Investors trading significant volumes of U.S. public equities face the prospect of new SEC reporting requirements for “large traders.” Investment managers and advisers to private funds, including hedge funds, are among the potentially covered entities. Compliance, legal and operations personnel at investment advisers will need to evaluate whether the new rules apply to their firms.

On July 26, 2011, the SEC adopted Rule 13h-1 under the Securities Exchange Act.1 The rule and its companion Form 13H introduce a reporting system for investors whose transactions in U.S.-listed stocks and options reach specified daily or monthly volume or market-value thresholds. These “large traders” must report to the SEC on new Form 13H and must self-identify to their broker-dealers. Broker-dealers will then maintain and provide to the SEC on request records of their large-trader clients’ transactions.

Rule 13h-1 and Form 13H are intended to give the SEC a new source of data about the impact of large traders on the public securities markets.2 In particular, the SEC may be expected to use these data to reconstruct trading activity following periods of unusual market volatility, such as the May 6, 2010 “flash crash.”3

The Form 13H reporting requirement for large traders takes effect on December 1, 2011.

WHO IS A “LARGE TRADER?”

Rule 13h-1 defines a “large trader” as a person that “directly or indirectly, including through other persons controlled by such person, exercises investment discretion over one or more accounts and effects transactions for the purchase or sale of any NMS security [i.e., a U.S.-listed stock or option]4 for or on behalf of such accounts, by or through one or more registered broker-dealers, in an aggregate amount equal to or greater than the identifying activity level” (emphasis added).5

“Identifying Activity Level”

A person becomes a larger trader when its aggregated trades in U.S.-listed stocks or options reach or exceed the “identifying activity level.” This threshold can be reached by a day’s or a month’s trading. The daily identifying activity level is total NMS security trades of at least two million shares or $20 million market value during one day. The monthly identifying activity level is total NMS security trades of at least 20 million shares or $200 million market value during a single calendar month.6 An investor that does not typically trade near these thresholds can become a large trader due to an uncharacteristic burst of trading on one day or over one month of the year.

Other than the limited exceptions listed in Rule 13h-1(a) (6), all transactions in U.S.-listed stocks or options, other than purchases or sales pursuant to exercises or assignments of option contracts, should be counted for purposes of determining whether a person is a large trader by volume or market value.7 Investors should gross up when calculating their activity levels; that is, offsetting or netting transactions among or within accounts, even for hedged positions, should be added to an investor’s activity level to show the full extent of its purchase and sale activity.

For U.S.-listed options, only purchases and sales of the options themselves, and not transactions in the underlying securities pursuant to exercises or assignments of the options, need to be included in the identifying activity level calculation. However, since Rule 13h-1 is intended to focus on the trading of options and the potential impact of option positions on the underlying markets, the volume and value of the options purchased or sold should be determined by reference to the equity securities underlying the options.

“Investment Discretion”

A person exercises investment discretion over an account if the person, directly or indirectly, “determines what securities or other property shall be purchased or sold by or for the account,” even if another person may also have responsibility for investment decisions.8 An investment adviser with investment discretion over the assets of the funds or accounts it manages would be the prospective reporting large trader, rather than the funds or accounts themselves.

“Control”

Control means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of securities, by contract, or otherwise.”9 In the Adopting Release, the SEC stated that “the definition of large trader is designed to focus on the ultimate parent company of an entity or entities that employ or otherwise control the individuals that exercise investment discretion.”10 Therefore, trades in U.S.-listed stocks and options by all controlled persons should be aggregated up to the parent level to determine if the daily or monthly identifying activity levels are tripped.

A person that, directly or indirectly, has the right to vote or sell 25% or more of a class of voting securities of an entity is presumed to control that entity. Similarly, a person that has contributed, or has the right to receive upon dissolution, 25% or more of an entity’s capital presumptively controls that entity.11 For investment advisers with a 25% or greater ownership interest in any subadvisers, this means the subadvisers’ trades (even if the subadvisers independently exercise investment discretion over their portfolios) should be counted for purposes of determining the whether the daily or monthly identifying activity levels are crossed. The presumption of control means that a minority investor with at least 25% ownership in a large trader would be expected to either ensure the large trader’s compliance with Rule 13h-1 or register itself as a large trader.

An investor need not separately report as a large trader on Form 13H if a person controlling it or controlled by it reports on its behalf.12 This means that only one Form 13H needs to be submitted for the related entities that may advise a family of funds, even though the different advising entities may be separately identified on the form.

