November 2020: Securities Litigation Update

Quinn Emanuel Urquhart & Sullivan, LLP
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Quinn Emanuel Urquhart & Sullivan, LLP

SEC Proposes Substantial Change to Asset Manager Reporting Thresholds

The Securities and Exchange Commission recently proposed amending Rule 13f-1 of the Securities Exchange Act of 1934 and Form 13F to dramatically increase the threshold for filing a Form 13F holdings report from $100 million to $3.5 billion.  See SEC, Reporting Threshold for Institutional Investment Managers, Exchange Act Release No. 34-89290 (July 10, 2020) (“Proposal”).  This proposed rulemaking would have significant impact on the number of asset managers that need to file 13F reports, the investors and companies that rely on them for transparency into the market for their stock, and could even impact the competitiveness among asset managers who have less visibility into the holdings of peer firms that may allow them to detect and respond to market signals. 

Exchange Act Rule 13f-1 was originally adopted in 1975.  Id. at 6.  The rule was originally passed in order to add transparency to the markets by requiring certain investors—institutional investors who manage over $100 million of exchange-listed equity securities in discretionary accounts—to disclose their holdings on a quarterly basis.  Id.  When adopted, Rule 13f-1 covered approximately 300 investment managers in the United States who accounted for approximately 75 percent of the total dollar value of institutional equity holdings.  Id. at 9.

For the past few years, advocates across a spectrum of interests have pushed for modifications to Rule 13f-1.  Some advocates, particularly those representing issuers, have pushed for reforms they believe will add more transparency to the markets, including requiring more frequent 13F disclosures.  See, e.g., National Investor Relations Institute, The Case for 13F Reform (Sept. 25, 2019).  Other advocates, particularly those representing investment managers, have advocated for reforms they believe will add more efficiency to the Rule 13-F process, including limiting the number of firms that need to file 13F disclosure forms.  On July 10, 2020, a divided SEC proposed new rules that are aimed at efficiency.  Proposal; see also SEC Proposes Amendments to Update Form 13F for Institutional Investment Managers; Amend Reporting Threshold to Reflect Today’s Equities Markets (July 10, 2020).  

Specifically, the SEC proposed to increase the threshold for Form 13F reporting obligations from $100 million to $3.5 billion.  Proposal at 1.  This change would eliminate reporting obligations for approximately 4,500 investment managers, who currently represent approximately 89.2% of all current filers and collectively manage approximately $2.3 trillion.  Id. at 18; Commissioner Allison Lee, Statement on the Proposal to Substantially Reduce 13F Reporting (July 10, 2020) (“Lee Statement”) at 1.  The SEC commissioners who voted in support of the proposed amendment argue that although the $3.5 billion figure is materially higher than $100 million that has been in effect for 45 years, the increased was tailored to account for changes in the overall size and structure of the U.S. equities market since 1975, when the $100 million figure was established.  Proposal at 17-18.  Those in support also note that the $3.5 billion threshold actually covers approximately the same proportion of the market as the initial threshold set in 1975 covered.  Id. at 12.  Those in support argue that by cabining Rule 13f-1 to the same percentage of investment managers as originally covered, smaller managers would avoid the compliance costs associated with filing Form 13F holding disclosures, which the SEC estimates is approximately $68.1 million to $136 million per year for the industry.  Id. at 18-19.  In addition, the SEC suggested that funds managing less than $3.5 billion made up a disproportionate number of the requests for confidential treatment of 13F disclosures.  Id. at 14.  Thus, those in support argue that the amendment would save the SEC resources as well.

Those opposed, including SEC Commissioner Allison Lee, argue that the new threshold make the markets less transparent by eliminating visibility into portfolios controlling $2.3 trillion in assets.  Lee Statement ¶ 1; National Investor Relations Institute, SEC Proposed to Reduce Equity Ownership Transparency (July 13, 2020) (NIRI Letter).  Opponents claims that this reduced transparency will harm smaller issuers who tend to have smaller investors.  Lee Statement 4.  They note that just last year the National Investor Relations Institute actually requested greater transparency and more timely access to 13F filings.  Id.  Those opposed also claim that the projected savings are overstated and inconsistent with prior SEC estimates.  Id. ¶¶ 7-11.

The debate regarding this amendment and future potential amendments now moves to the commenters on the proposal, which so far has drawn an extraordinary amount attention.  Thus far, the vast majority of commentators appear to be retail investors who oppose the proposal on the basis that it reduces transparency in the market, generally and specifically to retail investors.  They also argue that the reduced transparency will impact smaller issuers most significantly since small issuers’ investors tend to be the smaller funds that would be exempt from 13f-1 reporting requirements under the proposal.  An additional consideration against the proposal may be that institutional investors and private asset managers would be at competitive disadvantages to one another as result of the reduced transparency in each others’ holding. Who is investing in what companies, in what sectors and in what volumes sends important market signals that would be lost with reduced reporting. 

On the other hand, those in support of the amendment, and future increases in the reporting thresholds, have noted the reduced compliance costs, which they argue are particularly burdensome for smaller funds.  They have also noted that SEC has available to it another mechanism for understanding the systemic risk posed by private funds holdings through Form PF filings, which, although not public data, is available to the regulator to help it monitor market exposures.  Practically speaking, it is also the case that stale information (as Form 13F holdings are one quarter-old) regarding a small fund’s holdings does not necessarily hold much market value to retail investors or regulators, and was never the type of information intended to be captured by Rule 13f-1.  Although smaller funds likely favor reduced compliance costs, the lack of 13F filings may make it harder for law firms to identify smaller funds who may have strong securities claims that can be monetized and added to the fund’s bottom line.  Those smaller funds may wish to consider engaging law firms to monitor their portfolios for potential securities claims.  Of course, proponents also point out that although the proposed amendments may reduce transparency for smaller issuers, all investors still receive the benefit of SEC Rules 13-D and 13-G, which requires investors to disclose their holdings once they reach a 5 percent threshold in a particular issuer.

While the comment period for the rule closed on September 29, 2020, we do not expect the debate over Rule 13f-1 to be settled any time soon, and we will watch with interest to see whether this Commission is able to move to adoption before the election.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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