
United States headed by Milton Cohen stated that “the keystone
of the entire structure of Federal securities legislation is disclo-
sure”.2″ Recently, the Wheat Report again stressed this point by
saying that “disclosure is and has from the outset been a central
aspect of national policy in the field of securities regulation”. 21
Thus the purpose of the disclosure system is to provide an
equality of opportunity for all investors in the market place, sellers
17 Supra, note 3, para. 1.12.
1& 15 U.S.C. 77a et seq.
‘ 9 Federal Supervision of Traffic in Investment Securities in Interstate
Commerce, H.R. Rep. No.85, 73d Cong., 1st Sess. 2 (1933).
20Report of the Special Study of Securities Markets of the Securities and
Exchange Commission, H.R. Doc. No.95, 88th Cong., 1st Sess. 1 (1963), part 3.
2 lReport of the Disclosure Policy to the Securities and Exchange Com-
mission (1969), 10.
McGILL LAW JOURNAL
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as well as buyers. The object is to make available on a timely basis
all material facts the investor requires in order to make an informed
investment judgment.2 2
A. Disclosure without intervention: the classic approach
(the United Kingdom)
Can we be satisfied with proper disclosure, or must we create
some supervisory institution to verify a full disclosure? The basic
principle of English Company law is that disclosure and publication
are the best guarantees. This principle was first enunciated in the
Report of the Select Committee on Joint Stock Companies
in
England, chaired by Gladstone
(who served then as President of
the Board of Trade) and was expressed by the duty to publish a
prospectus. It was the Committee’s opinion that there should be
no limitation on public offerings of securities. Full and exact disclo-
sure of the nature of the offer an! the company should be attached
in a document known today as a prospectus, which must include
details that enable the potential investor to reach a decision.24 It
was not, however, until 1867 that an English statute set forth the
requirements and contents of the prospectus in detail. 25
The Companies Act, 190026 abolished these requirements as to
the prospectus and replaced them with a more broadly detailed
list of the contents of the prospectus. The statute of 1900 was
enacted in the wake of the report of the 1895 Commission headed
by Lord Davey.27 This report is especially interesting for its approach
to the duty of detailing and disclosure in the prospectus. Addressing
itself to the controversy over whether the state should be satisfied
22 Report of the Committee of the Ontario Securities Commission on the
Problems of Disclosure raised for Investors by Business Combinations and
Private Placements (1970), 15. (Merger Report, Dent. of Financial and Com-
mercial Affairs.)
2 1844, B.P.P., vol.7, 5. This was the first in a series of reports on company
law. In addressing Parliament on the Report, Gladstone said: “The most
wholesome remedy for a public evil is that of giving a power of public
opinion” (1844) 63 Parl.Deb. 1755.
24 An Act for the Registration, Incorporation, and Regulation of Joint Stock
Companies, 7 & 8 Vict., c.110 (U.K.), enacted on the recommendations of the
Committee, first established the requirement of registration of the prospectus
prior to issuance of securities to the public.
25The Companies Act, 1867, 30 & 31 Vict., c.131, s.38 (U.K.). On this subject
see Hunt, The Development of the Business Corporation in England, 1800-
1867 (1936).
26 63 & 64 Vict., cA8, ss.9-11 (U.K.).
27Cd. no 7779, para.42 (1895).
19781
COMMENTS – COMMENTAIRES
with disclosure alone or whether it should investigate, regulate and
intervene in the contents of the prospectus, the committee concluded
that:
[Y]t would be an attempt .to throw what ought to be the responsibility
of the individual on the shoulders of the State, and would give a fictitious’
and unreal sense of security to the investor and might also lead to grave
abuses.28
The statutory provisions of 1900 on questions of disclosure were
reinforced by a series of subsequent committees 9 following which
Parliament enacted the statutes of 1908, 1928, 1947 and 19670
Running through this English legislation is the notion that the best
protection is to make available to the public the information neces-
sary to allow it to determine for itself, in every case, the quality of
the securities offered.
Just about a century after the Gladstone Committee Report, the
concept was again expressed, as devoutly as ever, by the Cohen
Committee:
[T]he fullest practical disclosure of information concerning the activities
of companies will lessen such opportunities [of abuses] and accord with
a wakening social consciousness.&31
The new White Paper presented to the English Parliament in
July 1973 repeated the basic principle:
Disclosure of information is an essential part of the working of a free and
fair economic system. … The more people can see what is actually
happening, the less likely they are to harbour general suspicions –
and
the less opportunity there is for concealing improper or even criminal
activities. Openness in company affairs is the first principle in securing
responsible behaviour.3 2
Today, publication and registration of the prospectus with the
Companies’ Registrar is required by law. But, the Registrar has no
power to refuse registration of a prospectus which meets the formal
28Ibid.
