Shorter Deadlines and New Standards for Schedule 13D and Schedule 13G
If adopted, the proposed amendments would significantly tighten deadlines for initial and amended filings for both Schedule 13D and Schedule 13G filers. Under the proposed amendments, the following will take hold:
- For Schedule 13D filers, the time to file an initial Schedule 13D and any amendments thereto would be five calendar days and one business day, respectively.
- While the trigger for amendment filings (i.e., a “material change”) would remain unchanged, the flexibility for filing “promptly” would be eliminated.
- For Passive Investors3 who file under Rule 13d-1(c), the time to file an initial Schedule 13G and the 10% amendment (including subsequent 5% change amendments) to Schedule 13G would be five calendar days and one business day, respectively (again, eliminating the flexibility for filing such amendments “promptly”).
- In addition, as discussed in the last bullet below, the “annual” amendment filing obligation would become “monthly.”
- QIIs4 who file Schedule 13Gs under Rule 13d-1(b) and Exempt Investors5 who file Schedule 13G under Rule 13d-1(d) would need to monitor month-end positions to determine if any surpassed 5% and, if so, file an initial Schedule 13G within five business days of the month’s end.
- Once an initial Schedule 13G is filed, QIIs would also need to monitor daily whether any positions surpassed 10% (and, thereafter, if ownership has changed by more than 5%) and, if so, file an amendment to Schedule 13G within five calendar days of each trigger.6
- All Schedule 13G filers would need to monitor month-end positions for covered securities in which there is a current Schedule 13G outstanding to determine whether there has been a “material change” to the information therein and, if so, file an amendment to Schedule 13G within five business days of the month’s end (replacing the “annual” amendment obligation).
- While the proposing release describes a “material change” as a change to any disclosure in the Schedule 13G, the term “material change” is defined in Rule 13d-2(a) for purposes of “this section” to include “acquisition or disposition of beneficial ownership of securities in an amount equal to one percent or more,” which presumably would apply to these Schedule 13G amendments as well.
To accommodate these shorter deadlines and augmented filing obligations, the Commission’s EDGAR system would accept filings until 10 p.m. ET (consistent with the cutoff for Section 16 filings) instead of the current cutoff of 5:30 p.m. ET.
The charts at the end of this alert outline the changes in the Schedule 13D and Schedule 13G filing requirements.
Explicitly Capture Cash-Settled Derivatives, Other Than Security-Based Swaps, in “Beneficial Ownership”
In addition to shorter deadlines, the Commission is also proposing to deem a holder of certain types of cash-settled equity derivatives as the “beneficial owner” of the underlying reference equity securities if such person holds the derivative with the purpose or effect of changing or influencing the control of the issuer of such class of equity securities or in connection with or as a participant in any transaction having such purpose or effect. Accordingly, any person who is required to file on Schedule 13D because they cannot make the certification of passivity required for Schedule 13G filings under Rule 13d-1(b) or (c) would similarly need to include such cash-settled derivatives in its beneficial ownership calculation — even if such person does not have the voting or investment power over the underlying reference equity securities or the right to acquire such power (i.e., the current definition of “beneficial ownership” in Rule 13d-3).7
Cash-settled derivatives covered by this rule proposal would be based on the definition of “derivative security” contained in Exchange Act Rule 16a-1(c).8 Notably, however, the proposed definition would explicitly exclude cash-settled security-based swaps on the basis that such derivative securities separately will be subject to reporting on proposed Schedule 10B under proposed Rule 10B-1.9 This serves as a reminder that assuming proposed Rule 10B-1 and related Schedule 10B are adopted, any owners or sellers of security-based swaps should be considering the legal and operational changes that will be required in order to comply with the new reporting regime. The overall effect of the two sets of rule proposals, if both are adopted in some form, will likely be complex and comprehensive in its required disclosures of equity-related positions, especially for investors that may seek to influence or change control of issuers.
