As 2021 comes to a close, Chair Gensler caps an ambitious inaugural year by proposing sweeping changes to the availability of Rule 10b5-1 trading plans.
On February 10, 2022, the SEC proposed changes to Regulations 13D-G and related rules under the Securities Exchange Act of 1934 (Exchange Act) that, if enacted, would modify the existing securityholder reporting and disclosure framework for securityholders that own greater than 5% of a publicly traded company’s Exchange Act Section 12 registered securities and their derivatives (covered securities) (i.e., SEC Schedule 13G and Schedule 13D filers). The amendments, if enacted, will require issuers, Schedule 13G and 13D filers, to modify their filing practices to comply with significantly shorter filing deadlines and a clarified Regulation 13D “group” definition, and to account for certain previously excluded cash-settled derivatives, which would likely increase the number of securityholders deemed to beneficially own greater than 5% or 10% of an issuer’s covered securities, thereby subjecting them to the Exchange Act’s Section 13 and Section 16 beneficial ownership reporting framework, respectively, and related short-swing trading limitations under Exchange Act Section 16(b). This alert provides an overview of the current filing requirements for initial and amended Schedules 13D and 13G, followed by an analysis of the SEC’s proposed rule amendments to those filing requirements as well as the effects on the filing requirements under Section 16 of the Exchange Act and their impact on existing compliance and disclosure practices.
Current Schedule 13D and 13G Filing Requirements
When a securityholder acquires greater than 5% of an issuer’s covered securities, the securityholder must disclose its beneficial ownership on either a Schedule 13D, or the short-form Schedule 13G (if the securityholder is deemed a “qualified institutional investor,” “exempt investor,” or “passive investor”). A securityholder’s initial Schedule 13D must be filed within ten calendar days of the date the that the securityholder became a greater than 5% beneficial owner. A Rule 13d-1(b) qualified institutional investor must file an initial Schedule 13G within forty-five calendar days after the calendar year in which the holder became a greater than 5% beneficial owner, or within ten calendar days after the end of the first month in which the person’s beneficial ownership exceeds 10%. A Rule 13d-1(d) exempt investor must file an initial Schedule 13G within forty-five calendar days of the end of the calendar year in which the person becomes a greater than 5% beneficial owner. A Rule 13d-1(c) passive investor must file an initial Schedule 13G within ten calendar days of its acquisition of more than 5% of an issuer’s covered securities.
Schedule 13D amendments are required to be filed “promptly” to report a material change to a previously filed Schedule, such as the acquisition or disposition of 1% or more of the reference equity security. “Promptly” has not been formally defined by the SEC but many practitioners have interpreted it to mean within one business day. Schedule 13G filers must file a Schedule 13G amendment within forty-five calendar days after the calendar year end to report any change in the previously disclosed information. However, qualified institutional investors must also file a Schedule 13G amendment within ten calendar days after the end of the first month in which their ownership is greater than 10% (computed as of the end of the month) and within ten calendar days of the end of any month in which the qualified institutional investor’s beneficial ownership increases or decreases more than 5% (computed as of the end of the month). Additionally, Rule 13d-1(c) passive investors must file a Schedule 13G amendment “promptly” upon the holder’s beneficial ownership becoming greater than 10%, and thereafter “promptly” upon the holder’s beneficial ownership increasing or decreasing more than 5%.
To determine whether a Schedule 13D or 13G filing is required, a securityholder must initially analyze their level of beneficial ownership according to the definition provided by Exchange Act Rule 13d-3. Under Rule 13d-3, a securityholder’s beneficial ownership percentage of a covered security is equal to the quotient of (i) the sum of all shares of the covered security that it, through any contract, arrangement, understanding, relationship, or otherwise, has or shares voting power or investment power, and the shares underlying derivative securities that it may convert to shares of the reference security within sixty days; divided by (ii) the sum of the total outstanding shares of the covered security and any shares underlying the derivative securities that the securityholder may convert to shares of the reference security within sixty days.
