Several public watchdog organizations have sent a letter to the leaders of two congressional committees urging that Congress take action to shorten the 10-day filing period applicable to Schedule 13D. The long window applicable to Schedule 13D, which was originally adopted to promote transparency, is now, they contend, exploited by hedge fund activists to hide their share accumulations, “allowing them to reap outsize profits while ordinary investors are left in the cold.” 

As you know, Rule 13d-1 requires any person who, directly or indirectly, acquires beneficial ownership of more than 5% of any class of registered securities to file a Schedule 13D (or, in some cases, a 13G) with the SEC to report his or her holdings and intentions.  However, the holder has ten days to make the filing, practically enough time these days to do an IPO (ok, that’s a wild exaggeration, but you get my point). Congress and the SEC have accelerated the due dates for many types of corporate filings – Forms 4, 10-K, 10-Q, 8-K – but the timing for filing Schedule 13D remains, some would say, anachronistically untouched.

Now, as reported by the WSJ, several watchdog groups — Citizens for Responsibility and Ethics in Washington, Government Accountability Project and New Rules for Global Finance — have sent a letter to the chairs and ranking members of the Senate Committee on Banking, Housing and Urban Affairs and House Committee on Financial Services urging Congress to shrink the reporting window.  More specifically, they advocate reducing the reporting window from ten days to one, adopting a “cooling-off period” of two business days after filing of the initial Schedule 13D (during which acquirers would be prohibited from acquiring additional shares) and “modernizing”  the definition of “beneficial ownership” to preclude the use of stealth techniques and derivative instruments to acquire control and evade the reporting requirements.

The letter observes that lawyers and academics (and even a Republican senator) have long sought to convince the SEC to shorten the window, but to no avail. That may be due, in part, to a 2011 letter to the SEC, cited in the article, from several activists and other large holders, asserting that they need to retain the ability to increase their stakes without disclosure to maintain “market-driven incentives to address company underperformance” (presumably translated to mean avoiding reduced rates of return), particularly in light of company defenses such as poison pills (now also the target of many activists). In the absence of any regulatory action, the watchdog groups appeal to lawmakers to step in with a legislative solution.

What these groups hope will compel action by Congress is the increasingly prevalent hedge fund activist threat. The long filing window, they contend, creates a loophole that allows “activist investors to secretly buy large stakes in companies before initiating hostile take overs, depriving the market of material information and significantly disadvantaging ordinary investors.” Among other things, they cite in support of that claim another WSJ article that “documented that during this ten-day window, activist hedge funds are tipping each other off regarding their plans, while ordinary investors and targeted companies are left in the dark.” The analysis by the WSJ demonstrated that, in the “10 trading days before bullish activists revealed in regulatory filings that they had bought particular stocks, the stocks rose an average of 3.2% more than the overall market…. Similarly, an analysis of 43 announcements by bearish activists… found that in the preceding 10 trading days, shares of targeted companies fell by an average of 3.8% more than the market as a whole.” The hedge fund activist can then exploit these changes in share price. The practice of tipping other investors, the article charges, “is part of the playbook. Activists, who push for broad changes at companies or try to move prices with their arguments, sometimes provide word of their campaigns to a favored few fellow investors days or weeks before they announce a big trade, which typically jolts the stock higher or lower. In doing so, they build alliances for their planned campaigns at the target companies. Those tipped—now able to position their portfolios for price moves that often follow activist investors’ disclosures—benefit in a way that ordinary stockholders who are still in the dark don’t.”

As reported in this article, the watchdog groups may have some support from an unexpected venue: Chief Justice Leo Strine of the Delaware Supreme Court, who has recently argued, according to this article, that “investors crossing the 5% threshold should disclose their stakes in ‘real time,’ perhaps within as little as 24 hours. He also raised the possibility of lowering the disclosure threshold to 2%, saying changes to the rules would increase transparency in the markets. Mr. Strine said investors should be forced to report ownership of options and other derivatives, which aren’t counted under current rules but which can eventually be used for voting.”  In the same article, Michele Anderson, Chief of Corp Fin’s Office of Mergers and Acquisitions, was quoted as commenting that “tackling activist-disclosure issues is ‘like peeling an onion,’ where efforts to take on one issue simply reveal another. ‘Whatever we do end up doing will be very comprehensive,’ rather than just, for example, shortening the 10-day window, she said.”