The SEC’s planned modernization of beneficial ownership reporting requirements has sparked a variety of feedback, based at least in part on commenters’ stance regarding the value of activism versus the need for companies to have information so they can engage with investors building major stock positions.
The proposal is centered on Securities Exchange Act Sections 13(d) and 13(g). A key element involves proposed changes to Regulation 13D-G that would accelerate the filing deadlines for Schedule 13D beneficial ownership reports from 10 days to five days and require that amendments be filed within one business day.
The proposal attracted dozens of letters, with the comment period closing earlier this month. The SEC’s plan is widely seen as an effort to increase market transparency – with the potential impact of making it more difficult for activist investors to quietly build stakes in companies. As such, many commenters have provided feedback along traditional lines.
Opponents of the changes argue in part that they would curb activism and in doing so deny the benefits they believe activists bring by effecting positive change at poorly run companies.
For example, activist firm Elliott Investment Management is highly critical of the SEC’s plan. ‘[T]he commission proposes to expand the definition of beneficial ownership under Rule 13D in a way that also harms shareholder activism and would virtually shut down the ability of engaged shareholders to communicate with each other except at unreasonable legal peril,’ writes Richard Zabel, general counsel and chief legal officer with Elliott.
Zabel continues: ‘We are mystified as to why the commission, charged with the protection of investors and the promotion of efficiency, competition and capital formation, has proposed rules that would impair the ability of activists to spark healthy debate and create long-term value for all shareholders.
‘Although corporate managers, directors and advisory firms acting on their behalf have long agitated for changes such as the proposed rules, extensive empirical data demonstrates that the purported justifications of these views are flawed, and that the proposed rules would entrench the very managements and boards that have underperformed to the detriment of shareholders.’
The firm is also critical of the SEC’s proposed new Rule 10B-1, which would require any person (or group of people) who owns a security-based swap (SBS) position that exceeds a certain size to promptly file with the SEC a statement containing the information required by Schedule 10B. Elliott argues that proposed Rule 10B-1’s mandated next-day disclosure of cash-settled SBS transactions would ‘severely impair the ability of activist investors to catalyze positive change at companies.’
Separately, Alan Schwartz, professor of law at Yale Law School, and Steven Shavell, professor of law and economics at Harvard Law School, write: ‘The basic flaw in the SEC’s reasoning… is that [it] requires an activist buyer to disclose information the buyer has acquired, but the SEC fails to ask whether the buyer would acquire the information if it had to disclose pre-purchase. The answer is clear: the buyer would not.’
They describe a hypothetical example in which a potential buyer (B) considers spending $5 mn to determine whether target company (T) is worth acquiring because T might be inefficiently managed. ‘[I]f the SEC now imposes a five-day requirement that has the effect of faster disclosure by B to the market of its plans, B’s profits will be reduced because other buyers will learn what is going on and buy T’s stock before B has a chance to acquire much more of it at its present price,’ the academics write.
The result, according to Schwartz and Shavell, will be that activist B may be reluctant to investigate target T, meaning that if T is being poorly managed, B will not correct the situation. That would not lead to ‘desirable economic functioning’ and means T’s shareholders would not gain from a run-up of the company’s stock price, they state.
Managed Funds Association, which represents the alternative investment industry that includes hedge funds and private equity firms, writes: ‘If adopted in their current form, the commission’s proposed changes would hobble the free flow of information through the market by impeding ordinary, day-to-day communications between investors, including communications relating to corporate performance and operations.
‘They would also impair investors’ ability to engage with issuers and will ultimately harm companies, along with their shareholders and other stakeholders. The significant additional disclosure burdens the commission’s proposed changes would place on investors will impose impracticable costs, raise barriers to entry and, ultimately, inhibit capital-raising.’
NOT EVERYONE’S A CRITIC
The Society for Corporate Governance is among those that support the planned updates to the Schedule 13D and 13G rules. It notes that the existing Schedule 13D rules ‘are based on a reporting regime that dates back to the Williams Act of 1968 when stock transactions were tracked on paper and delivered by the postal service or couriers. Back then, investment managers didn’t have access to email, instant messaging, fax machines, market data terminals, computer-assisted trading technology or alternative ‘dark pool’ trading venues that help facilitate the accumulation of significant positions.’
The society believes the current 13D and 13G disclosure rules – particularly the 10-day disclosure period – are costly to both companies and investors generally, writes Ted Allen, vice president for policy and advocacy with the group. ‘The society’s support for modernization of the Schedule 13D and 13G reporting deadlines is premised on the fundamental concept that a public company must have timely information about its owners in order to engage with them effectively and respond promptly to their concerns,’ he states.
Allen adds: ‘Having timely data about activist positions and changes in a large investor’s ownership is critically important for public companies. Virtually every company will promptly seek to initiate engagement if it learns that an investment manager (whether active or passive) has acquired a 5 percent stake, so the company’s senior executives and directors can learn about that investor’s intentions and ideas for the company.
‘Whether or not a company welcomes an activist, its management teams and directors typically will listen and respond thoughtfully to its concerns. As hedge fund activists and their allies often argue, many activists have studied their target companies closely and have ideas that may be constructive.’
Nasdaq also sees benefits for issuers and investors in the proposal. Jeffrey Davis, senior vice president and senior deputy general counsel with the exchange, writes that companies would benefit from being able to identify large shareholders sooner and engage with them.
‘As stewards of shareholder capital, it is important for companies and their directors to have an open line of communication with all shareholders but, in particular, with large institutional shareholders,’ Davis states. ‘Engaging directly with such shareholders provides an opportunity to receive an unfettered view on the company’s governance and is an approach that requires an ongoing dialogue with shareholders designed to endure for the long term.’ He notes companies’ increasing pursuit of off-season engagement with investors.
The proposal would also benefit investors by giving them earlier access to market-moving information, such as the accumulation of a significant equity stake, Davis writes. Expediting disclosure of potential acquisitions of control and influence would give investors equal access to such material information when trading in securities at issue, he continues.
Meanwhile, the Council of Institutional Investors (CII) welcomes a measure in the proposed changes, Rule 13d-6(c), which spells out the circumstances under which two or more people may communicate and consult with one another and engage with a company without being treated as a group that must comply with beneficial ownership reporting obligations.
CII’s general counsel Jeff Mahoney writes: ‘This clarification is important to CII members, who often communicate with each other and with other shareholders regarding corporate governance issues at portfolio companies. In addition, CII members may collaborate with other shareholders to engage with board members and management at specific companies on issues of concern.’ These collaborations may involve engagement with individual companies on specific matters or may involve investor coalitions addressing topics on a broader scale, he notes.
CII also urges the SEC to clarify that the exemption from being subject to regulation as a group in proposed Rule 13d-6(c) is available to shareholders engaged in ‘vote no’ campaigns regarding individual board candidates in uncontested director elections.
The SEC by policy does not comment on comment letters.