On July 10, the Securities and Exchange Commission (SEC) proposed a 35-fold increase – from $100 million to $3.5 billion – in the threshold for requiring institutional investment managers to publicly report their equity holdings on Form 13F.[1] This is a remarkable development at a time when issuers and large sectors of the market are demanding more, not less, transparency from investment managers, particularly activist hedge funds.
Section 13(f) of the Exchange Act was adopted by Congress in 1975 and requires an institutional investment manager to file a report with the SEC if it exercises investment discretion over accounts holding certain equity securities – referred to as “section 13(f) securities” – having an aggregate fair market value of at least $100 million.[2] SEC Rule 13f-1 and Form 13F, which implement Section 13(f), require that investment managers publicly file quarterly reports on Form 13F disclosing their ownership of 13(f) securities.
Form 13F reports offer public companies an important and practical way to identify and engage with many of their shareholders.[3] The reports are particularly useful for smaller issuers that may not be able to afford more costly stock-surveillance programs. Without the reports, issuers would be left to rely on Schedule 13D and 13G reports filed by beneficial owners of 5 percent or more of their stock. This, in turn, would limit issuers’ ability to track ownership changes or to verify how much of their stock is owned by investors who refuse to disclose their stakes – even after reaching out to issuers, requesting meetings with issuer management, or launching activist campaigns against issuers.[4]
Section 13(f) reporting is an important tool for issuers, though far from perfect. Form 13F offers only a snapshot of the investment manager’s holdings as of the end of each fiscal quarter, and by the time the filing is due 45 days later, the information will to some extent be stale. The report does not include short sales or most derivative positions, including swaps. In addition, certain managers often request confidential treatment of specific positions, and the current system effectively grants them de facto confidential treatment during the period — sometimes several months long — between application and a final determination on the request.[5] Rule 13f-1 reform is indeed needed,[6] but the SEC is now proposing to move in exactly the wrong direction.
Increasing the ownership threshold from $100 million to $3.5 billion would allow some of the most prolific activist hedge funds to cease filing Form 13F reports altogether. This group would include prominent names like Starboard Value, JANA Partners, Greenlight Capital, Engaged Capital, Land and Buildings, and Marcato, all of which reported less than $3.5 billion in value of section 13(f) securities in their latest Form 13F filings. Tellingly, out of FactSet’s SharkWatch 50 table of top activists, only 10 would be required to file Form 13F reports under the new 13F reporting threshold.
The SEC advances various arguments in support of increasing the 13F reporting threshold, none of which are particularly persuasive. These arguments fall into three general categories:
First, the SEC cites various statistics to make the point that the $100 million threshold is outdated and out of synch with the original goals of Section 13(f). The SEC notes, for example, that in the year 1975 approximately 300 persons would have been subject to the Rule 13f-1 reporting requirements, while the number today is 5,089. Relatedly, the market value of publicly traded equities has increased from $1.1 trillion to $35.6 trillion, which the SEC believes evidences a “decrease in the market significance of managing $100 million in securities as compared with the overall size of the market.” But such quantitative approaches simply ignore the realities of a modern market and media ecosystem that permits small, vocal participants to greatly increase their significance to public companies, including through a heavy reliance on derivative instruments that do not even count toward the Form 13F reporting threshold.
Unlike in 1975, activists with minimal “real” equity exposure can today threaten to launch credible campaigns against multi-billion dollar public companies. Given that change, further review of the data should confirm that retaining the $100 million reporting threshold is required to both (1) facilitate consideration of the influence of institutional investment managers on the securities markets at large and (2) increase investor confidence in the integrity of the U.S. securities markets – which the SEC acknowledges are two of the goals of the Section 13(f) disclosure program.
Second, the SEC exaggerates the costs of reporting on Form 13F. For example, the SEC estimates $15,000 to $30,000 annually in such costs for “smaller managers,” an estimate that seems inflated given the limited information required and the fact that Form 13F filings are typically managed in-house by existing compliance departments.[7] Even more questionable is the SEC’s argument that speculative front-running and copycatting by competitors are “indirect costs” that help justify raising the 13F reporting threshold; this sets a troubling precedent for efforts to reform Schedule 13D or provide more transparency to investors. And the SEC’s claim that increasing the filing threshold will reduce staff costs in reviewing confidentiality requests is actually an argument for reforming the process of filing such requests, which is vulnerable to abuse.
Finally, the SEC argues that some of the data reported on Form 13F are available on, for example, schedules 13D and 13G, and Form N-PORT reports. As discussed above, schedules 13D and 13G only become applicable if a person acquires beneficial ownership of 5 percent or more of an issuer’s outstanding shares. Form N-PORT only applies to registered management investment companies, and such information is publicly available on a delayed basis.
