SEC Proposes Overhaul of Beneficial Ownership Reporting, including Accelerated Filing Deadlines, Changes to Group Rules and Treatment of Cash-Settled Derivatives
On February 10, 2022, the Securities and Exchange Commission (the “SEC”) announced its proposals to amend Regulation 13D-G and Regulation S-T to address, they said, information asymmetries in financial markets and to modernize the regulations under Section 13 of the Securities Exchange Act of 1934 (the “Exchange Act”) to account for technological and financial innovations. The amendments, if adopted in their proposed form, would represent some of the most significant changes to the beneficial ownership disclosure regime since the adoption of the Williams Act in 1968. The SEC’s proposed amendments would, as described in more detail below:
- Accelerate the filing deadlines for Schedules 13D and 13G;
- Clarify the way certain cash-settled derivatives are treated for beneficial ownership purposes;
- Clarify the way the SEC views group formation under Sections 13(d) and 13(g) of the Exchange Act; and
- Make technical changes to the electronic format of Schedules 13D and 13G and extend the filing time.
Accelerated Filing Deadlines
Currently, an investor who acquires beneficial ownership of over 5% of a public equity security with the purpose or effect of changing or influencing control of the issuer of such security is required to file its initial Schedule 13D within 10 calendar days of such acquisition (not counting federal holidays). Amendments, which must be made upon a material change in any item disclosed on Schedule 13D, currently have no set deadline, but must be filed “promptly” after such a change. The proposed amendment would shorten the period for the initial filing to five days, and set a deadline of one business day for the filing of amendments.
The amended regulations would also update Rules 13d-1(e), (f), and (g), which provide the timelines for conversion from a Schedule 13G to a Schedule 13D (which is required when an investor’s purpose changes from passively holding securities to influencing or changing control), to match the changes from 10 days to five and from “promptly” (often understood to mean two business days) to one business day.
The 10-day window of Rule 13d-1, which has been in place since the regulations were first enacted in 1968, has enabled activists and potential acquirors to increase their holdings once they cross the 5% threshold and establish a larger foothold in a target before their Schedule 13D is filed and the holdings are made public. The proposed amendments, narrowing this window, would give investors less time to grow their position before disclosing it.
Schedule 13G, the shorter and less onerous form of beneficial ownership reporting, is available for investors who acquire over 5% but are exempt from having to file the longer Schedule 13D. 13G filers can be (i) qualified institutional investors under Rule 13d-1(b); (ii) exempt investors under Rule 13d-1(d) ; or (iii) passive investors under Rule 13d-1(c) if they are simply passive holders holding less than 20% of the covered security.
The initial filing deadline for a Schedule 13G, reflecting the less intense disclosure required for these types of investors, is, for qualified institutional investors and exempt investors, currently 45 days after the end of a year in which, at the end of the year, such investor holds over 5% of the stock. Passive investors, meanwhile, have 10 calendar days after they exceed 5% to make their initial 13G filing.
The proposed amendments would dramatically shorten the time to make these filings for qualified institutional investors and exempt investors, giving them only five business days after the end of the month in which they own over 5% of the covered securities to file. Passive investors would now have five days after acquisition of the relevant securities to file their initial 13G.
Amendments to a filer’s 13G currently must be made 45 days after the year in which any change occurred, or, upon exceeding 10% ownership or upon 5% change in ownership, must be made “promptly”. The proposed amendments to the rule would shorten the 45-day period to five business days, but provide that an amendment would only need to be filed for a material change, which the current rules do not specify. For ownership changes over 10% or 5% swings, the proposed amendments would provide qualified institutional investors and exempt investors five business days to file an amended 13G, and one business day for passive investors.
The biggest changes here affect qualified institutional investors and exempt investors, who are used to the traditional mid-February deadline to update their 13Gs and who, under the proposed amendments, could face a meaningful additional disclosure burden for simply buying and selling in the public markets with no attempt to engage with the governance of the issuers of the securities.
