My Crypto Lawyer
Although better than the proposed rule,[1] the final beneficial ownership reporting rule continues to rest on flawed economics. Accordingly, I cannot support it.
The heart of the final rule is a shortening of the filing windows for Schedules 13D and G, which report an investor’s holding of large positions in a company’s shares. Although the original filing timelines are not necessarily the Platonic ideal, a decision to shorten the timeframes should be well justified. Here, a justification is lacking.
According to the Commission, shortening the 13D window will mitigate information asymmetries between everyday investors, on the one hand, and 13D filers and “informed bystanders,” on the other hand. By the Commission’s logic, narrowing the filing window should enable uninformed traders to share in profits created by the diligent efforts of more informed investors. But, absent a compelling reason, people who lawfully possess information should not have to hand that information over to their uninformed counterparties.
The Commission’s position ignores that disparities in information and perspective are central to the functioning of our markets.[2] Different people come to the market with different views of what a particular asset is worth and different levels of interest in buying or selling it. One person may desperately want to buy something that someone else is equally eager to sell. Hence, a market is made. The buyers and sellers generally do not have to explain their motivations. The prices speak for themselves.[3]
Of particular concern are rules that prevent someone who has worked hard to identify a mismanaged company and develop a strategy for improving it from getting adequately compensated for that work and the associated risk.[4] Indeed, the Commission acknowledges that “the initial information asymmetry between a prospective filer and the market is not a market failure because in its absence, the filer may not be sufficiently rewarded for the expenses of its efforts expended in information acquisition and in pursuing changes at the issuer, which often have market-level benefits.”[5] As one commenter explained, “permitting buyers to make a profit from their asymmetric information is often needed to induce them to invest effort to discover firms that are mismanaged.”[6]
Recognizing “that benefits may stem from the information asymmetry between a Schedule 13D filer and the market” and “that the information advantage of Schedule 13D filers results, in general, from their own expenditures . . . or efforts,” the adopting release emphasizes the informational advantages of so-called “informed bystanders.”[7] These informed bystanders are opportunistic traders who, observing the market, suspect that something is afoot or have become aware of the filer’s plans. The Commission worries that their consequent “informational advantage . . . over the selling shareholders in these transactions and the associated wealth transfers may be perceived by some market participants to be unfair.”[8] But it is unclear that we should give any weight to this concern. The release provides little evidence that informed bystanders are a large population.[9] Even if they were, they arguably contribute to price formation and market functioning.[10]
Economic principles have not changed since 1968, when the Williams Act, which forms the basis for the Section 13D mandate, became law.[11] The Commission points out that technology has changed and that those technological changes may enable investors to file their Schedules 13D faster[12] and accumulate “a large equity stake more quickly.”[13] However, as the Commission acknowledges, other technological[14] and legal[15] developments could increase costs for activists. Today, as a half-century ago when the Williams Act passed, the basic principle remains that people will not go to the trouble of identifying ways in which companies can improve unless they are rewarded for that work. And if investors pare back their monitoring of companies, other investors and the broader economy could suffer. The Commission’s economic analysis takes great pains to show that the changes will not impair activist investors that much, but in the process demonstrates that the rule will have substantial effects on how these investors proceed.[16] The result could be fewer potentially corporate value-enhancing campaigns.[17] This “modernization” effort might better be characterized as an insulation effort—insulating corporate managers from scrutiny.[18] Each campaign must be judged on its own merits, of course, and other reforms could be useful in ensuring that public company managers can respond to activists and present their side of the story to shareholders.
