On February 10, 2022, the U.S. Securities and Exchange Commission (the SEC) proposed amendments[1] to the rules governing beneficial ownership reporting under Sections 13(d) and 13(g) of the Securities Exchange Act of 1934 (the “Exchange Act”). The SEC described the proposed amendments as intended to “update those rules to provide more timely information to meet the needs of today’s financial markets.”

If adopted after a 60-day comment period, these proposed amendments would:

• Accelerate the filing deadlines for Schedules 13D and 13G beneficial ownership reports;
• Expand the application of Regulation 13D-G to certain derivative securities;
• Clarify the circumstances under which two or more persons have formed a “group” that would be subject to beneficial ownership reporting obligations; and
• Require that Schedules 13D and 13G be filed using a structured, machine-readable data language.

Background

Sections 13(d) and 13(g) of the Exchange Act, together with Regulation 13D-G thereunder, require an investor who beneficially owns more than 5% of a class of equity securities registered under Section 12 of the Exchange Act to report such beneficial ownership by publicly filing either a Schedule 13D or a Schedule 13G. Investors filing a Schedule 13D must make an initial filing within 10 days of crossing the 5% threshold; the deadlines for filing a Schedule 13G vary depending upon the category of investor making the filing. The current deadlines for filing the initial Schedule 13D and Schedule 13G were established in 1968 and 1977, respectively. The 10-day Schedule 13D deadline in particular has been criticized for permitting an investor to continue to accumulate stock above the 5% threshold before having to report its ownership.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amended Section 13(d)(1) of the Exchange Act to give the SEC the authority to shorten the deadline for filing the initial Schedule 13D. In proposing to shorten the Schedule 13D deadline to five days, SEC Chair Gary Gensler noted that “Investors currently can withhold market moving information from other shareholders for 10 days after crossing the 5% threshold before filing a Schedule 13D, which creates an information asymmetry between these investors and other shareholders. The filing of a Schedule 13D can have a material impact on a company’s share price, so it is important that shareholders get that information sooner.”[2]

Among other proposed changes, the proposed rules also would clarify when and how certain cash-settled derivative securities, when held for the purpose or effect of changing or influencing control of the issuer, count for purposes of the 5% threshold. The proposed changes would address concerns, among others, that an investor holding a substantial position in cash-settled derivative securities has the potential to significantly influence its counterparties or the issuer without having to disclose its derivative ownership position.

Proposed Amendments to Schedule 13D and 13G Filing Deadlines

Set forth below is a description of the proposed changes to the filing deadlines for initial and amended Schedules 13D and 13G. Appendix 1 contains a chart that summarizes the filing deadline proposals.

Schedule 13D

• Initial Filing Deadline. The proposed rules would shorten the filing deadline for an initial Schedule 13D from 10 days to five days following (1) the acquisition of beneficial ownership of more than 5% or (2) the loss of eligibility to file a Schedule 13G.
• Amendment Filing Deadline. The proposed rules would require amendments to be filed within one business day following a material change to the information in the Schedule 13D. Under current rules, investors must file amendments “promptly” following a material change.