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In her public statement opposing the proposed revisions to Rule 13f-1, Commissioner Allison Herren Lee notes that the proposal would eliminate access to information about discretionary accounts managed by more than 4,500 institutional investment managers representing approximately $2.3 trillion in assets.[8] And she gets to the crux of the problem with the SEC’s proposal when she notes that “[t]he costs of losing transparency are glossed over in brief narrative form and largely discounted.”
Given the facts, the best outcome would be for opposition to the proposed rule to attract enough support during the comment period to prevent its adoption. The SEC can then turn to other more pressing initiatives around Section 13(d) beneficial ownership reporting and revisit the NOBO/OBO rules to facilitate communications between issuers and their shareholders.
ENDNOTES
[1] Reporting Threshold for Institutional Asset Managers, Exchange Act Release No. 34-89290 (July 10, 2020), available at https://www.sec.gov/rules/proposed/2020/34-89290.pdf.
[2] “Section 13(f) securities” generally include U.S. exchange-traded stocks, shares of closed-end investment companies, shares of exchange-traded funds (ETFs), as well as certain convertible debt securities, equity options, and warrants. Conveniently, and relevant for assessing compliance costs, the SEC is required to publish a list of section 13(f) securities quarterly, which can be found online on the SEC website.
[3] See National Investor Relations Institute, The Case for 13F Reform (Sept. 25, 2019), available at https://www.niri.org/NIRI/media/NIRI/Advocacy/NIRI-Case-for-13F-Reform-2019-final.pdf; Ryan M. Carpenter, Providing Equal Investment Opportunity Via Securities Exchange Act Section 13(F), 46 Conn. L. Rev. 763, 772-73 (2013).
[4] It is not uncommon for activist investors to fall back on claims that they are a “top ten” or “page 1” holder. When an estimate is given, “right below 5%” (the Schedule 13D threshold) is a popular answer. Less vague approximations, though unusual, will likely mix real equity with derivative positions that only offer economic exposure.
[5] See Christian Bonser, If You Only Knew the Power of the Dark Side: An Analysis of the One-Sided Long Position Hedge Fund Public Disclosure Regime and a Call for Short Position Inclusion, 22 Fordham J. Corp. & Fin. L. 327, 365.
[6] For a constructive proposal made in conjunction by NYSE Euronext, the Society of Corporate Secretaries and Governance Professional, and the National Investor Relations Institute, see Petition for Rulemaking Under Section 13(f) of the Securities Exchange Act of 1934 (Feb. 1, 2013), available at: https://www.sec.gov/rules/petitions/2013/petn4-659.pdf. The proposal suggests changing the reporting period from 45 days to two business days after the end of the calendar quarter.
[7] In calculating such estimates the SEC includes, among other things, the costs of “developing and maintaining internal hardware and software systems to collect and analyze the information for submission” and use of internal compliance resources for advice on Form 13F filings. The image conjured by the SEC proposal of an internal compliance attorney, a senior programmer, and a compliance clerk all preparing a Form 13F report seems to overstate the complexity of a Form 13F filing. Further, most investment managers already as a matter of course maintain an electronic inventory of all their securities in order to comply with books and records requirements, such that generating a listing should not be problematic regardless of whether the Section 13(f) reporting threshold is $100 million or $3.5 billion.
[8] Commissioner Allison Herren Lee; “Statement on the Proposal to Substantially Reduce 13F Reporting” (July 10, 2020); available at https://www.sec.gov/news/public-statement/lee-13f-reporting-2020-07-10. Commissioner Lee also raises an intriguing argument related to the possibility that the commission simply lacks authority to raise the reporting threshold over $100 million based on the statutory text of Section 13(f). The argument seems supported by the September 2010 SEC Office of Inspector General’s final report detailing the results of its review of Section 13(f) reporting requirements; available at https://www.sec.gov/files/480.pdf (see Recommendation 10 and related management comments in Appendix V (“[t]he Division of Investment Management…should determine whether legislative changes to Section 13(f) of the Securities Exchange Act of 1934 should be sought, specially with respect to … increasing the Section 13(f) reporting threshold”(emphasis added)).
This post comes to us from Eduardo Gallardo, a partner in the New York office of Gibson Dunn & Crutcher, who specializes in mergers & acquisitions and corporate governance. The opinions in this piece are solely his and do not necessarily represent the views or opinions of Gibson Dunn or any other partner of the firm.