The modernization of disclosure rules may see the US finally close in on global peers but Alexandra Cain finds there is still a shortfall in the era of Elon Musk's Twitter takeover
The SEC is consulting on a range of proposals designed to give issuers more timely information about who owns and is trading in their shares and related derivatives. While companies and commentators welcome the proposals’ sentiment, some argue the mooted provisions do not go far enough.
One of the proposals concerns section 13D of the Securities Exchange Act of 1934, which requires investors that secure 5 percent or more of a public company’s shares to disclose this information to the market through an SEC filing within 10 days of reaching the 5 percent benchmark. The proposal would reduce this to five days.
It’s worth noting that the US is the outlier globally with regards to the length of time investors have to disclose a material interest in a stock. In the UK and Australia, the equivalent is two days, in Hong Kong it’s three and in Germany it’s four.
‘The 10-day rule was made at least 50 years ago, in a time without the technological advances we have now, when trading was much slower than it is today,’ explains Holch & Erickson attorney Niels Holch, who has advised NIRI and the US’ Society for Corporate Governance on these issues.
He has also been directly involved in the SEC’s working groups on shareholder transparency. Holch supports the five-day rule, which would mean the market has information sooner when an investor is acquiring a large volume of stock.
NIRI’s outgoing president Gary LaBranche says the information asymmetry the existing rules facilitate when a party is building up a material interest in a stock behind the scenes is not fair to the remaining 95 percent of the owners in a company.
‘It means the activist investor has the opportunity to buy shares cheaply and then benefit from an increase in value of those shares,’ he points out. ‘This disenfranchises the vast majority of the shareholders.’
There are reasons companies want to see the rules modernized, says Ted Allen, vice president for policy and advocacy at the Society for Corporate Governance.
‘It will make it easier for the executive team to engage with existing investors and find out whether they agree with the hedge fund’s demands – such as a sale of part of the company, job cuts or large share buybacks. Often, the hedge fund will want the company to take action that may raise the share price in the short term, but may not be in the best long-term interest of the firm.’
The 10-day rule was made at least 50 years ago, in a time without the technological advances we have now
More relevant info sooner The SEC is also canvassing amendments to section 10b-1 of the Securities Exchange Act of 1934, which relates to cash-settled equity swaps investors buy through financial institutions. Swap holders achieve the same exposure to a stock as they would have as a shareholder, minus voting rights. ‘They still enjoy any share price increases and receive dividends. They receive most of the benefits of being a shareholder, without actually being a shareholder,’ says Holch.
Under existing rules, cash-settled equity swaps don’t count toward the 5 percent threshold under which investors must disclose their holding in a company. So activist investors such as hedge funds use these derivatives to get around these rules, giving them more time to accumulate shares before they need to go public. This also gives them discretion as to when they want to convert the swaps into shares and trigger the 5 percent threshold. By the time they go public, the fund may have already built up a 6.5 percent or 7 percent stake in the firm without the company being aware.
This rule hit the headlines when Tesla founder Elon Musk first acquired a large position in Twitter shares. It’s understood that although Musk had built up a 5 percent position in the stock by the middle of March, he was able to secure an almost 10 percent position in Twitter shares by buying cash-settled equity swaps, without the market being aware he was accumulating stock.
‘The loopholes in 13D have been used as an opportunity for hedge funds to collect an interest of more than 5 percent of stock in a way that can surprise the market and the company,’ says Holch.
‘So the SEC is proposing to have cash-settled equity swaps count toward the 5 percent limit. We also support this rule, which I think has a very good chance of being finalized, although we’re just at the proposed rule stage now.’
Should the proposed rules be approved, listed businesses will have information about hedge fund positions in their stock sooner. This will give issuers more time to prepare to engage with the shareholder building a material position in their stock and potentially understand the reason behind the move.
The loopholes in 13D have been used as an opportunity for hedge funds to collect an interest of more than 5 percent of stock in a way that can surprise the market and the company
More transparency over short-sales The SEC’s final proposal concerns amendments to section 13f-2 of the Securities Exchange Act of 1934, which relates to short-sales. At the moment, there is only limited disclosure of shorts to the market.
Currently, companies are able to get aggregated data through broker dealer associations such as the Securities Industry and Financial Markets Association so they at least know how many shares are being shorted in their stock. But they don’t know who holds the short positions.