Schedule 13G 

• Initial Filing Deadline. The deadline for an initial Schedule 13G filing under the proposed rules would depend on the category of investor making the filing. The three categories of investors that file on Schedule 13G include: “qualified institutional investors” or “QIIs”[3] that file pursuant to Rule 13d-1(b); “passive investors”[4] that file pursuant to Rule 13d-1(c); and “exempt investors”[5] that file pursuant to Rule 13d-1(d).
  • Qualified Institutional Investors. The proposed rules would require an initial filing within five business days after the last day of any month in which the QII acquired and held more than 5% of a registered class of equity securities as of the last day of such month. QIIs currently must file the initial Schedule 13G within 45 days after the end of the calendar year if beneficial ownership exceeds 5% of a registered class as of year-end (or within 10 calendar days after the end of the month if beneficial ownership exceeds 10% as of the end of such month).
  • Passive Investors. The proposed rules would require an initial Schedule 13G filing within five calendar days after acquiring beneficial ownership of more than 5% of registered class of equity securities, down from the current 10-day requirement.
  • Exempt Investors. The proposed rules would require exempt investors who beneficially own more than 5% of a registered class of equity securities as of the end of any month to file a Schedule 13G within five business days after the end of such month. Exempt investors currently must file a Schedule 13G within 45 days after year-end if they own more than 5% as of year-end.
• Amendments Filing Deadline. The deadline for amending a Schedule 13G for material changes to the information contained therein likewise would depend on the category of investor making the filing.
  • Qualified Institutional Investors. The proposed rules would require a QII to amend its Schedule 13G within five business days after the end of any month in which there are material changes in the information reported in the Schedule 13G (other than changes in the percentage of the class beneficially owned if such change results solely from a change in the number of shares outstanding). Currently such amendments are required within 45 days after year-end. A QII also would be required to amend the Schedule 13G within five calendar days after its beneficial ownership exceeds 10% of the registered class. Thereafter, such a filer would be required to amend the Schedule 13G within five calendar days after its beneficial ownership increases or decreases by more than 5% of the registered class of equity securities. Current rules require such amendments within ten days of the end of a month in which ownership first exceeds 10%, or thereafter increases or decreases by more than 5%.
  • Passive Investors. The proposed rules would require a passive investor to amend its Schedule 13G within five business days after the end of any month in which there are material changes in the information reported in the Schedule 13G (other than changes in the percentage of the class beneficially owned if such change results solely from a change in the number of shares outstanding). Currently such amendments are required within 45 days after year-end. A passive investor also would be required to amend the Schedule 13G within one business day after its beneficial ownership exceeds 10% of the registered class of equity securities. Thereafter, such a filer would be required to amend the Schedule 13G within one business day after its beneficial ownership increases or decreases by more than 5% of the registered class. Current rules require such amendments to made “promptly” after the triggering event.
  • Exempt Investors. The proposed rules would require an exempt investor to amend its Schedule 13G within five business days after the end of any month in which there are material changes in the information reported in the Schedule 13G (other than changes in the percentage of the class beneficially owned if such change results solely from a change in the number of shares outstanding). Currently such amendments are due within 45 days after year-end.

Proposed Amendments to Beneficial Ownership Reporting of Cash-Settled Derivatives

Under current Rule 13d-3, a person is deemed to be the beneficial owner of any securities he or she has the right to acquire within 60 days, such as through an option, a warrant, or a convertible security. If the person acquired the right for the purpose or with the effect of changing or influencing control of the issuer of the securities, that person is treated as a beneficial owner of the underlying class of equity securities, regardless of when the right is exercisable, exchangeable, or convertible. A holder of a derivative that provides only economic exposure to the reference security, however, generally has not been considered a beneficial owner of the reference security. In the proposing release, the SEC highlighted various concerns that a holder of such a derivative position could seek to use its position to exert influence or control over the issuer or the holder’s counterparties. In particular, the SEC noted that cash-settled derivatives “ordinarily do not entitle their holders to acquire the reference securities,” but concluded that, “[t]o the extent such derivative security is held with the purpose or effect of changing or influencing the control of the issuer . . . the potential for a holder of a cash-settled derivative security to exert influence on a counterparty that may directly hold the reference securities implicates the same concerns that the [SEC] articulated in adopting Rule 13d-3(d)(1).”[6] The proposed rules, as described below, address when ownership of cash-settled derivatives would confer beneficial ownership of the reference security, as well as certain disclosure requirements regarding such beneficial ownership.

Beneficial Ownership

• Under the proposed rules, a holder of a cash-settled derivative security, other than a security-based swap,[7] will be deemed the beneficial owner of the reference equity securities if the holder holds the derivative with the purpose or effect of changing or influencing the control of the issuer of the reference securities, or in connection with or as a participant in any transaction having such purpose or effect.
• The term “derivative security” would have the meaning set forth in Rule 16a-1(c) under the Exchange Act.