My concerns extend also to the 13G changes, which would shorten filing timelines for large investors with no control intent.[19] Shortening filing deadlines for investors who generally have no plans to effect a change in control lacks any economic rationale. Under the amendments, 13G filers will have to give up their intellectual property earlier than they do now and thus subject themselves to copycatting and frontrunning.[20] This cost to one group of investors is not outweighed by a corresponding benefit to other investors. As commenters noted, 13G information is not of immediate interest to market participants who are not trying to front run.[21] Amendments to reflect changes in the amount of holdings by 13G filers are particularly uninteresting.[22] Moreover, the costs of speedier filings for these investors, some of whom are small and not financial firms, are likely to be high.[23] Meeting the final rule’s timelines for filing amended 13Gs, although more reasonable than what was proposed, will nevertheless be costly and difficult.[24] The Commission pointed to a rationale for shortening the 13G initial filing window for passive investors: some investors improperly hide their control intent by filing a 13G instead of a 13D.[25] If this problem is real, why not address the errant filers’ violations directly by enforcing existing regulations governing 13G eligibility? Rather than dragging 13G filers along for the ride in a release that is focused on 13D filers, the Commission should have, as one commenter recommended, set aside this issue for study.[26]
Much of commenters’ attention was focused on aspects of the rule other than filing timetables; the proposal also included guidance about cash-settled derivatives and the definition of group. The adopting release also addresses these topics, albeit more practically than did the proposing release. The adopting release, however, continues to raise questions. For example, how clear is the analytical framework with respect to cash-settled derivative securities that the Release imports from the 2011 security-based swaps release? Does the group guidance inappropriately downplay the importance of an “agreement” in group formation?[27] Is the group guidance unnecessarily accommodating to activists whose objectives are not to increase the value of the company at issue, but to further a cause that is either neutral or detrimental to the value of the company?[28] It would have been easier to answer these questions had the Commission put this guidance out for proposal.
While I cannot support this rule, I am thankful to the Commission staff for their excellent and diligent work on this rulemaking. I particularly appreciated a number of lively, thought-provoking conversations about the rule. Among others, I want to thank Corey Klemmer in the Chair’s office, Valian Ashfar, Ted Yu, and Nick Panos in the Division of Corporation Finance, the Division of Economic and Risk Analysis, the Office of General Counsel, and others throughout the Commission.
[1] The final rule drops potentially unworkable regulatory changes to the “group” and “beneficial owner” definitions and lengthens the filing deadlines for Schedule 13D (“13D”) and Schedule 13G (“13G”). But the final rule narrows the 13D and 13G windows and includes ambiguous guidance about what constitutes a group and how cash-settled derivatives affect beneficial ownership.
[2] See, e.g., Letter from Council for Investor Rights and Corporate Accountability at 16, (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123223-279501.pdf (“A fundamental structural aspect of highly regulated U.S. capital markets is that uncoerced, willing sellers and willing buyers are permitted to trade at the time and price of their own choosing and without revealing their identity, actions, plans, proposals or transactions to their counterparties in advance. While significantly bounded by disclosure and prudential regulations, this remains an animating feature and a significant part of the basic structure of free markets. Willing sellers and willing buyers develop their own, independent views on value and when their views diverge, the fact of this divergence creates the conditions for trading to begin and for all market participants to receive the benefits of liquidity and efficient pricing over time.”).
[3] See Milton and Rose Friedman, Free to Choose, Chapter 1: The Power of the Market, Avon: New York, (1980), https://sites.oxy.edu/whitney/xaccess/ec101/friedman.html (“Prices facilitate “a simple exchange between two individuals . . . without central direction, without requiring people to speak to one another or to like one another, cooperat[ing] peacefully in one phase of their life while each one goesabout his own business in respect of everything else.”).
[4] Economic activist investors are distinct from other activists, who seek to redirect companies’ resources in service of non-corporate-value-maximizing purposes that do not inure to the benefit of other shareholders. Given the Commission’s investor protection mandate, our rules should not aid these kinds of activists.