Rule 13d-3 governs the calculation of beneficial ownership for the purposes of determining whether and when an investor crosses over the thresholds required to file a Schedule 13D or 13G. Generally, beneficial ownership means the direct or indirect power to determine the voting or disposition (sale) of a security. While straightforward enough when it comes to ownership of ordinary equity securities, beneficial ownership is less clear when an investor holds derivatives instead of the underlying reference security directly. Rule 13d-3(d)(1) currently clarifies by providing that an investor is deemed to beneficially own the underlying security if the derivative it holds gives the investor the right to acquire the underlying security within 60 days. An investor who holds a derivative is also treated as the beneficial owner of the underlying security if the derivative was acquired for the purpose or with the effect of changing or influencing control of the issuer. Cash-settled derivatives, which provide nothing more than economic exposure to the underlying security, traditionally have not been counted as contributing to beneficial ownership at all.
The SEC’s proposed amendments to Rule 13d-3 would add a new paragraph 13d-3(e) which would deem the holders of cash-settled derivatives (other than security-based swaps) who hold such derivatives with the purpose or effect of changing or influencing control of the issuer beneficial owners of the reference equity securities.
Alongside this change, the SEC is proposing to amend Item 6 of Schedule 13D to explicitly require disclosure of interests in all derivatives, including cash-settled derivatives, that use the issuer’s equity as reference security.
The SEC’s primary concern here is to prevent investors from using cash-settled derivatives to gain not only economic exposure to, but also economic power over, an issuer without having to disclose that power. Investors who pursue cash-settled derivatives as part of an activist strategy would, if these changes are made, potentially need to reconsider the role of derivatives in their approach.
Rule 13d-5(b) tells us that when two or more persons act together in their acquisition, sale or voting of an issuer’s securities, they become a group whose beneficial ownership constitutes the ownership of all members of the group, and who must, if the group collectively exceeds the relevant thresholds, jointly file a Schedule 13D or 13G.
The proposed new Rule 13d-5(b)(1)(ii) would require a person who shares non-public info about an upcoming Schedule 13D filing with another person who then buys the relevant securities based on that information to be deemed a “group”. The new (b)(1)(iii) would also specify that a group acquires the equity securities acquired by any member after the group is formed, and a new (b)(2) makes corresponding clarifications to the beneficial ownership of groups under Section 13(g).
Rule 13d-5(b)(1)(i) would also be revised to clarify that no express or implied agreement among group members is necessary for a group to be formed, which the current text of the rule does not make explicit. However, new exemptions would also be provided in Rule 13d-6: under the new (c), investors would be allowed, without triggering the formation of a group, to communicate or consult with each other or with the issuer as long as such communication does not have purpose or effect of changing or influencing control of the issuer, and under the new (d), investors and financial institutions would be able to enter into agreements relating to derivatives without fear that such agreements would deem the investor and the institution to belong to a group.
The establishment of clearer rules around group formation may bring into sharper focus questions about when and how to engage with other investors. If these changes are adopted, it will be more important than ever to consult with qualified counsel as early as possible in the process of building a position.
Technical Changes to Filings
The accelerated filing deadlines for Schedules 13D and 13G discussed above do, however, extend the cut-off time to make such filings, which is currently 5:30 p.m. Eastern Time, to 10:00 p.m., giving investors a few more hours to timely complete their electronic submissions.
Further, Schedules 13D and 13G (excluding exhibits) would be required to be filed using an XML-based language (like Forms 3, 4, 5 and 13F), rather than HTML or ASCII, as is currently required for Schedules 13D and 13G. Filers should familiarize themselves with the XML-based language and be ready to make the switch to stay abreast of the requirements to submit to EDGAR.
Investors in public markets should carefully consider the impact of these proposed amendments on their business and investment strategies.
The SEC is currently soliciting public comments on the proposed amendments, and the public comment period will remain open until at least April 11, 2022. As with any proposed rulemaking, it is difficult to predict whether the SEC’s proposals will be enacted, either in their proposed form or modified as a result of public comment. Kleinberg Kaplan will continue to monitor the situation and update as appropriate.