Number and Percentage of Shares Deemed Beneficially Owned

• The number of shares that a holder would be deemed to beneficially own is equal to the larger of (i) the product obtained by multiplying the number of securities by reference to which the amount payable under the derivative security is determined by the delta of the derivative security and (ii) the quotient obtained by dividing the notional amount of the derivative security by the most recent closing market price of the reference security, and then multiplying such quotient by the delta of the derivative security. The term “delta” refers to the ratio that is derived by comparing the change in value of the derivative security to the change in the value of the reference equity security.
• Only long positions in derivatives would be counted for purposes of determining the number of equity securities that a holder of a cash-settled derivative security would be deemed to beneficially own. Short positions, whether held directly against a covered class or synthetically through a cash-settled derivative, cannot be netted against long positions or otherwise taken into account.

Percentage of Beneficial Ownership

• Under the proposed rules, any securities not outstanding that are referenced by such a derivative security would be deemed outstanding for purposes of calculating the reporting person’s percentage of beneficial ownership.

Schedule 13D – Item 6 Disclosure

• Item 6 of Schedule 13D currently requires the reporting person to “[d]escribe any contracts, arrangements, understandings or relationships (legal or otherwise) among the persons named in Item 2 and between such persons and any person with respect to any securities of the issuer.” The proposed rules would revise Item 6 to clarify that a reporting person is required to disclose interests in all derivative securities (including cash-settled derivative securities) that use the issuer’s equity security as a reference security. 

Proposed Amendments relating to Groups

Section 13(d)(3) of the Exchange Act provides that “when two or more persons act as a partnership, limited partnership, syndicate or other group for the purpose of acquiring, holding or disposing of the securities of an issuer, such syndicate or group shall be deemed a ‘person’ for purposes of [Section 13(d)].” As a group is deemed a “person” for purposes Section 13(d), it has its own beneficial ownership reporting obligations, which would include disclosure of all shares beneficially owned by the group members. Rule 13d-5(b)(1) expands the list of purposes to explicitly include voting and includes language that the persons must “agree to act together” rather than just “act” as provided in Section 13(d)(3). The proposed rule changes, described below, are intended to clarify the circumstances under which two or more persons have formed a group.

• The proposed rules would clarify that forming a group does not require an agreement. Concerted actions by two or more persons for the purpose of acquiring, holding, or disposing of securities of an issuer may be sufficient to establish the formation of a group, depending on the particular facts and circumstances.
• Further, a group would be formed under the proposed rules where, in advance of filing a Schedule 13D, a filing person discloses to any other person that such filing will be made and the other person acquires securities covered by the Schedule 13D, to the extent that the information is not yet public and is communicated with the purpose of causing others to make purchases. In the Proposing Release, the SEC likened this activity to a “tipping arrangement.”[8]
• A group will be deemed to have acquired beneficial ownership of all of the equity securities of a covered class beneficially owned by each of the group’s members as of the date on which the group is formed. The group also would be deemed to have acquired additional equity securities if and when acquired by any member of the group, unless the acquisition was made from another member of the group.
• The proposed rules would exempt certain actions taken by two or more persons from forming a group if those actions do not have the purpose or effect of changing or influencing the control of an issuer and are not made in connection with or as a participant in any transaction having such purpose or effect.  Such actions include ordinary course communications between investors regarding an issuer’s performance or corporate policy matters and derivative transactions between financial institutions and their customers.

Other Proposed Amendments/Implications

Filing Cut-Off Time

• In addition to the proposed changes to the filing deadlines described above, the proposed rules would permit filings of Schedules 13D and 13G, and amendments thereto, up until 10:00 p.m. Eastern Time rather than the current 5:30 p.m. filing cut-off. 

Structured, Machine-Readable Data Language

• The proposed rules would require Schedules 13D and 13G to be filed using a structured, machine-readable data language. All disclosures, including quantitative disclosures, textual narratives, and identification checkboxes, on Schedules 13D and 13G would have to be filed using an XML-based language to facilitate the ability to access, compile, and analyze information that is disclosed on Schedules 13D and 13G.
• Exhibits would not be covered by this requirement.

Section 16 Implications

• The proposed rules described above also would apply when determining if a shareholder is subject to Section 16 as a greater than 10% beneficial owner or part of a group that is over 10%.
• The SEC requested comment on, among other Section 16 implications, whether a holder of cash-settled derivatives covered by proposed Rule 13d-3(e) should be deemed the beneficial owner of the reference securities in a covered class for purposes of Sections 13(d) and (g), but not the beneficial owner of those securities for purposes of determining whether that person is a 10% holder for purposes of Section 16.