WHEN DOES A LARGE TRADER FILE FORM 13H?

Form 13H provides for various types of filings, each with its own deadline.13 Form 13H is filed via EDGAR.

Initial Filing

An investor must file an initial Form 13H with the SEC “promptly” upon reaching or exceeding the daily or monthly identifying activity level. The SEC has indicated that the “prompt” standard normally will be satisfied if the large trader files its initial Form 13H within 10 days after crossing the identifying activity level.14

Annual Filing

Following its initial Form 13H, a large trader must submit a Form 13H within 45 days after each calendar year-end.

Amended Filing

If any information on its most current Form 13H becomes inaccurate for any reason, a large trader must submit an amended filing “promptly” following the end of the calendar quarter in which the inaccuracy emerged. Amendments may be filed voluntarily more frequently than at quarter-end.

WHAT INFORMATION DOES A LARGE TRADER REPORT ON FORM 13H?

Form 13H is “designed to collect basic identifying information about large traders that will allow the [SEC] to understand the character and operations of the large trader.” This information relates to the businesses, trading strategies and affiliate relationships of, and the brokerage services used by, the large trader and its controlled group. More specifically, the data sought by Form 13H includes:

  • The type(s) of business in which the large trader engages. One option to check is “Investment Adviser to Hedge Funds or other Funds not registered under the Investment Company Act.”
  • A description of the operations, including a general description of trading strategies, of the large trader and its “securities affiliates” (affiliates that exercise investment discretion over U.S.-listed stocks and options). It appears that the general description of trading strategy can be quite brief; the Adopting Release gives the example “Investment adviser specializing in fundamental analysis.”
  • A list of other forms the large trader and its securities affiliates file with the SEC, including the name of each filing entity, the form(s) it files and its CIK number.
  • Whether the large trader or any of its affiliates is registered with the CFTC or regulated by a foreign regulator.
  • An organizational chart identifying the large trader, its parent (if applicable), and all securities affiliates and CFTC-registered affiliates.15 The large trader must describe each identified entity’s business and the relationship among the identified entities.
  • What type of entity the large trader is (e.g., limited partnership, LLC or corporation).
  • If the large trader is a partnership or limited partnership, the identity of its general partner and each limited partner with a greater-than-10% financial interest in the large trader’s accounts.
  • If the large trader is a corporation or trust, the identity of each of its executive officers, directors or trustees.
  • The jurisdiction in which the large trader is organized.
  • A list of broker-dealers at which the large trader or any of its securities affiliates has an account. The role of each identified broker dealer must be specified, i.e., prime broker, execution broker or clearing broker.

Upon the SEC’s request, a large trader must promptly provide additional information to allow the SEC to further identify the large trader and all accounts through which it trades.

IS IT POSSIBLE TO EXIT THE LARGE TRADER REPORTING SYSTEM?

If a large trader that has filed Form 13H subsequently goes a full calendar year without effecting aggregate transactions equal to or greater than the daily or monthly identifying activity level, it may file a Form 13H to claim “Inactive Status.” Inactive Status is effective upon filing and relieves an investor from having to submit future annual or amended Forms 13H. An investor on Inactive Status that re-crosses the daily or monthly identifying activity level must re-enter the Form 13H reporting system by promptly filing for “Reactivated Status.”

A large trader that is dissolving, ceasing operations or, in some cases, being acquired may make a “Termination Filing” on Form 13H. This permanently ends the large trader’s reporting obligations.

HOW DO THE LARGE TRADER’S BROKERS FIT IN?

Once a large trader submits an initial Form 13H, the SEC will issue it a large trader identification number, or LTID. The large trader must disclose its LTID to the registered broker-dealers effecting trades on its behalf, and must indicate each account at that broker-dealer to which the LTID applies.16 Registered broker-dealers then must maintain specified trade records for all accounts they carry for the large trader.17 Broker-dealers are required to update the trade records daily and submit them to the SEC upon request.

CONFIDENTIALITY

Section 13(h)(7) of the Exchange Act requires the SEC to keep Form 13H filings confidential, except in response to inter-agency information requests or U.S. court orders. The Adopting Release confirms the SEC’s commitment to treating confidentially the Form 13H information it collects from large traders. In particular, Form 13H information should be exempt from Freedom of Information Act requests.18

EFFECTIVE AND COMPLIANCE DATES

Rule 13h-1 becomes effective on October 3, 2011. Large traders must file their initial Forms 13H beginning on December 1, 2011.