[5] Release at n. 666. See also Lucian A. Bebchuk, The Myth that Insulating Boards Serves Long-Term Value (September 1, 2013). Columbia Law Review, Vol. 113, No. 6, pp. 1637-1694, October 2013, Harvard Law School John M. Olin Center Discussion Paper No. 755, https://ssrn.com/abstract=2248111 (“[T]he stock appreciation accompanying activists’ initial announcement reflects the market’s correct anticipation of the intervention’s effect, and the initial positive stock reaction is not reversed in the long term.”); Letter from Dodge & Cox at n.3 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123578-279808.pdf (“Multiple academic studies have found that active investment managers provide an overall benefit to markets by positively contributing to more efficient and more accurate price discovery.”) (citations omitted); Letter from T. Rowe Price at 6 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123410-279671.pdf (noting that T. Rowe Price, as a long-term investor, benefits from the “the presence of engaged investors incentivized to commit significant resources and time toward the goal of improving individual companies,” even though it only agrees “[a]bout half the time” with the activist investor).
[6] Letter from Alan Schwartz and Steven Shavell at 3 (May 18, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20129439-295568.pdf (emphasis omitted). As the commenter went on to explain, it is highly unusual to require buyers to disclose their motives for buying. Id. at 4 (“It has been the law in the United States for over two hundred years that an informed buyer who seeks to purchase a parcel of land, an antique, a small business, or whatever, is under no duty to disclose what makes that party want to make a purchase.) (citations omitted).
[7] See, e.g., Release at 50 (“[A]lthough the Proposing Release referred to information asymmetries between Schedule 13D filers and selling shareholders and expressed concern that those information asymmetries ‘could harm investors,’ we do not focus on the reduction of these asymmetries as a justification for shortening the initial Schedule 13D deadline . . . .”) (citing Proposing Release at 13850 & n. 19, 12881 & n.214). In adopting the rule, the Commission focuses instead on “information asymmetries between ‘informed bystanders’ and other, less-informed investors who sell their shares during the period after which an initial Schedule 13D filing obligation has been incurred but before the filing is made.” Release at 51 (footnote omitted).
[9] See, e.g., Letter from International Institute of Law and Finance at 4 (Jun. 27, 2023), https://www.sec.gov/comments/s7-32-10/s73210-212841-434943.pdf (“[T]here is no support in the DERA Memo for the assertion that purchasers other than the 13D filer are more informed than sellers during the relevant period.”); Letter from Elliott Investment Management L.P. at 12-13 (Jun. 27, 2023) (“Elliott 2”), https://www.sec.gov/comments/s7-06-22/s70622-214360-437103.pdf. (“DERA points to increases in trading volumes as potential evidence of ‘potentially informed trading.’ Of course, trading volumes could spike in the time preceding the filing of a Schedule 13D for any number of reasons (including other market participants correctly anticipating the identity of a soon-to-be subject of activism based on their own analysis, the soon-to-be subject of activism encountering its own adverse developments that increase focus on the stock, or trading activity triggered by quant or high-speed traders). DERA’s reliance upon vague allegations that ‘potentially informed trading’ may occur, without consideration of remedies already available to the Commission to restrict such activity, does not provide an adequate basis upon which to construct a cost-benefit analysis justifying any shortening of the Schedule 13D filing deadline.”).
[10] See, e.g., Letter from Edward P. Swanson, Glen M. Young, and Christopher G. Yust at 2-3 (Mar. 24, 2023), https://www.sec.gov/comments/s7-06-22/s70622-20161485-330270.pdf (“[H]edge funds and other activists improve stock price formation . . .Thus, disclosure requirements that reduce their ability to profit from price discovery may also harm market efficiency.”) (citation omitted); Letter from International Institute of Law and Finance at 10 (“As the DERA memo notes, academic literature in this area has not been able to identify any reductions in liquidity or changes in standard measures of ‘information asymmetry’ during these periods. In fact, the literature has found that measures of adverse selection are generally lower on these days, perhaps because activist investors use limit orders, and hence add to market liquidity.”) (citations omitted).
[11] The Williams Act added Section 13(d) to the Exchange Act, which is the basis for the disclosure regime at issue in today’s Release. Pub. L. 90-439, 82 Stat. 454 (July 29, 1968).
[12] See Release at 39 (citing “advancements in technology and developments in the financial markets that have occurred since that deadline was enacted in 1968” including “market professionals’ use of information technologies to compile the necessary data and prepare a filing, as well as their ability to submit filings electronically through the Commission’s Electronic Data Gathering, Analysis, and Retrieval (‘EDGAR’) system.”) (citations omitted).
