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ISA approves general draft for implementation of Goshen Report


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In December 2006 the Goshen Committee completed its work and submitted its recommendations to the ISA. 
Given the process of globalization and the growing competition between financial markets, and as Israel is considered an emerging market, the Committee places great importance on setting proper corporate governance standards and rules that align themselves with standards adopted in leading western economies. The Committee believes that the best way to implement these principles is through the imposition of disclosure requirements on public companies. The approach is based on “adopt and disclose” principle. However, the Committee does not believe that requiring companies to explain why they did not adopt certain principles or rules will be particularly effective. Based on the nature of the disclosure and experience in other countries, these explanations, particularly when they are legally mandated do not contribute material information to the investor. At times, these explanations can serve as a smoke screen that to a certain extent undermine the intent of disclosure requirement.
Key recommendations of the Goshen Committee include:
1. Independence of the Board of Directors
In the Committee’s opinion, board of director independence is one of the cardinal principles of good corporate governance. In various countries that have adopted similar codes, various arrangements have been devised conforming to the characteristics of the capital market and cost/benefit considerations. The Committee believes that the issue of board independence necessitates a balance between objectivity, professionalism and risk-taking in corporate management. This balance is required because the board of directors plays a dual function which may collide at times: formulation of the company’s business policy; supervision of corporate management. While the first task requires a deep understanding of business and a close fiduciary relationship with corporate management, which facilitates the directors’ ability to advise and help mold corporate strategy, the second task requires objectivity and an arms-length relation with management. After examining accepted practices abroad and the characteristics of Israel’s capital market, it recommended that every public company shall have external directors who will constitute one third of all directors and their number shall not fall below two.
2. Composition and Role of the Internal Audit Committee
To compliment board of director independence the Committee recommends consolidating the independence of the internal audit committee of public companies. The Committee states that “in light of the auditing committee’s importance, and as a complimentary step insuring directors’ independence, great significance is attached to the independence of the auditing committee’s members and their financial qualifications”. Hence, the Committee recommends that a majority of members of the audit committee be independent directors (including external directors) and the chairman of the committee will also be an external director. The Committee stipulates the duties of the audit committee in process of approving financial statements and recommends that audit committee hold preliminary discussions on the company’s financial statements and that its recommendations be brought before the board of directors. The board of directors is obligated to discuss the Committee’s recommendations prior to approving the financial statements.
3. Approval of Transactions with Related Parties
In Israel’s capital market, where most public companies are held by controlling shareholders, the centr  concern of misappropriation is in related party transactions, harboring conflicts of interest. Hence, the main protection extended to minority shareholders is – demand for a majority quorum, of shareholders bearing no interest in the transaction, for approval of corporate transactions with controlling shareholders in which conflicts of interest exists. The Committee recommends that until a specialized court for corporate and securities law is established, approval of corporate transactions with controlling shareholders in which conflicts of interest exist will require a majority of the quorum of shareholders bearing no interest in the transaction, as opposed to the one third threshold effective to date. The Committee believes that once the court is established, public companies will be able to approve related party transactions with a simple majority (without qualification of a majority of disinterested shareholders).
However, in cases in which a shareholder disputes the fairness of the transaction in court, the burden of proof will fall on the company. The costs of a trial will be paid by the company.
4. Establishment of a Court Specializing in Corporate and Securities Law
The Goshen Committee recommends establishing a court specializing in corporate and securities law. The Committee believes that the existence of a dedicated court will prevent exploitation and discrimination of minority shareholders and will constitute a key factor in enhancing the quality of public company management, developing the capital market and improving the economy. Empirical research demonstrates a clear correlation between the quality of investor protection, financial development and economic growth. Moreover, in the absence of a court empowered to prevent minority shareholder discrimination, the development of a market characterized by diffused ownership will not come to pass. Controlling shareholders will simply not have an incentive to sell control in the market, as long as they are able to “appropriate” benefits from the company at the minority shareholders’ expense. Only when the ability for misappropriation is restrained by a court, controlling shareholders will reach the conclusion that the dispersion of risk favors diffuse ownership or that the proceeds received from selling shares to the public justify the relinquishment of control.
As aforesaid the committee’s report the approach adopted by most countries is based on “adopt and disclose” principle. According to this approach, despite the fact that the adoption of the corporate governance code is not mandatory, the corporations are required to disclose whether they have adopted the code as part of their annual reports to the public. Where certain parts of the code weren’t adopted the corporation is required to provide an explanation as to why it chose not to adopt it. The committee recommends that the application of the corporate governance code shall be through disclosure requirements imposed on the companies as part of their reporting to the public. The aforesaid disclosure will be carried out according to the list in to the appendix attached to the committee’s report.
The plenum of the ISA had decided to adopt the committee’s recommendations and stipulated that a plan pertaining to the application of said recommendations shall be presented to the plenum after its
The guide lines approved by the ISA this week stipulate that the Securities Law shall include disclosure requirements generally pertaining to regulations stipulated under the company’s code andor by its organs, authorized to regulate corporate governance, in addition to the regulations stipulated under the Companies Law.
The guide lines are therefore as follows:
* The disclosure requirements will be part of the directors’ report; the company will be required to detail the regulations stipulated under the company’s code andor by its organs authorized to regulate corporate governance, accordingly, and which relate to corporate governance, that in addition to the regulations stipulated under the Companies Law, including specific reference to regulations that already exist under the Companies Law. For example, reference to whether the Chairman is also a CEO and whether the number of external directors is above the minimum stipulated under the law.
* Applicable corporate governance regulations shall be compiled under an appendix to the Companies Law titled “Recommended Corporate Governance Regulation for Public Companies in Israel”. Following the publication of the Recommendations in Reshumot (The Official Gazette), the disclosure regulations in the director’s report will be extended to obligate the companies to follow the principals provided under the aforesaid appendix.
The ISA and the Ministry of Justice had agreed upon the issues which will be regulated under legislation, inter alia – rules to be adopted by the balanceauditing committee regarding authorization of financial statements and submission of an audited directors’ statement as part of the authorization of financial statements in public companies. The aforesaid issues shall be presented under regulations of the Companies Law, which authorizes the Minister of Justice to provide regulations pertaining to authorization of financial reports of public companies, following his consultation with the Israel Securities Authority.
We would like to point out that the approach taken by the Goshen Committee and by the ISA is very similar to the approach taken by the European Forum for Corporate Governance, which stipulated that – were control in the company is not spread between various public parties it is recommended that external directors shall perform a singular function by approving company’s statements pertaining to appropriateness of its corporate governance.

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