The SEC has missed a prime opportunity to revamp shareholder reporting rules and level the playing field for hostile takeover activity – at least in the eyes of some influential market participants. As part of its desire to modernize the beneficial ownership reporting structure, the SEC asked for comment letters on its proposal to update Section 13D of the Securities Exchange Act. Despite widespread concerns about the treatment of security-backed swaps and the 10-day disclosure rule, the SEC is broadly sticking with the status quo.
In March, and again on April 15, prominent law firm Wachtell, Lipton, Rosen & Katz proposed in its comment letters to the SEC that the current 10-day reporting deadline be shortened and the definition of beneficial ownership be expanded. “We believe that the current reporting regime fails to fulfil its stated purposes,” Wachtel lawyers wrote in the letter filed with the SEC on April 15. The law firm believes that investors, issuers and the market as a whole would benefit from such changes.
“There is no valid policy-based or pragmatic reason the purchases of significant ownership stakes in public companies should be permitted to hide their actions from other shareholders, the investment community and the issuer; indeed the need for transparency, fairness and equality of information in our financial markets has never been higher,” Wachtell reasoned.
“Changing the 10-day disclosure rule is part of the larger project that the SEC is undertaking to modernize the rules. Dodd-Frank has a provision that gives the SEC the authority to close the reporting window and it is on the slate. We propose that the period is changed to one-day. Our most recent comment letter reaffirms our call for a broader review of the shareholder disclosure system,” says Eric Robinson, Partner in the corporate practice at Wachtell.
This argument is not new. In fact, many different groups have raised concerns over the 43-year-old reporting rules, including the SEC. Michele Anderson, chief of the SEC’s Office of Mergers & Acquisitions, told MarketWatch that she has plans to recommend that the number of days activist investors have before they must publicly disclose they have a five per cent stake in the company be shortened. Existing timeframes for disclosure have been in place since 1968 as part of the Williams Act.
“The staff believes that period may be outdated, it has been in place for over 40 years now, and we have concerns that it may provide opportunities for investors to obtain a sizeable stake in the company before they are obliged to make any public disclosure,” Anderson said in February.
Investors are now able to execute trades in seconds and it is possible to prepare ownership reports in very short periods of time. Many investors can—and do— exploit the 10-day reporting gap to secretly acquire more stock in the company, hidden from the issuer and market at large.
Bruce Goldfarb, founder and CEO of Okapi Partners, a proxy solicitation firm, sees pros and cons on both sides. “I think it will mean activists will find that it is harder to quickly accumulate a position and for investors to build up an investment before there is additional market movement. Some investors purport this to be a real issue with activism. I think there is some truth to that.”
Some market participants complain that the lag in reporting requirements allows an investor to accumulate large voting interests before disclosure is made that would impact the price of the stock and that this is not fair.
“I think it will impact some investors in their interest and ability to rapidly accumulate shares at a price they believe to be good value. I agree with investors that say expediting the reporting timeframe will impact their ability to accumulate a large position. Without a value judgment of whether that is a good thing or a bad thing there is absolute truth that faster reporting will move markets. We have already seen that when people file a 13D. It has an effect depending on who the investor is and what position they are taking. So if you are accelerating that follow-on effect it is going to have an impact,” explains Goldfarb.
With changes to the director election process these reporting requirements can be of real and significant importance to directors. “I have empathy for companies that are trying to figure out who owns their shares. The process as it stands now does not help issuing companies or other investors to have an understanding of who the owners are of a company. If you are a director and trying to act in the best interest of shareholders yet you don’t always know who those holders are, it creates a serious conundrum.”
Changing the system is not without problems. Some investors feel that the current reporting regime is burdensome and compliance too time consuming. Even though trading platforms have accelerated and news is distributed faster, the 13D process hasn’t kept pace. It is, in the eyes of some investors, faster to accumulate the shares than it is to report exactly what holdings they have.
“I have empathy on both sides and I think that while the board may appreciate the changes, I don’t know how well received it will be by the investors community. Not just by activist funds but by traditional investment management firms that are heavily burdened sometimes by the reporting requirements,” cautions Goldfarb.
In an April 15 release the Commission left unchanged reporting requirements under 13D(c) for derivatives such as convertible instruments (that can result in accumulating a “stealth” voting position).
While the SEC made no change at this stage to security-backed swaps it is still considering shorting the disclosure window as part of a broader review of beneficial ownership disclosure.
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