[14] Release at 172 (“[W]e also recognize that accumulating significant ownership could instead be more difficult in the face of modern algorithmic and high-frequency trading, more sophisticated surveillance of equity trading and ownership by other traders, market participants, and issuers.”); see also Letter from Letter from Council for Investor Rights and Corporate Accountability at 10 (June 27, 2023), https://www.sec.gov/comments/s7-06-22/s70622-214101-436784.pdf (“Electronic trading and its attendant elements, such as dark pools, are also important market developments since the Williams Act’s passage but in no way justify truncating the filing deadline. These changes have not made it easier, faster or less expensive to build a stakehold in a target company. In fact, the developments have impeded the ability of activists to accumulate positions. In today’s marketplace, the danger of being front-run is far greater than it was in 1968. Systematic and algorithmic traders may pick up activists’ buying signals and drive up prices during the activists’ stake accumulation phase.”).
[15] See Release at n.679 (“Researchers have found that the increased use of low-threshold poison pills within the last decade or two could increase the difficulty of accumulating an equity stake beyond a certain size.”) (citations omitted); see also, e.g., Letter from Irenic Capital Management LP at 10 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123247-279520.pdf (“During the period since 1968, the majority of states have adopted antitakeover statutes that shield against unwanted changes in corporate control and that otherwise help to entrench management. State takeover statutes, in their various formulations and numerous varieties, have had their intended effect of making takeovers by outside blockholders more difficult. Further, the advent of the poison pill effected a seismic shift in the balance of power between corporations and shareholders seeking to acquire large blocks of securities, as the Proposing Release recognizes. . . . [U]sing publicly available information, issuers are able to preempt the filing of an initial Schedule 13D with the adoption of a poison pill and prevent additional share accumulations within Rule 13d-1(a)’s ten-day filing window.”) (citations omitted); Letter from Prof. Jeffrey Gordon at 3 (June 20, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20132543-303070.pdf (“Since the 1968 legislation, private ordering as permitted under state law has engendered the ‘poison pill,’ possessed in shadow form by all companies even if not formally adopted. This generally has limited activist accumulations (except in the rare case) to less than 10 percent.”).
[16] The Release’ analysis, based on activist campaigns between 2011 and 2021, showed the average aggregate increase in shareholder value across all campaigns combined was $12.6 billion. Release at 229, Table 6, Row 12 Columns 1 and 2. Further, the Release at 228 reports that “80 percent of campaigns . . . over the period from 2011 to 2021 would not have been affected by a five-business day filing deadline,” which indicates that a not insubstantial 20 percent would have to take a different approach under the new rule. The Release suggests that activists can respond by “(a) accumulating a smaller stake in the issuer’s shares; (b) accumulating shares more quickly; or (c) accumulating an economic stake using other instruments, such as cash-settled swaps or other derivatives.” Release at 229. However, as one commenter explained, operationalizing these suggestions is not so easy; “these ‘options’ would fundamentally alter how an activist assembles its exposure to a given company in ways that would impair the ability of an activist to pursue a particular campaign.” Letter from Elliott 2 at n. 59. See also Letter from Prof. Jeffrey Gordon at 3 (explaining the particular importance of the 10-day window in ensuring an economic return for identifying opportunities for improving the management of medium-cap and small-cap companies).
[17] Campaigns are not universally beneficial, but it is not clear that the rule changes we are adopting today will dissuade the bad campaigns and encourage the good ones. But see Zohar Goshen and Reilly Steel, Barbarians Inside the Gates: Raiders, Activists, and the Risk of Mistargeting, Yale Law Journal, 132 Yale L. J. 411 (2022), https://www.sec.gov/comments/s7-06-22/s70622-192399-382962.pdf (suggesting that raiders, not activists, are likely to improve corporate value).