Implications for Shareholder Activism and Hostile M&A

The proposed amendments would have significant tactical implications for activist shareholders and the companies they may target, as well as for “toe-hold” accumulations of shares by a hostile bidder. A few examples include:

• The proposed amendments could make it more difficult for a market participant to obtain a position that is large enough to provide it the desired leverage in an activist campaign or hostile offer, by shortening to 5 days from 10 days the period of time in which accumulations beyond the 5% reporting threshold can continue to be made prior to public disclosure.
• Alternatively, an activist’s desire to make significant purchases before filing the Schedule 13D could increase the cost of those purchases by compressing the demand for shares into a shorter buying period.  Purchases after the Schedule 13D filing also would likely come at an increased cost, increasing the blended cost of the toe-hold position.
• Monthly amendments by QIIs and Exempt Investors will give issuers the ability to better prioritize and tailor their investor outreach programs over time, both outside and during an activist campaign or hostile offer.
• The practice of one activist investor talking with another in advance of a Schedule 13D filing to “tip” the other about the activist’s designs on the company and intent to file a Schedule 13D may be significantly impacted by the increased likelihood that the SEC would conclude that a Schedule 13D “group” had been formed by that communication.
• Market participants should consider that changes to the definition of beneficial ownership for Schedule 13D purposes may have impact in other contexts – for example, where a change in control provision of a contract incorporates the definition of beneficial ownership from Rule 13d-3 for purposes of defining beneficial ownership under the contract.

Next Steps

The SEC’s proposed amendments are subject to a relatively short comment period ending on the later of (1) 60 days following issuance of the proposed rules (April 11, 2022), or (2) 30 days following publication of the Proposing Release in the Federal Register. Given the potentially significant impact of the proposed rules on investors and the over 100 topics upon which the SEC requested comment in the Proposing Release, we expect the SEC will receive substantial feedback on the proposals that it will need to consider in finalizing the rule changes.

Proposed Changes to Schedule 13D and 13G Filing Deadlines

[1] Release Nos. 33-11030; 34-94211, Modernization of Beneficial Ownership Reporting (February 10, 2022) (the “Proposing Release”), available at https://www.sec.gov/rules/proposed/2022/33-11030.pdf.

[2] Press release SEC Proposes Rule Amendments to Modernize Beneficial Ownership Reporting (February 10, 2022), available at https://www.sec.gov/news/press-release/2022-22.

[3] Under Rule 13d-1(b), “qualified institutional investors” include, among others, registered broker-dealers, banks, insurance companies, registered investment companies and registered investment advisers. The investor also must hold the shares in the ordinary course of business without a control intent or effect.

[4] Under Rule 13d-1(c), an investor that owns less than 20% and holds the shares without control intent or effect may file as a “passive investor.”

[5] Rule 13d-1(d) makes Schedule 13G available to “exempt investors,” which are investors that became beneficial owners of more than 5% without having made an acquisition recognized under Section 13(d)(1). Typical exempt investors are pre-IPO investors who acquired their shares before the issuer had registered a class of equity securities under Section 12. An exempt investor may lose its eligibility to file on Schedule 13G by acquiring more than 2% of the equity security in a 12-month period.

[6] Proposing Release at page 61.

[7] The SEC has separately proposed Rule 10B-1, which would require reporting of certain security-based swap positions. The SEC expressed its view that Rule 10B-1, if adopted, would provide sufficient information regarding holdings of cash-settled security-based swaps such that addressing it in the proposed rules discussed herein would be duplicative. See Release No. 34-93784, Prohibition Against Fraud, Manipulation, or Deception in Connection with Security-Based Swaps; Prohibition Against Undue Influence over Chief Compliance Officers; Position Reporting of Large Security-Based Swap Positions (Dec. 15, 2021), available at https://www.sec.gov/rules/proposed/2021/34-93784.pdf.

[8] Proposing Release at page 86.

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