While security-based swaps would not count toward a person’s “beneficial ownership” under the proposed rules, information concerning security-based swaps would be required to be disclosed in Item 6 of Schedule 13D. The Commission has proposed to amend the instructions to Item 6 of Schedule 13D to expressly require that a person disclose interests in all derivative securities that use the issuer’s equity security as a reference security, even though the current form of Item 6 arguably requires disclosure of security-based swap and other derivative contracts related to the covered security already. Item 6, as amended, would require reporting ownership of cash-settled security-based swaps and other equity derivatives that are settled exclusively in cash.
Daily Calculation Required for Cash-Settled Derivatives
The proposed rule would also set forth a formula for calculating the number of equity securities that a holder of cash-settled derivatives would be deemed to beneficially own. Specifically, the number of securities that a covered derivative would represent in a reporting person’s beneficial ownership would be based on that derivative’s “delta”10 and would equal the larger of the numbers calculated pursuant to the following two formulas, to the extent applicable to the derivative:
- if applicable, the number of securities by reference to which the amount payable under the derivative security is determined multiplied by the delta of the derivative security
- (i) the quotient of the notional amount of the derivative security divided by the most recent closing market price of the reference equity security multiplied by (ii) the delta of the derivative security; this calculation would be required to be done on a daily basis
Notably, these calculations may change daily, which could impose a sizable burden on operations teams tasked with monitoring for whether a person has tripped a filing threshold.
Group Formation Does Not Require “Agreement”
The proposed amendment also broadens the circumstances under which two or more persons would be deemed to have formed a “group” for purposes of Section 13(d) and (g) and thereby subject to aggregation in calculating the group’s beneficial ownership of the covered security. As proposed, the Commission would remove reference to the need for two or more persons to “agree” to act together currently in Rule 13d-5(b)(1) under the Exchange Act. In the proposing release, the Commission emphasizes that certain concerted actions may be sufficient to constitute the formation of a group, which may greatly increase the risk of circumstantial evidence being used, in hindsight, to assert the existence of a “group.” For example, this broad definition of “group” might capture different funds with parallel investment strategies, notwithstanding a lack of agreement among the funds.
The proposal would also explicitly deem a “group” to be formed between a tipper and tippee, where the tipper communicates its plan to file a Schedule 13D with the purpose of causing others to make purchases, and the tippee subsequently purchases securities based on that information. Further, the proposal would deem a group to have acquired beneficial ownership if any member of the group acquires beneficial ownership of additional securities after the group’s formation. This proposal would implicate the group’s ability to file Schedule 13G under Rule 13d-1(d) as Exempt Investors if acquisitions by individual members, in the aggregate, surpass 2% over any 12-month period.
Exemptions From Group Status
Helpfully, the proposal would exempt from group status discussions among shareholders or with the issuer that do not have the purpose or effect of changing or influencing the control of the issuer of the relevant class of equity securities or in connection with or as a participant in any transaction having such purpose or effect, so long as the persons are not obligated to act. As the proposing release notes, this should benefit large passive institutional investors who “wish to communicate and consult with one another regarding an issuer’s performance or certain corporate policy matters involving one or more issuers” and even “take similar action with respect to the issuer or its securities, such as engaging directly with the issuer’s management or coordinating their voting of shares at the issuer’s annual meeting with respect to one or more company or shareholder proposals,” all without fear of becoming a group for Section 13(d) purposes. However, entry into a cooperation or voting agreement would eliminate the availability of this exemption.
The proposal would also exempt from group status persons who enter into a derivative securities agreement, so long as they do not enter into the agreement with the purpose or effect of changing or influencing the control of the issuer of such class of equity securities or in connection with or as a participant in any transaction having such purpose or effect.
Section 16 Impact
Because Section 16 uses the same definition of “beneficial ownership” from Section 13(d) for purposes of determining if a person is a greater-than 10% beneficial owner subject to Section 16, the proposed changes in the definition of “beneficial ownership” would also affect the determination of when persons would become “insiders” subject to Section 16.
As an initial point, a person who holds a cash-settled derivative security with the purpose or effect of changing or influencing the control of the issuer of such class of equity securities, or in connection with or as a participant in any transaction having such purpose or effect, would be required to count the underlying reference securities — calculated pursuant to the formula set forth above — toward the 10% threshold for Section 16 purposes. Given that this calculation would be required to be computed daily and may be particularly burdensome, it may be prudent for investors who near the 10% threshold and own cash-settled derivatives that must be counted toward their beneficial ownership to consider implementing certain Section 16 safeguards prophylactically.