29 This conservative view was never changed by the Labour Party when it
came into power. It was, in fact, the Labour Party which, in 1948, adopted
the majority of the recommendations of the Cohen Committee which had
been appointed by Winston Churchill. It was Wilson’s Labour Government
which adopted the Report of the Jenkins Committee (although appointed by
a Conservative Government).
80 See the Companies (Consolidation) Act, 1908, 8 Ed. VII, c.69; the Com-
panies Act, 1928, 18 & 19 Geo. V, c.45; the Companies Act, 1947, 10 & 11 Geo.
VI, c.47; the Companies Act, 1967, 1967, c.81 (U.K.).
3 lReport of the Committee on Company Law Amendment, Cmd. no.6659
32 Supra, note 14, 7, para.10.
(1945), 7, para.5.
McGILL LAW JOURNAL
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requirements of the statute.3 3 Legislators in England, Israel and
other common daw countries, have not granted the Companies’ Reg-
istrar any power to examine the various details of the prospectus
or the authenticity of its contents; they have contented themselves
with the imposition of civil and criminal sanctions for furnishing
fraudulent information in the prospectus.
B.
Is disclosure enough? (the American approach)
Whereas England persists in its liberal tradition and leaves
supervision over issuance of securities in private hands (the issuing
houses and the stock exchange, for example), the economic crisis
which ravaged the United States in 1929 provoked a departure from
the British approach and the development of a system of greater
regulation over the issuance of securities to the public at both the
federal and state levels. As was later explained in one of the cases:
Because judicial remedies could only be invoked after the harm had been
done, and because there were so many procedural difficulties in the
way, the net result of what the courts … accomplished has been dis-
appointing. Nowhere is there better proof of the adage that an ounce of
prevention is worth a pound of cure.3 4
1. Securities legislation on the state level
State regulatory statutes, popularly known as “The Blue Sky
Laws”,3 5 preceded the federal Securities Act of 1933.30 The United
States Congress preferred to preserve state laws rather than to
exhaust the federal government’s regulatory powers 37 The chaotic
state of the securities market and the floatation of worthless securi-
ties prompted the various states to enact special legislation to
protect the public against fraud by promoters of companies and by
33 Cf. Reuss (Princess of) v. Bos (1871) L.R. 5 H.L. 176, 192; Rex v.
Registrar of Companies [1914] 3 K.B. 1161. When, in 1925, the English Com-
panies’ Registrar appeared before the Green Committee
the
Companies Law, he was asked whether it would not be proper to enlarge
his authority with regard to the prospectus. He refused the offer, saying:
“We are not judicial functionaries”. (Cmd. no.2657, 99 (1926)).
to Amend
4 See Jeffs v. Utah Power & Light Co. 136 Me 454, 12 A.2d 592, 595 (1940).
35 To protect the investors against companies who “have no backing for
their securities except water or blue sky”, Hall v. Geiger-Jones Co. 242 U.S.
539, 550 (1917).
s3 15 U.S.C. 77a et seq. (1976).
3 7 Loss, Securities Regulation 2d ed. (1961), vol.1, 30 et seq.; MacChesney,
(1938) 33
Further Development in “Disclosure” under the Securities Act
Ill.L.Rev. 145; Loss, The Conflict of Laws and the Blue Sky Laws (1951) 71
Harv.L.Rev. 209. For a comprehensive bibliography of Blue Sky Laws, see
Loss and Cowett, supra, note 2, app.4.
19781
COMMENTS – COMMENTAIRES
those who issue securities. 38 During te
1920’s there had been no
statute protecting the public, and the artificial remedies created by
judges who tried to prevent the perpetration of fraud on the public
were fruitless attempts, closing the barn door after the horse was
gone.
2. Federal securities legislation
It was the hard blow suffered by New York with the outbreak
of economic crisis in October 1929 and the great losses encountered
by the shareholding public that drove home to the Federal Govern-
ment the positive need for comprehensive legislation to regulate
and control interstate trading in securities. The legislation had
three basic purposes: to furnish the public with all such facts on
the business and financial status of a company as would allow the
potential investor to consider properly whether to invest his money
in the offered securities; 9 to guarantee a basis of proper conduct
in the trading of securities by establishing norms for the supplying
of appropriate information; to disclose fraudulent acts, prevent
them and punish those responsible. The federal government did not
assume any responsibility for examining the stability and soundness
of the securities; this was left to the judgment of the individual. In
presenting the bill to Congress, President Roosevelt emphasized
that:
[t]he Federal Government cannot and should not take any action which
might be construed as apiproving or guaranteeing that … issued securities
are sound in the sense that their value will be maintained or that the
properties which they represent will earn profit 40
Such limited state intervention was not without its critics.
