One of Wall Street's heavy-hitting law firms is calling on the Securities and Exchange Commission to propose new rules that would make it harder for activist investors to remain in the shadows as they buy up large holdings of stock in companies. So far, the SEC appears to be listening.
Wachtell, Lipton, Rosen & Katz filed a petition in early March with the SEC, asking it to propose new rules that would shorten the reporting deadline for Schedule 13D, which requires investors to disclose beneficial ownership of more than 5 percent of publically traded shares. It also wants the definition of beneficial ownership expanded to include cash-settled swaps. The two measures are an attempt to keep activist investors from surprising companies with large ownership stakes just before major events, such as a shareholder vote on a merger or board elections.
“It has become both simple and commonplace for aggressive investors to intentionally structure their acquisition strategies to exploit the gaps created by the current reporting regime to their own short-term benefit and to the overall detriment of market transparency and investor confidence,” Wachtell Lipton said in the petition.
Current SEC rules require investors who acquire beneficial ownership (generally the voting rights or investment gains and losses that accompany a security) of more than 5 percent of a company's equity securities to file a Schedule 13D with the SEC within 10 days of purchase.
The Dodd-Frank Act includes a provision that lets the SEC shorten that 10-day window for filing a Schedule 13D and no longer requires filers to send copies to the issuer and to the stock exchange where the security is traded.
Wachtell's request to expand the definition of beneficial ownership stems from its concern that certain sections of Dodd-Frank, slated to become effective on July 16, could actually cancel out the existing rules on beneficial ownership and prevent them from applying to investors who buy or sell security-based swaps. If that happens, the thinking goes, hedge funds, corporate raiders, and other shareholder activists could use swaps to build up economic control over a company without anyone else knowing.
On March 17, the SEC proposed a rule to preserve the status quo of its beneficial ownership rules relating to security-based swaps. In the release, the Commission also noted that the SEC staff is working on a separate project to “modernize reporting” for Schedule 13Ds—a hint that the agency may indeed propose a shorter filing deadline.
The SEC staff will accept comments on the rule proposal through April 15.
“The staff is seeking comment on whether a definition of beneficial ownership more inclusive of derivatives is warranted,” says Peter Golden, partner at the law firm Fried, Frank, Harris, Shriver & Jacobson. “Accordingly, we should expect a continuation of the debate on how derivatives, including cash- settled swaps, should be treated.”
The release does not expressly address the 10-day window, but includes a generic invitation for comment on other ways in which the Schedule 13D rules might be amended, Golden says. ”Therefore, we probably should expect comments dealing with the appropriate filing deadline, as well,” he says.
Time for a Change?
“The 13D filing periods haven't been updated since they invented electricity,” says Gary Lutin, chairman of the Shareholder Forum. “It's one thing when you had a bunch of clerks writing things and then passing the slips of paper around for book entry, and then mailing it and it took 10 days to do a filing. It could certainly be accelerated to the shortest possible time period that's reasonable to report it.”
Shortening the reporting deadline "would significantly enhance the protection of investors by alerting them to potential changes in corporate control in a more timely manner.”
— Elizabeth Powers,
Partner,
Dewey & LeBoeuf
The marketplace also has a significant interest in the immediate disclosure of positions large enough to influence either corporate decisions or trading activity, says Lutin. “Rules need to allow a reasonable time for administrative processing, but you don't want to leave the market exposed to confusion for even one unnecessary day,” he says.
In its petition, Wachtell Lipton notes that lower reporting thresholds and shortened deadlines have been required for years in other developed financial markets, such as Britain, Germany, Australia, and Hong Kong. For example, Britain makes investors disclose within two trading days whenever they acquire more than 3 percent of an issuer's securities.
Wachtell suggests shortening the deadline to one business day. Shortening the reporting deadline "would significantly enhance the protection of investors by alerting them to potential changes in corporate control in a more timely manner and provding them with an opportunity to evaluate these potential changes, says Elizabeth Powers, partner at the law firm Dewey & LeBoeuf.
One crucial question is where institutional investors will come down on this debate, since they are not targets of activism nor usually activists themselves. Hedge funds and activists often argue that they generate value for this group, Golden says.
“The key to the policy debate is what the mutual funds and the other shareholders, who influence the proxy advisory services and presumably would have a bit more weight with the SEC, will say—rather than people who are saying either, ‘Help me fend off activists' or, ‘Help me make a lot of money by buying a bigger share in a company, before I have to become public,'” he says.
Quick Decisions
If the SEC were to shorten the filing deadline, corporations would then need to be prepared to evaluate situations very quickly. That could mean adopting new anti-takeover defenses, such as a poison pill (where companies try to make their stock less attractive to the acquirer), or engaging in transactions that increase the stock price rapidly, before an accumulator can rack up enough shares to achieve a controlling position, Golden says.
BENEFICIAL OWNERSHIP AMENDMENT
What follows is the amendment to Sec. 929R of the Dodd-Frank Act, “Beneficial Ownership and Short-Swing Profit Reporting”:
(a)BENEFICIAL OWNERSHIP REPORTING.—Section 13 of the Securities Exchange Act of 1934 (15 U.S. C. 78m) is amended—
(1)in subsection (d) (1)
(A)by inserting after “within ten days after such acquisition” the following: “or within such shorter time as the Commission may establish by rule”; and
(B)by striking “send to the issuer of the security at its principal executive office, by registered or certified mail, send to each exchange where the security is traded, and”;
(2)in subsection (d)(2)—
(A)by striking “in the statements to the issuer and the exchange, and”; (B) by striking “shall be transmitted to the issuer and the exchange and”;
(3)in subsection (g)(1), by striking “shall send to the issuer of the security and”; and
(4)in subsection (g)(2)—
(A)by striking “sent to the issuer and”; and
(B)by striking “shall be transmitted to the issuer and”.
Source: The Dodd-Frank Act.
In other words, general counsels, corporate secretaries, and other governance executives might want to game out various scenarios and brief their boards on how to respond quickly, should a new threat emerge quickly, thanks to faster filings of Schedule 13D, says Golden.
For example, if a company discovers a new activist in its shareholder base, it could invite that person to join the board. If that move doesn't seem sensible, the board could also try “defensive conduct,” such as adopting a traditional poison pill, “or they could re-focus their strategy to enhance value in a way that they think is preferable to the activist's agenda,”says Golden
Until the SEC does act, Golden offers companies a do-it-yourself alternative to an actual change in the filing requirement: the “window-closing pill.” He says companies should consider a shareholder rights plan (that is, a poison pill) that compels disclosure by acquirers of stock and derivative ownership in excess of 5 percent, and blocks acquisitions of stock until the disclosure is made,” according to a legal bulletin he wrote last month.
While this pill neither prevents an acquirer from buying more than a 5 percent voting or financial interest in a company, nor prevents purchasing shares pursuant to a tender offer, the market price of stock would probably go up thanks to the accelerated disclosure obligation. That achieves the goal of making it more expensive for the activist to keep buying shares.
“What I proposed was: forced disclosure, let the market absorb it, and then investors can continue accumulating—but at least it gives people an opportunity to assess what's going on, which presumably was the point of disclosure law in the first place,” Golden says.
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