The type of derivatives held by a securityholder impacts the securityholder’s Rule 13d-3 beneficial ownership analysis. Currently, cash-settled derivatives are treated differently from derivatives settled “in-kind” for purposes of beneficial ownership reporting. Holders of derivatives settled “in-kind” are deemed the beneficial owners of the underlying securities. Similarly, a person who acquires a security or right “with the purpose or effect of changing or influencing the control of the issuer” is deemed the beneficial owner of the underlying securities, regardless of when the security or right is exercisable or convertible. In contrast, holders of cash-settled derivatives are generally not considered the beneficial owner of the reference equity security, as the derivative represents only an economic interest (i.e., the right to receive, or the power to direct the receipt of, dividends from, or the proceeds from, the sale of securities).
A securityholder’s beneficial ownership analysis is also impacted by the beneficial ownership of other securityholders that may be deemed members of a Regulation 13D “group” with the securityholder, because group members are deemed to beneficially own securities owned by other group members. Exchange Act Section Sections 13(d) and 13(g) and SEC rules, however, do not clearly define the term “group.” Generally, a Regulation 13D “group” is formed where two or more persons act together to acquire, hold, or dispose of securities of an issuer, although case law has clarified that fundamental to “group” analysis of whether a “group” exists is whether the persons’ actions are “combined in furtherance of a common objective,” and need not be memorialized in writing.
Proposed Rule Amendments
The proposed SEC rule amendments would shorten the filing deadline for initial Schedule 13D filings from ten calendar days to five calendar days and require that amendments be filed within one business day, the latter change effectively codifying a common interpretation of the “promptly” standard. The deadline for initial Schedule 13G filings would also shorten. For Rule 13d-1(c) passive investors, the initial Schedule 13G filing deadline would shorten from ten calendar days to five calendar days, and amendments to Schedule 13G reports would be required five business days after the month in which the amendment-triggering change occurred, rather than the required annual amendment by the forty-fifth day of each calendar year. Unlike the current rules, which require the filing of a Schedule 13G amendment to report any change in previously disclosed information, the proposed amendment to Rule 13d-2(b) would require the filing of Schedule 13G amendment only for a material change in the information previously reported on an initial or amended Schedule 13G.
The proposed amendments to Rule 13d-3 would expand the definition of “beneficial ownership.” Specifically, in adding new paragraph (e) to the rule, a holder of cash-settled derivatives, other than security-based swaps, would be deemed the beneficial owner of the reference equity securities when the derivatives are “held with the purpose or effect of changing or influencing the control of the issuer or the reference securities.” The addition of paragraph (e) to Rule 13d-3 would likely increase the number of securityholders that are deemed 5% and 10% beneficial owners, with a parallel increase to the number of securityholders with Schedule 13D and 13G reporting obligations, Exchange Act Section 16(a) disclosure obligations, Exchange Act Section 16(b) short-swing profit liability, and Exchange Act Section 16(c) short sale prohibitions.
Since cash-settled derivatives on securities that are not security-based swaps generally will not have a “one to one” relationship with the reference securities, proposed paragraph (e)(2) of Rule 13d-3 sets forth a beneficial ownership calculation method for derivatives covered by proposed paragraph (e)(1). Proposed paragraph (e)(2)(ii) defines “delta” as the ratio between (x) the change in the value of the derivative security and (y) the change in the value of the reference equity security. Under proposed paragraph (e)(2)(i), the holder of a cash-settled derivative would be deemed to own the number of equity securities equal to the greater of the product of the delta of the derivative security multiplied by (x) the number of securities by reference to which the amount payable under the derivative security is determined, or (y) the quotient of (a) the notional amount of the derivative security divided by (b) the most recent closing market price of the reference equity security. When applicable, both the delta calculation and the beneficial ownership calculation based on the closing market price must be performed on a daily basis. These amendments, if adopted, could have an impact on activist investors who seek to build stakes through cash-settled derivatives.
Proposed Rule 13d-3(e) would require that securities that are not outstanding, but that are referenced by the relevant cash-settled derivative security, be deemed outstanding for the purpose of calculating the holder’s beneficial ownership percentage, but that they not be deemed outstanding for the purpose of any other person’s beneficial ownership calculation. Additionally, holders of cash-settled derivatives would be deemed to beneficially own only long positions, not short positions. Furthermore, proposed Rule 13d-3(e) would not cover security-based swaps, as defined in Section 3(a)(68) of the Exchange Act and the rules and regulations thereunder, which are addressed in a separate proposed rulemaking.