Professor William Douglas, for example, later named Justice of the
United States Supreme Court, was against the system of disclosure
devised and called it a throw-back to nineteenth century legislation
which totally ignored the fact that people do acquire shares without
examination. He called for broader control over companies, invest-
ment plans and fund raising, stimulating the economy with a view
to better protecting the public:
(S.E.C.)
the Securities and Exchange Commission
38 See Cook, Watered Stock – Blue Sky Laws (1920) 19 Mich.L.Rev. 583, 591.
39 Any one who intends to offer securities for sale to the public must send
a “registration
to
notice” together with a prospectus which contains important facts on the
corporation and its securities. These documents are open to public perusal
as soon as they are filed with the S.E.C. The registration notice must include
within it, extensive material, and those who present it must answer in detail
the numerous questions set forth in the various forms.
40 77 Cong.Rec. 2931 (1931).
McGILL LAW JOURNAL
[Vol. 24
Those needing investment guidance will receive small comfort from the
balance sheets, contracts, or compilation of other data revealed in the
registration statement. They either lack the training or intelligence to
assimilate them and find them useful, or are so concerned with a spe-
culative profit as to consider them irrelevant. 41
The stand taken by Douglas, who was one of Roosevelt’s New
Deal devotees, did not find its expression in the legislation. Recently,
however, several states adopted a modified approach by enacting
the American Uniform Securities Act,4 2 which provides for a com-
prehensive list of facts to be included in the prospectus and em-
powers the regulatory body to prohibit dissemination of a prospectus
on a number of grounds.4 3
IV. The approach of the Israel Securities Law
A. Disclosure without intervention
As between these two basic approaches the Israeli legislator
favoured supervised disclosure over state intervention. The Securi-
ties Law, 1968 leaves examination and determination of the quality
of securities to the public. The legislator does not deny the individual
his basic right to be a fool; it seeks merely to prevent others from
making a fool of him. This, astonishingly enough, represents a
change from the legal situation prevailing in Israel prior to the
new law. The Securities Committee which previously acted as
advisory committee to the .Minister of Finance acted without a clear
statutory basis. The Committee was unfettered by any provisions
whatsoever and its recommendations were dependent on the fulfil-
ment of certain preliminary requirements which, in part, bore the
character of intervention into the manner in which information was
presented in the prospectus.4 4 Such intervention is now precluded
by statute, the Israeli legislator having decided that statutory regula-
tion of disclosure is sufficient.
The Yadin Committee rejected recommendations of the American
experts who contended that Israel was too poor a country to allow
itself failures in the securities market. The American experts argued
for minimal standards enforced by state intervention: a minimum
41 Douglas, Protecting the Investor (1934) 23 Yale Rev. (N.S.) 521; Cf.
Meeker, Preventive v. Punitive Security Laws (1926) 26 Colum.L.Rev. 318.
42 9c U.LA. 86 (1957).
43 E.g., where “the offering has worked or tended to work a fraud upon
purchasers or would so operate” (306(a) (E)). See the Federal Securities Code
(Tentative Draft No2, 1973).
44 E.g., the voting ratio between shares offered to the public and those
retained by the promoters; who may act as trustee to debenture holders, etc.
19783
COMMENTS – COMMENTAIRES
time period during which the company must operate; a minimum
investment by the promoters, etc. For them, disclosure was a
primary but not an exclusive goal4 5
The “full disclosure” theory actually adopted by the Israeli
legislator has a dual effect. On the one hand, it is apt to deter
fraudulent transactions which will be exposed by publication and
to discourage those transactions that cannot stand the light of
public scrutiny; on the other hand, the judgment of those capable
of absorbing the details presented to them, will influence the market
price of the securities.
B. Establishment of the Securities Authority
-Disclosure is not left to the company alone; it is a matter of
public interest and therefore Israel has adopted the American view
to the extent that it recognizes the necessity of establishing an
Authority whose function “shall be to protect the interests of the
public investing in securities”.4 6 The Authority is not a government
body as in the United States and Canada, but rather an independent
body composed of members of both the government and the public.
The Securities Authority in Israel operates with a significant
measure of success within the limited scope of its powers as defined
by statute. Although its control is exercised primarily at the time
of issue of securities to the public, for some reason, unlike the
American Securities and Exchange Commission, the Authority has
not been empowered to deal with “take-over bids” which is one of
the most important problems in this area. There is no effective
difference in the protection of the investor between cases of take-over
and cases of offering securities to the public.
C. The test of “public offering”
The Israel Securities Law prohibits any offering of securities
to the public other than by means of a prospectus, the publication
of which has been permitted by the Securities Authority.1 The
term “securities” has been most broadly defined in the statute as
including “certificates issued in series by a company, a cooperative
society or any other body corporate and conferring a right of
45 Testimony of Professor L. Loss, given 28 Dec. 1962 (unpublished).
46Laws of the State of Israel no.56, 1968, s.2 (hereinafter referred to as
Securities Law).
