Impending 13D Rule Changes

Lippert Heilshorn & Associates Inc., the well-known investor relations firm (LHA), has published the following interesting summary of the impending rule change to 13D reporting and shareholder buying (www.lhai.com).

Schedule 13D Rules

Large fund managers, activist investors and hedge funds are squaring off against some major corporations and their legal counsel over a proposal to significantly modify the Schedule 13D reporting requirements.  Currently, institutional investors must report to the SEC when they have reached a 5% or greater equity stake in a public company within 10 days of establishing the position.  The proposal sent to the SEC by the prominent law firm Wachtell, Lipton, Rosen & Katz recommends shortening that reporting period to one day, followed by a two-day cooling off before being able to buy more shares.

According to Wachtell, the current system allows “market manipulation and abusive tactics” as investors can buy far more than 5% before the public is aware of its intentions.  The firm cites the case of J.C. Penney, where two hedge funds amassed 27% of the company’s shares before filing a 13D.  Wachtell adds that investors who sell shares in the days prior to the 13D filing lose out on a potential profit, as share prices typically increase following the disclosure.

As expected, funds and activist investors see this as an attempt to unjustly protect underperforming corporate management and, according to a document they presented to the SEC, will “chill activity which helps give life to shareholder democracy.”  They contend that shortening the reporting period increases their cost of building a position; consequently, they would invest in fewer companies and fewer shareholders would receive the premium hedge funds pay.  Some of the nation’s largest money managers and pension funds joined together earlier this year in a meeting with the SEC to argue against the Wachtell proposal.

LHA’s position is that the SEC needs to consider what is best for all investors and the market, as well as look at its requirements for “transparency” as applied to issuers against its requirements of investors and other market participants.  We believe timely disclosure of accurate information leads to efficient markets.  Thus, a shortening of the window between accumulating and reporting a position is positive. On the other hand, a two-day cooling-off period makes no sense if the objective is an efficient market.  We also note that according to Factset Mergermetrics, there have been only two cases since 2008 where hedge funds have accumulated positions greater than 15%, one of which is the aforementioned J.C. Penney.  As one blogger wrote, the Wachtell proposal “may be a remedy in search of a problem.”

Finally, from our investor relations perspective, if information flow is made more efficient by earlier disclosure via a Schedule 13D, the same logic applies to shortening the Form 13F reporting rules, under which institutional investors currently report their holdings on a quarterly basis some 45 days after the quarter end.  Certainly the technology exists to drastically cut that timeframe, which would allow for better communication with current shareholders.