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A Warning to the Public from the Israel Securities Authority on the Dangers of Unregulated Investments
There has recently been a spate of projects directed at the public through advertisements offering yield-bearing investments. Some of these offers are made on the Internet and via electronic communications and some by other marketing methods. This phenomenon would appear to be spreading against the background of a low interest rate environment that induces investors to seek out attractive investment channels and given the general public's access to the Internet and to information distributed on it that contribute to the increase in the phenomenon.
The ISA would like to warn and caution the public about the risks involved in unregulated investments. For this purpose, "unregulated investments" – investments in projects that have not published a prospectus approved by the Authority or investments through parties that have not been licensed by the Authority.
Any financial investment is known to involve risks by its nature. However, a cash investment in unregulated investments is subject to greater and more serious risks, which, if realized, may lead to the loss of all the money invested. Following are the main risks of which the public needs to be aware in connection with unregulated investments:
These activities may be illegal – As a rule, financial activities vis-à-vis the general public are supervised by one of the relevant regulators. Financial activities vis-à-vis the general public that are not subject to that supervision may be illegal. For example, the offer and sale of securities that is not subject to a prospectus is a breach of the Securities Law.
Financial instability – Many regulated bodies are bound by requirements aimed at preserving financial stability (for example, minimum capital requirements). In contrast, bodies whose operations are unregulated may be unstable, with investors being unaware of the fact, and this may result in obligations not being met.
Absence of due disclosure – The risk of losing the investment obviously also applies to regulated investments. However, the ability of the public to assess these risks and to forward plan is considerably greater in regulated investments. The requirement for a prospectus, for example, does not eliminate risk but provides comprehensive disclosure concerning an investment offered to the public, intended to allow the investing public to make educated investment decisions. The prospectus is examined by the Securities Authority and is subject to criminal, administrative and civil liability. After publication of the prospectus, the issuing company is bound by ongoing disclosure obligation as long as its securities are held by the public. These obligations are intended to give investors the ability to continue to make educated decisions concerning the securities it holds after the initial investment, and to asses, among other things, the value of their rights.
Absence of rules of good governance – Regulated bodies are subject to rules of conduct and various external audits. For example, the provisions of corporate governance apply to companies that have offered shares, dealing with, among other things, the appointment of external directors and the approval of interested parties transactions, and provisions apply to companies that have offered bonds, regarding the obligation to appoint a trustee, corporate governance provisions, and the rights of the holding public in connection with calling for immediate repayment of the debt. All these contribute to reducing the risks for the investing public.
Absence of controls and risk-reducing mechanisms – Regulated bodies are subject to a number of controls and mechanisms intended to reduce various risks in their operations. For example, money invested with a portfolio manager must be invested separately from his own money, and his transactions must be performed separately from those he is performing on his own account. Or for example, money invested in a trust fund is protected, among other ways, by having the fund's assets given to the trustee (and not to the fund manager). Unregulated investments may be operating without these controls and mechanisms.
Defrauding the public and fraudulent schemes – Unregulated operation may be a fertile ground for fraud and "Ponzi schemes" – capital fraud, in which investors are promised an especially high return on their investment in a short time period, with the funds to repay the investment, presented as its profits, actually coming from new-future investors. The Ponzi scheme eventually results in the loss of practically the entire investment. A fraud of this type and others is sometimes accompanied by the use of technological tools, innovative products, and complex financial terminology, intended to attract as large a number of investors as possible to invest their money, on the understanding that unsophisticated investors are inclined to be less wary due to lack of acquaintance with or lack of sufficient understanding of what they are being offered.
Exploitation of projects for criminal and/or other illegal purposes – Investment transactions made via the Internet give investors no way of knowing for certain who is behind the project, what the professional basis is for its operations, how strong it is financially, and how able it is to meet its obligations. Consequently, at a later stage it may be difficult to trace these parties in order to recoup the investment. Anonymity may be exploited for criminal purposes, including money laundering, financing illegal activities, and financing terror. The law enforcement authorities may sometimes stop the operation of a certain project if it is a fund that it is being used for illegal purposes, and thus prevent access to or use of the investing public's capital which may be held by the project.
In view of all the aforesaid, the ISA would like to stress the importance of investing through regulated parties, and the level of caution that should be exercised in transferring money to unregulated parties. The list of financial agents and regulated parties on the ISA's website can be used to ascertain if a certain party is regulated by the ISA.