47Ibid., s.15(a): “A person shall not offer securities to the public otherwise
than under a prospectus the publication of which has been permitted by the
Authority”.
McGILL LAW JOURNAL
[Vol, 24
membership or participation in it or a claim against it and in-
cludes… certificates conferring a right to acquire securities…
The key point is the public nature of the offering; if it is not public
the provisions of the law do not apply. The Act does not define the
term “public”, and, in the absence of a definition, its meaning must
be interpreted in conformance with the statute’s general purpose –
the provision of information concerning the issuing company.
Where the offer is made to a limited number of persons, the inter-
ested parties can request and receive all information necessary to
allow them to make an informed decision. Intervention and protec-
tion by the legislator in such a case is superfluous. In order to deter-
mine whether or not an offering is “public”, there are two tests
which may be applied, the “circumstances test” and the “need of
protection test”.
The circumstances test requires an examination of all factors
connected with the offer including, inter alia, the possibilities of
access to the sources of information and the relationship between
the offeror and the offeree. The number of people to whom the offer
is made is a significant component of this test but in itself is not
conclusive,49 although it does carry the greatest weight. For example,
the Securities and Exchange Commission in the United States turns
a bind eye to an issue of securities to less than twenty-five people,
unless it is proved that this group intends to sell its shares to others
and is acting as underwriter.50
The need of protection test is, in fact, added to the circumstances
test. In construing the concept of “public”, the court, in addition
48 Ibid., s.1.
41DCf. Viscount Sumner in Nash v. Lynde [1929] A.C. 158, 169 (H.L.): “No
particular number are prescribed. Anything from two to infinity may serve;
perhaps even one, if he intended to be the first of the series of subscribers
but makes further proceeding needless by himself subscribing the whole.”
While the U.S. Supreme Court relied on this position in S.E.C. v. Ralston
Purina Co., 346 U.S. 119, 125 (1953), a number of states in the U.S.A. waive
the requirement of publishing a prospectus if the offer is made to a small
number of persons, say up to 20.
The American Uniform Securities Act, sA02(b)(9), also waives the pros-
pectus requirement where the offer is made to not more than 10 people
over a period of 12 months, and the seller is convinced that the acquisition
is for investment purposes.
Under The Securities Act, 1978, Bill 7, (1978), 2d Sess., 31st Leg.(Ont.),
the exemptions from prospectus requirements are found in ss.71-73.
moCf Op.Gen. Counsel Sec.Act.Rel. 285 (1935): “Under ordinary circum-
stances an offering to not more than approximately 25 persons is not an
-offering to a substantial number and presumably does not involve a public
offering”; Orrick, Some Observations on the Administration of the Securities
Laws (1957) 42 Minn.L.Rev. 25, 33.
19781
COMMENTS – COMMENTAIRES
to reviewing the circumstances of the offer, must consider the aims
of the law and the interest it is designed to protect. The court must
consider whether the group of persons to whom the securities have
been offered is in need of the protection of the statute. Is the group
capable of taking care of itself as regards this investment and suffi-
ciently sophisticated to do without the statute’s protective wing? 51
Both tests should be used to determine the “public” served by
securities legislation.
D. The prospectus
The basic provision of every securities act requires companies
which intend to raise money from the public to publish a prospectus
containing the facts necessary to enable the potential investor to
consider the advisability of the investment and arrive at an “invest-
ment decision” concerning the offered securities. In Israel, the
details which must be included in the prospectus have been laid
down by regulation but are not exhaustive. 2 Section 17(a) of the
statute requires that:
An offeror who submits to the Authority a draft of a prospectus shall
notify the authority of everything likely to be important for a reasonable
investor who considers acquiring the securities offered …. 3
The Securities Authority may require the offeror to include in
the prospectus the additional material supplied under this section,
the broad language of which allows the Authority to decide which
It is
of the additional details will be included in the prospectus.’
difficult to understand why this requirement of including every fact
which may be important to the investor was not made obligatory
by the statute, instead of being left to the Authority’s discretion.5
However, section 20 of the Securities Law contains an important
general provision: “Everything mentioned in the prospectus shall
be faithfully presented and the prospectus shall contain no mislead-
ing particular.” Contravention of this section creates both civil and
51 “The focus of inquiry should be on the need to the offerees for the pro-
tections afforded by registration”, S.E.C. v. Ralston Purina Co., supra, note
49, 127. “An offer can be made to a large class and not be public, and con-
versely to a small class and be public”, Central Bank & Trust Co. v. Robinson,
137 Colo. 409, 417, 326 P.2d. 82, 87 (1958). An offer of securities to institutional
investors was approved by the S.E.C. without a prospectus, Orrick, supra,
note 50, 33.
