On March 17, 2016, Senators Jeff Merkley and Tammy Baldwin introduced the Brokaw Act (the “Act), legislation intended to overhaul disclosure rules governing the reporting of beneficial ownership in U.S. public companies. The proposal arose out of a concern that activist hedge funds inflate and capitalize on short-term profits at the expense of a corporation’s long-term financial health, as well as the best interests of its workers and surrounding communities.
However, rather than directly seeking to curb short-term activity sometimes promoted by activist investors (such as buybacks, dividends, and high debt-leveraging), the legislation attempts to make it more difficult for an investor to become an activist in the first place. That is, the proposal makes it more difficult for a person to accumulate a significant enough stake in a company to impact its governance.
Under the Act, the Securities and Exchange Commission (the “SEC”) would be directed to promulgate new rules pursuant to Section 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The new rules would decrease, from ten to two days, the time investors have to disclose a greater than five percent ownership stake in an equity security. Investors would also have to disclose short interests (the sale of borrowed shares) representing more than five percent of a class of equity security. Those who hold both long and short interests in the same security would be required to use the greater of their short or long interest as the basis for their beneficial ownership calculation, rather than simply disclosing their net position.
Also under the Act, the definition of “beneficial owner” would be expanded to cover any person with a “pecuniary or indirect pecuniary interest” in a security, thus broadening the disclosure requirement to certain owners of cash-settled derivatives. In addition, the definition of “person” would explicitly include hedge funds and groups of hedge funds that are, as determined by the SEC, working together to evade or assist others in evading the Exchange Act disclosure requirements. The Act doesn’t detail what criteria, other than the already established markers of group activity, would assist the SEC in making a determination as to concerted action.
Whatever its more attenuated effects, should the legislation pass, management and corporate defenders would be advantaged by quicker notice of investor attempts to quietly, and at a non-inflated price, accumulate significant minority stakes in their company. There is some debate, however, as to whether the Act would actually reduce short-termism given that activist investors are not the only ones to engage in short-term activity.
Some commentators suggest that the Brokaw Act’s effort to protect employees and larger communities only benefits entrenched management—a constituency that also may engage in short-term activity. Just as activist investors can promote short-termism, they argue, so too can they serve as a check on short-term behaviors by corporate management.