The Dodd-Frank Act mandated that the SEC develop short-sale regulation, so short-sale positions are disclosed on a monthly basis once a certain threshold is reached. The proposed amendment to existing short-sale rules would see the SEC aggregate short-sale information about individual companies and the value of the shares that are being shorted and release this information to the market.
But Holch says the proposal doesn’t leave companies any better off because there’s no access to who is behind the short trades. ‘The SEC is going to have more information about large short positions, but unless it shares it with either the issuer or the market, it doesn’t improve the status quo,' he says.
'If the regulator doesn’t want to share this information with the marketplace, it could at least consider giving the issuer information about who is shorting its stock on a confidential basis.’
IR impact The US investor relations sector has broadly welcomed the SEC’s proposed changes. ‘The more investor relations professionals know about their shareholders, the better they are able to understand their points of view and respond to them in an appropriate way,’ says LaBranche.
‘It’s unfortunate when a company doesn’t know who its owners are, other than in very limited circumstances. It’s an old-fashioned way of doing business so we would like to see a much more flexible regime, wherein issuers would have the opportunity to know – and better engage– all their shareholders, or at least those that are open to building relationships.’
Patrick Davidson, senior vice president of IR at Oshkosh Corporation, says it’s advantageous if he knows who his shareholders are.
‘Of course, we want to communicate with all potential shareholders equitably and we support rule changes that make it easier and more expedient to understand our shareholder base,’ he notes. ‘There’s nothing wrong with traders buying or selling our stock. But we want to engage with investors that have a longer time horizon and are really more interested in participating in the capital formation of publicly traded companies.’
Davidson says Oshkosh is open to engaging with traders. ‘It’s helpful to understand their motivations,’ he explains. ‘I’ve been in investor relations for more than 20 years. I remember when hedge funds were very new and there weren’t that many of them.
‘Some companies took the position that they didn’t want to speak with hedge funds – but not me. Wherever you participate in the markets ecosystem, we’re willing to spend some time with you. But we may not be able to allocate as much time with traders that buy and sell quickly as we would with other long-term investors.’
If all three rules are finalized, it will help IROs do their jobs and give companies more visibility into who their investors are. It will also allow companies to keep tabs on activist investors entering their stock and ensure they are better able to respond to them. It’s impossible to tell what the final version of the rules will look like after the consultation process and redrafting of the new provisions. But there’s precedence for the SEC to bow to pressure from hedge funds and scale back the swaps rule.
There’s nothing wrong with traders buying or selling our stock. But we want to engage with investors that have a longer time horizon
‘There’s a proposal for funds with large swap positions to report their interest to the SEC within one business day,’ Allen explains. ‘This has been opposed by hedge funds and some pension funds, which argue it would not be possible to disclose within the time period.
‘There could also be modifications to the threshold that would trigger disclosure, and no guarantees this rule will be finalized.
‘Back in 2010, the SEC tried to update beneficial ownership rules to address swaps and derivatives. It abandoned its proposals after receiving a lot of opposition from hedge fund investors.’
The way ahead The IR community and its allies welcome the SEC’s proposed rule changes, but the markets regulator still has more work to do to bring US markets’ laws into the 21st century. LaBranche mentions other areas to which the market regulator should pay more attention as part of its process to modernize rules for current market circumstances.
‘After a decade of discussions and hearings, the SEC approved reforms to proxy adviser firms so companies could have access to their reports before they are sent to the proxy advisory firm’s clients,’ he points out.
‘This was so management could have the opportunity to comment and fix material errors. But the SEC rolled back the new rules before they went into effect. We thought that was unfortunate and we will continue to push against the rollback of what we feel are really reasonable and well-thought-out reforms.
‘The Biden administration and the current leadership of the SEC are clearly pursuing an activist agenda. It is very important that investor relations practitioners pay attention and keep up with the issues as they emerge, and as the rule making takes shape. Some aspects of the proposed rule changes are positive and some less so. So it’s incumbent on IR practitioners to pay attention, learn and be engaged in the rule-making process.’
The SEC will collect and collate comments during the consultation stage before releasing another draft of the proposed new rules and then release a subsequent final draft. This process could take a year or more.