62 Securities Regulations (Details of Structure and Form of the Prospectus),
5729-1969. Securities Regulations (Preparation of Financial Reports), 5729-1969.
6 Securities Law [emphasis added].
5
4 Ibid., s.18.
r5South Africa Companies Act, No.61, 1973, s.148(1)(a): “Every pros-
498
McGILL LAW JOURNAL
[Vol. 24
criminal liabilities.56 Perhaps section 20 means that the duty of
disclosure is broader than that apparently required by the regula-
tions, since a “misleading particular” is defined in the statute to
include “a thing likely to mislead a reasonable investor and such
absence of a thing as is likely so to mislead”. 7 Thus a general obliga-
tion not to exclude from the prospectus any important fact the
absence of which is likely to mislead a reasonable investor would
seem to be created.
The duty of disclosure is not limited to information on the parent
company alone but relates to subsidiary companies, 8 affiliated
companies, 59 associated companies, 0 and significant affiliates.”‘
Great weight is attached to disclosure of the entire group. In the
past, companies hid certain of their activities behind affiliated
companies, hence the requirement of consolidated financial reports
for all subsidiary companies 62 together with balance sheets of all
associated companies.P
The legislator’s increased demands as to the contents of the
prospectus and the serious legal liability involved have, predictably,
prompted issuing companies to include vast amounts of substantial
matter in their prospectuses. Less predictably, the net result has
been that many important facts drown in this sea of information
and the prospectus becomes prolix and obscure. The average in-
vestor is incapable of digesting or interpreting all the facts and
figures. The Israeli experience is no exception; following enactment
of the law, prospectuses swelled in comparison with their former
sizes. It is clear that other means must be found to accomplish
what the disclosure provisions have failed to do.
pectus issued in terms of this Act shall contain a fair presentation of the
state of the affairs of the company, the shares of which are being offered
and shall state at least the matters specified in, and set out the reports
referred to in Schedule 3.”
56 Securities Law, ss.31, 53(a) (i).
57 Ibid., s.1.
58″ ‘Subsidiary’ means a company … in which fifty percent or more of
the nominal value of the issued share capital, or of the voting power, is held
by another company, or of which one half or more of the directors, or the
general manager, may be appointed by another company”, ibid.
59 Where the interest is 10%, ibid.
6oWhere the interest is 25%, Securities Regulations (preparation of finan-
cial reports), s.1 (hereinafter referred to as Financial Regulations).
61 Where 25% of its capital is invested in another company. Securities
Regulations (Particulars of the Prospectus), 1969, s.1.
62 Financial Regulations, s.48.
83Ibid., s.61.
19781
COMMENTS – COMMENTAIRES
V. Continuous supervision over corporate business activities
A. Periodical reports
The capital market consists of two closely related components,
the primary market for new capital and the secondary market for
the re-sale and the continuous trading of securities. Because public
confidence must be directed to both, thorough reporting on both
is essential. The Israel Securities Law, faithful to the principle of
disclosure alone, treats the subject of the secondary market only
partially. The statute establishes a duty to furnish periodical
reports to the Securities Authority and to the Companies’ Registrar
providing details of corporate activities, benefits granted to inter-
ested parties during the past year, changes in stock holdings, and
a long line of additional details required by the regulations.” The
periodical report may thus be viewed as a minor, annual prospectus.
It is open to public perusal at the Companies’ Registrar office and
its importance lies in the continual stream of information which
it assures to shareholders.
B.
Immediate reports
In addition to these periodical reports, the company must
furnish immediate reports to the Companies’ Registrar, the Securi-
ties Authority, and to the Stock Exchange on particular events
which have taken place.6 5 The list of events which require the filing
of such reports is long, but the fundamental concept underlying
the requirement is to disclose to the public, with utmost speed,
information on important events which are likely to influence
trading in the company’s securities.
C. Investigations
The Securities Authority in Israel has not been empowered to
conduct investigations into corporate affairs, as is the Securities
and Exchange Commission in the United States,6 6 or the Ontario
Commission in Canada. 7 However, the Authority in Israel has re-
64 Securities Law, ch.6; Recurrent Reports and Securities Regulations
(Immediate and Periodical Reports), 5730-1970.
5 Securities Regulations (Immediate and Periodical Reports), 1970, ch.C.
66 Cf. Loss, supra, note 24, 1945 et seq. The U.S. Commission may conduct
investigations “to aid in the enforcement of the provisions of this title, in
the prescribing of rules and regulations thereunder, or in securing informa-
tion…”.
