A rulemaking petition has been submitted to the SEC by a biopharmaceutical company that is “developing and marketing regenerative and therapeutic biologics.” The petition requests that the SEC promulgate rules to establish a pilot program that would mandate “periodic public disclosure of short-sale positions in securities of biopharmaceutical companies by investment advisers.” Will the SEC take action on the request in the petition?
The essence of the company’s argument is that “the current dearth of reporting and disclosure of short positions” has led to an
“information vacuum [that] is manipulated by persons seeking to peddle inaccurate data and unfounded rumors (often unverifiable) in order to maximize their own financial gain at the expense of the investing public. Companies are often left defenseless in the face of well-orchestrated media ‘distort’ attacks. These practices are particularly damaging for biotech and life science companies—the favored prey of so-called ‘wolfpacks’ engaging in ‘short and distort’ schemes. These schemes often prove devastating to the company and its investors, and worse, deprive our society of potential advances in lifesaving technologies, resulting in costlier or fewer products and services for patients and consumers.”
What is a “wolf pack”? As discussed in this post from Columbia Law Professor John Coffee, a “wolf pack,” is “a loose association of hedge funds (and possibly some other activists) that carefully avoids acting as ‘group’ so that their collective ownership need not be disclosed on Schedule 13D when they collectively cross the 5% threshold.” Coffee observes that, for the past decade or so, wolf packs have often relied on “offensive” tactics (i.e., where the hedge fund purchases shares “specifically to challenge management”) that, in effect, seek to engineer stock price changes, such as through stock buybacks. One of the wolf pack tactics that Coffee identifies is the practice of “conscious parallelism.” As discussed in this PubCo post, citing a WSJ article, members of the pack often use the 10-day window prior to disclosure to tip their plans, profiting from the use of material nonpublic information. An 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.” However, Coffee observes, notwithstanding authority given to the SEC in Dodd-Frank to shorten the 13D filing period, the SEC has been reluctant to do so. (The reason, according to Coffee: the SEC “knows that to do so would expose it to outraged criticism from institutional investors and knee-jerk academics, who both believe that activists are doing the Lord’s work.”) Will the same reluctance perceived by Coffee lead the SEC to leave the petition languishing? (See this PubCo post.)
Specifically, the petition requests the SEC, under the authority of Sections 10 and 13(f) of the Exchange Act, “to set up a pilot program to require the periodic public disclosure of short-sale positions in securities of biopharmaceutical companies by investment advisers.” In the view of the company,
“the appropriate disclosure of short positions would:
- Require the periodic reporting by investment advisers of the name of biopharmaceutical company and the title, class, CUSIP number, aggregate amount of the number of short sales of each NMS security, and any additional information determined by the Commission;
- Require public disclosure of the reported information, including the investment adviser’s identity and the short-sale transaction and position information for…each NMS security of a biopharmaceutical company, on no more than a two-week delayed basis; and
- Address the disparity between long-position and short-position reporting requirements.”
In the petition, the company styles itself as the “poster child” of victims of market manipulation, having “endured various techniques and results of illegal short selling,” which it describes at some length. Briefly, however, the company contends that, in the previous 60 days, it “has come under a severe and coordinated short sell attack by numerous sources. This was prompted by publications from three organizations that we believe have been paid by persons involved in this coordinated and concerted attack, or are otherwise financially motivated to participate in the attack. Some of these persons are not easily located because there is no information on their principals or their location. As part of their strategy, these persons operate in the shadows, digging up numerous sources of data and attempting to turn that into negative information and innuendo on the Company.” According to the company, these attacks severely and artificially depressed its stock price.
The company considers its experience to be “common to companies in the biopharmaceutical industry.” Although the company recognizes that some forms of short selling can “contribute to efficient price formation, enhance liquidity, and facilitate risk management,” manipulative short sellers “engage in practices that are not calculated as part of a rational and legitimate hedging or market making strategy, and often attempt to illegally manipulate share prices for personal monetary gain.” For example, manipulative short sellers “use various strategies to distort markets for personal gain. For example, the ‘bear raid,’ or ‘short and distort,’ strategy involves selling a security short in an effort to drive down the security’s price by creating an imbalance of sell-side interest.” According to the petition, “the short selling done in the shadows has become out of control, and it is causing significant dislocations in the U.S. financial markets.”
In an argument that seems framed to appeal to the SEC Chair’s special interest, “Mr. & Ms. 401(k)” (see this PubCo post), the petition also argues that the “damage that it causes small investors is particularly outrageous. These individuals do not understand what is transpiring when one of their investments is under attack. The markets have become very unbalanced and unfair, particularly to the millions of small shareholders.” To address these issues, the petition urges the SEC to “end the current lack of transparency of short positions which enables trading behaviors that unfairly harm companies and their investors.”
In addition, the company contends that the concerns expressed in its petition are not new and that many others have expressed interest in mandatory disclosure of short positions, including, at various points, members of Congress, the SEC, two of the largest U.S. stock exchanges, and participants at the 2016 SEC Government-Business Forum on Small Business Capital Formation. The petition observes that the SEC’s Division of Economic and Risk Analysis has previously investigated the possibility of requiring real-time short position reporting, concluding that it was cost-prohibitive; the petition maintains that its petition does not request real-time reporting and, as a result, would impose “far lower reporting burdens.”
SEC Chair Jay Clayton has recently expressed interest in promoting transparency in the securities markets in other contexts, contending that “a thoughtful approach to transparency can enhance both governance and investor protection.” Time will tell whether the petition elicits any interest by the SEC or falls on deaf ears.