[18] See, e.g., Letter from Managed Funds Association at 16 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123269-279539.pdf (“Accelerating the current ten-day timeline would thus encourage entrenchment of corporate management, weaken corporate accountability, and impede engaged investors from waging campaigns that generate value in numerous ways . . . .”); Letter from Irenic Capital Management LP at 7 (“The consequence of a reduction in the ability of engaged shareholders to acquire a sufficient ownership stake at an economically rational price may be fewer campaigns at issuers and, accordingly, less corporate innovation and more market stagnation.”); Letter from Swanson, Young, and Yust at 1 (Mar. 24, 2023), https://www.sec.gov/comments/s7-06-22/s70622-20161485-330270.pdf (describing their newly released study, which “find[s] strong evidence that activist interventions increase both short- and long-term shareholder value”).
[19] Both Rule 13d-1(b), which allows Qualified Institutional Investors (“QIIs”) to file a Form 13G in lieu of a 13D, and Rule 13d-1(c), providing for the same for passive investors, requires that filers have no purpose or effect “of changing or influencing the control of the issuer.” 17 CFR § 240.13d-1. However, Exempt Investors have no such constraint and are typically “founders of companies and early investors in an issuer’s class of equity securities who made their acquisition before the class was registered under Section 12 of the Exchange Act.” Release at 55.
[20] See, e.g., Letter from Dodge & Cox at 2 (speaking of 13D and G, noting: “Earlier and more frequent reporting means that proprietary information of even greater value would be taken from both activist and active managers and given to the marketplace, allowing free riders and predatory traders to profit from managers’ work product to the detriment of their clients.”); Letter from T. Rowe Price at 4 (“[T]he SEC does not address which investors stand to benefit from the release of that [13G] information, and why it would be appropriate for those investors to benefit rather than the 13G filer, which itself is an investor in the market equally deserving of SEC protection.” Also noting that “releasing information critical to understanding which investment positions are borne of our strongest convictions has an extremely high likelihood of facilitating free riding and front running behaviors, reducing a fund’s returns, and harming fund shareholders.”); Letter from Teachers Insurance and Annuity Association of America at 4-5 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123282-279548.pdf (“[W]e are concerned that shortening the deadline for Schedule 13G reporting from a yearly to a monthly basis could result in competitors attempting to copy or trade ahead of QIIs’ investment strategies and engage in other manipulative trading practices, to the detriment of advisers, funds, investors, and the market as a whole. . . . Ultimately, requiring investment advisers to disclose their beneficial frequently may put the value and potential performance of their proprietary investment strategies at risk.”); Letter from the Investment Company Institute at 12 (Apr. 7, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20122777-279139.pdf (“[P]articularly with respect to investments in small cap issuers, prematurely disclosing a position publicly risks increasing trading and portfolio management costs, to the detriment of investors.”). Only around 30% of 13G filers also report their ownership of securities on the Form 13F. See Release at 191, Table 4. This fact suggests that 13G filers may face high operational burdens.
[21] See, e.g., Letter from Managed Funds Association at 21 (“[Passive or QII] Schedule 13G filers have no intent to change or influence control of the issuer and are already subjected to significant disclosure requirements through the filing of Forms 13F. Thus, the information on Schedule 13G is less significant to the marketplace, and the need for disclosure less urgent, than in the Schedule 13D context.”); Letter from American Bar Association at 11 (Apr. 28, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20127577-288819.pdf (“Accelerating the filing deadline for Exempt Investors will provide no additional information to the market given that the vast majority of Exempt Investors become Exempt Investors following the effectiveness of a registration statement under the Act. Any such registration statement contains all of the information, if not more, that would be included in a Schedule 13G. Thus, this additional burden of an accelerated filing deadline for investors will yield no additional information being released to the market in the case of shareholders who become Exempt Investors as a result of a class of securities becoming registered under Section 12 of the Act.”).