67 See The Securities Act, 1974, Bill 75, (1975), 4th Sess., 29th Leg.(Ont.).
Part V, s.11 states that “the Commission may, by order, appoint any person
McGILL LAW JOURNAL
[Vol. 24
cently assumed such powers indirectly. It summoned the directors
of The Israel Corporation to furnish certain details which would
enable the Authority to determine whether the corporate prospectus,
published some months before, should be revised. Whether the
Israeli Securities Authority should be given statutory investigatory
powers such as now exist in the United States and Canada, to
supplement its assumed powers, is still open to debate.
D. Insider trading
One of the main weaknesses of the Israeli Statute is the absence
of any proper treatment of insider trading. A company insider may
for his own advantage exploit information which he obtains as a
result of his position or in the course of his work. The company
itself may suffer no loss as a result, but such activity on the part
of directors would tend to undermine shareholder confidence. This
is not to suggest that directors and insiders be prohibited from
owning stock in their companies, -as the granting of stock options
and other opportunities to employees to acquire shares in the
corporation is a universally accepted practice. Nevertheless, it is
necessary that guidelines for permissible trading in these shares
be clearly delineated.
Under English common law, directors and employees are un-
authorized to profit personally from inside information which
reaches them as a result of their position in the company. The same
rules apply in Israel, but more are needed. The Israeli legislators
would do well to follow the recommendations of the Kimber Report
in Ontario:
… the law should clearly provide that the use by insiders, for their own
profit or advantage, of particular information known to them but not
available to the general public is wrong and that the law should give
appropriate remedies to those aggrieved by such misuse.Ps
to make such investigations as it deems expedient for the due administration
of this Act, and in the order shall determine and prescribe the scope of the
investigation.”
68Supra, note 3, para.2.03. This recommendation has been implemented in
s.113(1) of The Securities Act of Ontario (R.S.O. 1970, c.426):
“Every
insider of a corporation or associate or affiliate of such
insider, who, in connection with a transaction relating to the capital se-
curities of the corporation, makes use of any specific confidential information
for his own benefit or advantage that, if generally known, might reasonably
be expected to affect materially the value of such securities, is liable to
compensate any person or company as a result of such transaction, unless
such information was known or ought reasonably to have been known to
such person or company at the time of such transaction, and is also account-
19781
COMMENTS – COMMENTAIRES
1. The policy behind the rule
In the United States far-reaching doctrines of liability covering
the exploitation of information by corporate insiders have been
developed through rule 10b-5,’ 9 a regulation promulgated by the
Securities and Exchange Commission in 1943. Rule 10b-5 provides as
follows:
It shall be unlawful for any person, directly or indirectly, by the use of
any means or instrumentality of interstate commerce, or of the mails,
or of any facility of any national securities exchange:
(a) To employ any device, scheme or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state
a material fact necessary in order to make the statements made in
the light of the circumstances under which they were made, not
misleading, or,
(c) To engage in any act, practice, or course of business which operates
or would operate as a fraud or deceit upon any person, in connection
with the purchase or sale of any security.
This provision” expresses one of the basic purposes of securities
legislation, that of assuring maximum propriety in stock transac-
tions by making full information about material facts relating to
able to the corporation for any direct benefit or advantage received or re-
ceivable by such insider, associate or affiliate, as the case may be, as a
result of such transaction.”
The section has been somewhat altered by The Securities Act, 1978, Bill 7,
(1978), 2d Sess., 31st Leg.(Ont.).
“131(1) Every person or company who sells or purchases the securities
of a reporting issuer with knowledge of a material fact or material change
with respect to the reporting issuer that has not been generally disclosed
and every person who, directly or indirectly, knowingly informs the vendor or
purchaser of the material fact or material change other than in the necessary
course of business is liable to compensate the purchaser or vendor of the
securities for damages as a result of the trade unless,
(a) the person or company had reasonable grounds to believe that the
material fact or material change had been generally disclosed;
(b) the material fact or material change was known or ought reasonably
to have been known to the other party to the sale or purchase or
(c) the vendor, purchaser or informer, as the case may be, proves
that he did not make use of knowledge of the material fact or
material change in purchasing or selling the securities.-
.(3) Every person or company referred to in subsection I who is
also an insider of the reporting issuer, or who is an associate or affiliate of
such insider, is, in addition to the liability imposed by subsection 1, account-
able to the reporting issuer for any benefit or advantage received or re-
ceivable by the insider or associate or affiliate, as the case may be.”
69 17 C.F.R. 240.106-5 (1943).
‘0 See Bromberg, Securities Law: Fraud (1975), 22.6 for a discussion of the
accidental way in which this provision came about.