The proposed rules would also clarify the circumstances under which two or more persons have formed a Regulation 13D “group” that is subject to beneficial ownership reporting obligations. The proposed rules would expand the definition of “group” to include two or more persons that have a “tipper-tippee” relationship in which a person shares non-public information about an upcoming Schedule 13D filing with another person who subsequently purchases the issuer’s securities based on that information. The proposed rules would also exempt from being construed as a “group” certain communications between persons that consult with one another, jointly engage issuers, and enter into certain transactions.
The proposed rules would also require that Schedules 13D and 13G be filed using a structured, machine-readable data language such as Inline XBRL, which is likely to require greater processing and formatting than the existing filing standard. Additionally, the proposed rules would extend the cut-off time for filing Schedules 13D and 13G from 5:30 PM ET to 10:00 PM ET on SEC working days, aligning the deadline with the existing Forms 3, 4, and 5 filing cut-off time.
Proposed Amendments Address Modernization and Perceived Inconsistencies
In the SEC Release for the proposed rule amendments shortening the deadlines for the various Schedule 13D and 13G filings, the SEC noted that modern securityholders and other filers have the capability to comply with shorter deadlines given advancements in technology, such as mandatory electronic filing on EDGAR (compared to paper delivery). By shortening the deadline, the SEC addresses perceived information asymmetries that could harm investors as well as shifts in expectations of timeliness in modern financial markets. The SEC acknowledged that the proposed rule changes may have a chilling effect on securityholders’ ability and incentive to effect changes at companies that may benefit all securityholders through change of control efforts, but that ultimately it did not believe the proposed rules would unduly disrupt that balance. Moreover, the SEC expressed its view that the shortened deadline is consistent with the purpose of Sections 13(d) and 13(g) as a means of requiring timely disclosure needed for informed investment decisions that ultimately contribute to the accurate valuation of securities.
In the SEC Release for the proposed rule amendments, the SEC also highlighted that proposed addition of paragraph (e) to Rule 13(d)-3 could give “investors, issuers and other market participants . . . greater transparency regarding persons with significant interests in an issuer’s equity securities and potential control intent.” Over the years, concerns have been raised regarding Rule 13d-3’s exclusion of cash-settled derivative securities from the definition of “beneficial ownership” because holders may have the economic power to influence or control the issuer or the reference securities. For example, a counterparty to a cash-settled derivative agreement may acquire reference securities to hedge the economic risk of the transaction or may vote or dispose of securities in a manner that entices the derivative holder to transact further with the counterparty. Parties could also enter arrangements separate from the derivative agreement that reserve shares of the reference security for the derivative holder, resulting in shares being impermissibly parked for the derivative holder but not recorded in the derivative holder’s beneficial ownership reports. Ultimately, some commenters are concerned that cash-settled derivative holders could influence counterparties to rapidly vote, sell, or accumulate reference securities in a manner that affects the stock price and control of the issuer.
Refocusing on Compliance Procedures
If adopted as proposed, the amended regulations would place increased responsiveness burdens on securityholders and personnel responsible for compliance with the rules. In particular, the shortened five calendar day deadline for initial Schedule 13D and 13d-1(c) passive investor Schedule 13G filings as well as the codified one business day deadline for Schedule 13D amendments, will likely require securityholders to plan or prepare their filings in advance of executing transactions that would trigger an initial filing or amendment (to the extent their prior practices differ from the proposed rules). Securityholders and compliance personnel will also need to establish or update communication frameworks with filers, or securityholders who may become subject to beneficial ownership reporting, that provide such compliance personnel access to holdings information necessary to enable the timely preparation and processing of any required disclosure. Likewise, many filers will have to procure compliance solutions that are capable of converting disclosure to Inline XBRL, or other acceptable formatting. Currently, such conversions are outside the scope of many filers’ formatting capabilities.