[22] Letter from T. Rowe Price at 4 (“[T]he ‘value-relevant’ information in our 13G filings consists entirely of the fact that we have either accumulated or reduced a significant position. Nothing in the filing adds any material information about the company or the holdings of anyone seeking to control or influence management; the only relevant information is that we, as a QII, own a stake in the company . . . .”); Letter from Simpson Thacher & Bartlett LLP at 3 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-20123426-279682.pdf (“the Commission has not articulated how these additional filing obligations, whether for passive investors beneficially owning less than 10% of the registered class of equity security or for predominantly pre-IPO investors beneficially owning more than five percent of the registered class of equity security already required to be fully described in existing disclosure (i.e., the IPO prospectus) will promote transparency into matters of corporate control.”).
[23] Only around 30% of 13G filers also report their ownership of securities on the Form 13F. See Release at 191, Table 4. This fact suggests that 13G filers may face high operational burdens.
[24] See, e.g., Letter from Simpson Thacher and Bartlett LLP at 4 (“While there have been advances in technology since the rules were first adopted, the Proposed Rules ignore the practical limitations on preparing the required disclosures, as the calculation of beneficial ownership remains an extremely manual process, can involve significant judgment and relies on third party information. We are not aware of any current technology that would perform this analysis and prepare such reports in any reliable manner.”).
[25] See Release at 75 (“[R]esearch indicates that at least some beneficial owners may improperly rely on Rule 13d-1(c) to file a Schedule 13G in lieu of a Schedule 13D to obscure their control purpose. Given this increased likelihood, as compared to QIIs and Exempt Investors, of Passive Investors ultimately having a control purpose with respect to an issuer, we believe it is appropriate to shorten their initial Schedule 13G filing deadline to five business days in order for that deadline to continue to mirror the initial Schedule 13D filing deadline.”) (footnotes omitted).
[26] See, e.g., Letter from Simpson Thacher and Bartlett LLP at 6 (“If the Commission seeks to apply the accelerated initial filing requirements or more onerous amendment requirements to a broad set of investors whose activities are largely unrelated to matters of corporate control, or where such matters may be implicated but are already subject to disclosure requirements under the existing disclosure regime, we would recommend further study and analysis to better understand what percentage of such investors ever are implicated in actual change in control scenarios—to determine the percentage of activist matters where earlier and more frequent disclosure of such investors’ holding would have been materially beneficial to investors.”).
[27] See, e.g., Letter from Prof. Jeffrey Gordon at 5 (“Any ‘group’ concept that goes beyond ‘agreement,’ explicit or implicit, sets up a trap for the unwary and could chill legitimate activity.”); Letter from Elliott Investment Management L.P. at 4 (Apr. 11, 2022), https://www.sec.gov/comments/s7-06-22/s70622-279518.pdf (“The Commission[‘s proposal would establish] . . . a radical new regime in which ‘an agreement is not a necessary element of group formation.’ . . . By jettisoning the need to establish such an agreement, the Commission would create an entirely unbounded concept of group—one that would provide no guidance to market participants as to what behavior is, and is not, permitted. In essence, the Commission would define a group on the basis of ‘we’ll know it when we see it.’”).
[28] For example, the guidance clarifies that investors would not create a group if they had discussions about “a non-binding shareholder proposal, a joint engagement strategy (that is not control-related), or a ‘vote no’ campaign against individual directors in uncontested elections . . . ,” as including these activities in the definition of group could capture non-economic activist campaigns. Release at 133-134. Notably, the discussions at issue could be about proposals or campaigns that are binding in practice even while being technically non-binding. See, e.g., Testimony from Jonathan Berry to the Subcommittee on Capital Markets, House Committee on Financial Services at 18 (July 13, 2023), https://docs.house.gov/meetings/BA/BA16/20230713/116207/HHRG-118-BA16-Wstate-BerryJ-20230713.pdf (“Votes on shareholder proposals position proxy-process actors like ISS, Glass Lewis, and large asset managers to ultimately play their trump card: denying reelection to corporate directors. These actors pressure companies through whipping up support for the actual shareholder proposals themselves, but those are formally precatory and non-binding. The real pressure comes in voting against or withholding votes from directors who fail to follow the activists’ directions that are communicated via shareholder proposals. This forces individual directors to take a stand on those topics, or otherwise risk their careers.”).
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