McGILL LAW JOURNAL
[Vol. 24
the corporation available to the investing public. The criminal
prohibition against exploitation of inside information for personal
advantage is a necessary extension to the policy of full disclosure
for two reasons: firstly, the insider’s privileged position allows him
direct or indirect access to sources of information designed for the
exclusive use of the corporation and not for anyone’s personal
advantage; secondly, one party to a transaction exploiting inside
information to which he knows the other party has no access is
inherently improper.71
In addition to the criminal liability, established by rule 10b-5,
civil liability was gradually imposed on the insider by American
courts, and an obligation was developed to restore to the company
profits realized through exploitation of inside information which
had not been brought to the public’s attention or which had not
been sufficiently “digested” by it. Following the decision in Kardon
v. National Gypsum Co.,72 a series of cases crystallized the rule
allowing a civil wrong –
to be based on
the criminal provisions of the securities laws. Since these provisions
were designed to protect the investing public, the courts deemed
it only proper to provide civil remedies to the public which had
been adversely affected.
a tort derived from a crime –
The duty of disclosure is addressed to “material facts”,173 a con-
cept broadened by the courts over the years. It was held in S.E.C.
v. Texas Gulf Sulphur Co.74 that materiality must be examined from
the point of view of the reasonable investor at the time that he is
considering whether to buy, sell or continue to hold the securities
in his possession.75
The breach of this duty involves failure to disclose the details
of the inside information to both the company and the third party,
and confers a cause of action on the company and on any person
damaged. While the remedies available to a private claimant relying
on the rule include indemnification for the actual damage caused
as a result of the non-disclosure as well as equitable relief, punitive
damages are not available. The importance of the relief lies not in
71 1n re Cady, Roberts & Co., 40 S.E.C. 907 (1961).
7269 F.Supp. 512 (E.D.Pa 1946).
73 Kohler v. Kohler Co., 319 F.2d. 634 (7th Cir. 1963).
74401 F.2d 833 (2d. Cir. 1968).
75 Ibid. See also List v. Fashion Park, 340 F.2d 457 (2d Cir. 1965); S.E.C. v.
Great American Industries Inc. 359 U.S. 920 (1969), 407 F.2d 453, 459 et seq.
(2d Cir. 1968), cert. denied 395 U.S. 920 (1969).
19781
COMMENTS – COMMENTAIRES
the grant of damages to the injured party, but in depriving the
defendant of profits so as to prevent his unjust enrichment.76
2. The Israeli approach
Neither in the Companies Ordinance7 nor in the Securities Law
did the Israeli legislator address himself specifically to the question
of the exploitation of inside information, although the Yadin Com-
mittee Report emphasized the duty to disclose the directors and
main shareholders in both the prospectus and periodic reports.
The Report also dealt ‘with the interests in the company, 78 the
various means available to combat dangers inherent in insider
trading,” and specifically recommended the enactment of provisions
against insider fraud.80 One of the Committee’s main considerations
was that investment and trading in the stock market be under
clear, effective legislative and administrative control, in order to
reinforce public confidence, at home and abroad, in Israel’s stock
market.8′ It was also recommended that, in addition to the punitive
provisions, the statute contain general provisions preventing acts
which contradict the spirit of the proposed regulation and which
might in some way mislead the investing public.82 Realizing the
importance of civil liability in protecting the investor, the Committee
recommended that the statute make explicit that all provisions
requiring disclosure or reporting are designed to protect the
investor, and that anyone damaged by breach of these requirements
might, in an action for breach of a statutory duty, demand com-
pensation from the party in breach3 Yet despite all these recom-
mendations, the statute contains no specific provisions on questions
of insider trading.
Is it possible, then, to bring an action against an insider who
has exploited inside information for his own advantage? As far as
directors and employees of the company are concerned, it would
appear that general principles of fiduciary law, under both English
76 Loss, “The Rationale of Rule 10(b)5”, Second Annual Institute on Se-
curities Regulations (1971), 11.
77 Ordinance No.18 of 1929.
IB Report of the Committee on the Securities Market in Israel (1963), chs
68, 71, 123, 126, 128.
79 Ibid., ch.5, pars 207-14.
80 Ibid., ch.6, para 207-14.
81 Ibid., para.11.
8 Ibid., para207.
83 Ibid., para214. The Committee further recommended enactment of a
provision which would make “any breach of the general provisions against
McGILL LAW JOURNAL
[Vol. 24
and Israeli law, may be applied to enforce restoration to the com-
pany of profits realized as a result of use of inside information.
But this remedy is available to the company and not to a third party.
It is likewise limited to directors84 and employees,” and does not
apply to other insiders.
3. New trends in insider trading
The British government was recently forced by the pressure of
public opinion to agree to make insider dealing a criminal offence.
A White Paper of 1973 stated that, “[t~he object of legislation on
insider dealing must be to ensure that anyone who is in possession
of information which would be likely, if generally known, to have
a material effect on the price of the relevant securities, refrains
from dealing until the material information has properly been made
generally available”.86 Thus, The Companies Bill, 19738 7 of Great
Britain covers various aspects of insider trading. For example, section
12(1) states that:
Subject to section 14 below, a person who is, or at any time in the pre-
ceding six months has been, connected within the meaning of this section
with a company shall not deal in any securities of that company if he is
in possession of information which is not generally available but, if it
were, would be likely materially to affect the price of those securities.
