Our Debate on the Williams Act and Shareholder Activism: Takeaways for the SEC

Our Blog’s most recent Marketplace for Ideas series has considered whether the SEC should tighten its rules under the Williams Act, which now require that investors must disclose purchases of a 5% or greater stake in public companies within ten days of crossing the 5% level. This debate began in March 2011, when Wachtell, Lipton, Rosen and Katz first petitioned the SEC to reduce the disclosure window from ten days to one, and SEC Staff immediately signaled that they were indeed inclined to tighten the disclosure period. In response, Lucian Bebchuk and I filed a comment letter urging the SEC not to proceed with changes to these rules before undertaking a complete examination of the effects of these changes on investors. We later published an Article, The Law and Economics of Blockholder Disclosure, explaining that the proposed changes did not reflect mere mechanical changes needed to bring the Williams Act into line with modern markets but a policy choice about the optimal balance of power between incumbent directors and the investors that acquire large blocks of stock in public companies. Four Wachtell Lipton partners later published a paper responding to our claims and urging the SEC to adopt the Firm’s proposed changes to its blockholder disclosure rules.

Some two years later, the Wachtell Lipton petition remains untouched on the SEC’s regulatory agenda, and as our debate shows, the proposal remains highly controversial. My colleague John Coffee insists that faster disclosure is always to the good, even if disclosure deters blockholders from monitoring incumbent management. Moreover, as Martin Lipton has recently argued in these pages, allowing blockholders to impose pressure upon corporate insiders may be socially destructive. That proposition is hotly debated, though, both by academics and by those who, like Paul Hilal, argue that activist blockholders generally increase corporate value. And Columbia’s own Ron Gilson and Jeff Gordon have further complicated the picture by showing how activists can prompt other shareholders to focus on value-enhancing governance changes.

Where does this leave the SEC? Our debate offers three key lessons for the Commission and its Staff. First, it is clear by now that the proposed changes to the SEC’s rules are not merely “technical” regulatory adjustments required by changing market conditions. Instead, one’s view about the desirability of the proposal depends on fundamental policy choices that are best resolved by empirical study, and the SEC should pursue that analysis before adopting any changes to its rules. Second, rather than the proposed changes—which have little support in the existing empirical evidence—the SEC should focus on enforcing its existing rules under the Williams Act. In a recent paper, Lucian Bebchuk, Alon Brav, Wei Jiang and I show that investors frequently do not comply with the SEC’s current rules. Third, while more general changes to the rules on blockholder disclosure—for example, tightening the disclosure window but raising the ownership threshold— might be desirable, under current law the SEC lacks the authority to pursue such changes. If the SEC is convinced that revisions to the blockholder-disclosure regime are needed, it should ask Congress for the authority it needs to pursue defensible policy changes rather than undertake a rulemaking project with no empirical basis.

First, while the Wachtell Lipton petition characterized its proposals as necessary to close the “substantial gap[s]” that have arisen in the Williams Act’s disclosure regime in the forty years since the statute’s passage, as our debate shows the petition instead reflects policy intuitions about the benefits and costs of activist blockholders’ activities more generally. For one thing, the ten-day disclosure window is hardly a “gap” left open by incompetent draftsmen in Congress. Instead, the ten-day period reflects a careful compromise struck after Senator Williams introduced three different versions of his proposal and acknowledged on the floor of the Senate that blockholders “should not be discouraged, since they often serve a useful purpose by providing a check on entrenched but inefficient management.” The law allows blockholders to acquire additional shares for ten days without disclosing their stake in order to encourage them to accumulate the large blocks of stock that induce them to monitor corporate management closely.

Whether or not we should encourage blockholders to do this is an important policy question. To answer that question, though, the SEC should not rely on a general intuition that transparency is good, or the claim that the drafters of the Williams Act mistakenly left a giant loophole in the disclosure regime. Instead, the SEC should examine the benefits and costs of blockholder activity through review of the substantial body of empirical study in this area. When it does, it will find that the overwhelming majority of the evidence suggests that blockholders’ activities provide substantial benefits to public companies, and that imposing costs on blockholders may well harm shareholders. Because the courts have made clear that changes to the Commission’s rules must have benefits that exceed their costs, the SEC has little legal basis for adopting the proposed changes to its rules on blockholder disclosure.

Second, if the SEC is inclined to make changes in this area, it should tighten the enforcement of its existing rules before examining the proposed acceleration of the disclosure deadline. In a recent paper, Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy, my co-authors and I show that about 10% of the required filings under the Williams Act are made after the ten-day window has expired. As we explain in the paper, that estimate is actually a rather conservative one; depending upon how one interprets the SEC’s rules on how to calculate the ten-day period, as many as 20% of filings likely arrive late. The Williams Act gives the SEC broad authority to ensure that investors comply with its rules, but the Commission has rarely sanctioned the investors who flout the current ten-day window. Given that the evidence offers little support for the rulemaking project that Wachtell Lipton has requested, the SEC should focus on enforcing its existing disclosure regime.

Finally, it bears noting that there is no magic in the balance between blockholders and incumbent managers that Congress struck in 1968 by requiring disclosure of 5% blocks within ten days. It may be that changes to that balance are appropriate, either because Congress struck the wrong balance then or because a new balance is necessary now. For example, investors might benefit from raising the disclosure threshold—say, from 5% to 10%—but tightening the deadline. I suspect that many opponents of Wachtell Lipton’s proposed changes would be open to a more comprehensive reassessment of the rules that govern blockholder disclosure.

The problem is that the SEC does not have the power to pursue that approach. Instead, in the Dodd-Frank Act Congress gave the SEC power to consider only whether to shorten the disclosure deadline, leaving the ownership threshold fixed at 5% by statute. If the SEC is to alter the balance between corporate insiders and activist investors, it should have the tools it needs to strike that balance correctly. Rather than pursue the piecemeal tightening of the rules proposed in the Wachtell Lipton petition, the SEC should ask Congress for the authority it needs to ensure that any changes it makes in this area are beneficial for investors.

As our debate has made clear, the policy questions raised by Wachtell Lipton’s petition implicate fundamental matters of corporate governance. And the petition, along with the objections that have been raised to it, are currently before the SEC. We hope very much that our readers will share their thoughts on these questions in comments to our posts. And we hope that the SEC will carefully consider the arguments raised here before altering the balance between corporate insiders and activist investors.