This Bill has, however, not yet been enacted in-to law. Similarly
in Israel, a law proposed in 1971 that would make it a criminal
offence to exploit inside information, was not enacted. 8 The South
African Companies Act, 1973, s9 and the Ontario Securities Bill of
fraud carry with it civil liability to pay damages to the extent that monetary
damage was caused”.
v. Phipps (1967) A.C. 45 (H.L.).
84 Regal (Hastings) Ltd. v. Gulliver [1942] 1 All E.R. 378 (H.L.); Boardman
85 Reading v. Attorney General (1951) A.C. 507 (H.L.).
86 Cmnd. 5391, (1973), 9, para.17. See also the Green Paper, supra, note 12,
pare.8.
87Bill 52, 1973, 4th Sess., 45th Par1. (U.K.).
88 Companies Ordinance (Amendment No.13) Bill, 5732-1971, H.H.936, 5732,
129. “A member of a board of Directors or a business manager of a company
who exploits information in his hands for his personal advantage or for the
advantage of a person other than the company shall be liable to one year’s
imprisonment of a fine of IL.20,000.”
89 See s233: “Every director, past director, officer or person who has
knowledge of any information concerning a transaction or proposed trans-
action of the company or of the affairs of the company which, if it becomes
publicly known, may be expected materially to affect the price of the shares
or debentures of the company and who deals in any way to his advantage,
directly or indirectly, in such shares or debentures while such information
1978]
COMMENTS – COMMENTAIRES
1974, 0 have more recently devoted greater attention to the problem.
In Germany, a Committee of Stock Exchange Experts was appointed
by the Federal Minister of National Economy in 1968. Its 1970
recommendations did not propose any new legislation, but instead
recommended that all companies whose stock is traded on a German
exchange ensure, through individual agreements with their directors
and employees, that the following rules are observed:
(1) Members of the executive board (Vorstand) and of the. super-
visory board (Aufsichtstrat) may not( at any time and in any way), to
their own profit or to the profit of third persons, engage in transactions
concerning shares quoted on the stock exchange and issued by their
company or an affiliated company, or offered to the public with a view
to having them listed on a stock exchange, by use of confidential in-
formation that may influence the valuation of such shares and that
came to their knowledge as a result of their position in the company.
(2) Information of this nature includes knowledge about important
changes in earnings or about important facts that may.influence changes
in earnings; changes in the dividend rate; measures for raising capital
or reducton of capital stock; planned mergers, transfers of assets, re-
organizations, takeover bids or dissolution of the company before official
announcements’
Similar agreements are to be entered into with other employees
who may have access to confidential information and, in addition,
the Committee recommended allowing a stock exchange to investi-
gate an inquiry by the company in question, into suspected illicit
insider trading.92
No formal legal remedy exists in the United Kingdom or in Israel
against directors who exploit inside information, save by virtue of
the common law. Securities Law or Companies Acts can no longer
be excused for ignoring this subject in both its civil and criminal
aspects. Given the intricacies of securities regulation and their some-
times unsuspected ramifications,
the American solution seems
preferable; existing common law and equitable remedies should be
allowed t 9 complement statutory remedies. There can be no doubt,
however, that the current legal situation in the United Kingdom
and in Israel, as in many other countries, is far from satisfactory
has not been publicly announced on a stock exchange or in a newspaper or
through the medium of the radio or television, shall be guilty of an offence.”
90The Securities Act, 1974, Bill 75, (1975), 4th Sess., 29th Leg.(Ont.).
OlSee
(1975) 30 The Business Lawyer 667 and Loss, Multinational Ap-
proaches to Corporate Insiders (1976), ch.9.
92See Zahn, Regulation of Insider Trading in the Federal Republic of
Germany (1974) 2 Int’l Bus.Law. 82; Bruns, Der Wertpapierhandel von
Insiders als Regelungsproblem (1973); Hopt and Will, Europaisches Insidern-
recht (1973).
McGILL LAW JOURNAL
[Vol. 24
and that specific, explicit statutory provisions must be enacted.
Israel is only starting to depart from the common law rules in
this complicated area of protecting investors. There is still much
to be done. However, the integrated disclosure system is a goal to
be pursued even if its complete refinement and efficiency cannot
be envisaged. 3 It will be interesting to see how Israel adapts its
common law heritage to changing policies in an extremely compli-
cated area of the law.
Professor Joseph Gross*
0, Compare with Emerson, “An Integrated Disclosure System for Ontario
Securities Legislation” in Ziegel, vol.2, supra, note 4, 400.
* Of the Faculty of Law, Tel-Aviv University.