Further, the expansion of the “group” definition could result in persons becoming subject to Section 16 — and being exposed to short-swing profit liability — due to concerted actions that even without an agreement may be deemed sufficient “group” activity.
In his public statement on the proposed amendments,11 Chair Gary Gensler focused on how the shortened deadlines will minimize the time that activist investors can withhold “market moving information” from other shareholders. He offered no explanation, however, for why the shortened timelines and revised standards are needed for Schedule 13G filers.
In her dissent, among other things, Commissioner Hester Peirce noted that the 10-day initial filing deadline may not be a magic number, but the reasons for shortening it — all stemming from technological advances — ignore the purpose for having a delay in the filing obligation – namely, striking a balance between “shareholders’ interest in learning of potential changes in corporate control [and] the benefit of allowing the party seeking to engage in a change in control of the company to keep that information private.”12
The comment period for the foregoing proposals extends to the later of (i) 30 days after publication of the proposing release in the Federal Register (which has not occurred as of the date of this publication) and (ii) April 11, 2022. The proposals did not include an anticipated effective date.
Summary of Changes in the Schedule 13D and Schedule 13G Filing Requirements
1 Modernization of Beneficial Ownership Reporting, Securities Exchange Act Release Nos. 33-11030; 34-94211 (proposed Feb. 10, 2022), https://www.sec.gov/rules/proposed/2022/33-11030.pdf.
2 A “covered class” is a class of equity securities described in Section 13(d)(1) of the Exchange Act and Rule 13d-1(i) and generally includes a voting class of equity securities registered under Section 12 of the Exchange Act or issued by a closed-end investment company registered under the Investment Company Act of 1940.
3 The term “Passive Investors” refers to beneficial owners of more than 5% but less than 20% of a covered class who can certify under Item 10 of Schedule 13G that the subject securities were not acquired or held for the purpose or effect of changing or influencing the control of the issuer of such securities and were not acquired in connection with or as a participant in any transaction having such purpose or effect.
4 The institutional investors qualified to report on Schedule 13G, in lieu of Schedule 13D and in reliance on Rule 13d-1(b), include a broker or dealer registered under Section 15(b) of the Exchange Act, a bank as defined in Section 3(a)(6) of the Exchange Act, an insurance company as defined in Section 3(a)(19) of the Exchange Act, an investment company registered under Section 8 of the Investment Company Act of 1940, an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, a parent holding company or control person (if certain conditions are met), an employee benefit plan or pension fund that is subject to the provisions of the Employee Retirement Income Security Act of 1974, a savings association as defined in Section 3(b) of the Federal Deposit Insurance Act, a church plan that is excluded from the definition of an investment company under Section 3(c)(14) of the Investment Company Act of 1940, non-U.S. institutions that are the functional equivalent of any of the institutions listed in Rules 13d-1(b)(1)(ii)(A) through (I), so long as the non-U.S. institution is subject to a regulatory scheme that is substantially comparable to the regulatory scheme applicable to the equivalent U.S. institution, and related holding companies and groups (collectively, Qualified Institutional Investors or QIIs).
5 The term “Exempt Investor” refers to persons holding beneficial ownership of more than 5% of a covered class at the end of the calendar year but who have not made an acquisition of beneficial ownership subject to Section 13(d). For example, persons who acquire all their securities prior to the issuer’s registering the subject securities under the Exchange Act are not subject to Section 13(d), and persons who acquire not more than 2% of a covered class within a 12-month period are exempted from Section 13(d) by Section 13(d)(6)(B) but in both cases are subject to Section 13(g). Section 13(d)(6)(A) exempts acquisitions of subject securities acquired in a stock-for-stock exchange that is registered under the Securities Act of 1933.
6 Notably, the proposal would remove the current obligation for QIIs to file an initial Schedule 13G within 10 days of the end of a month at which the QII’s beneficial ownership surpasses 10%, such that this obligation to monitor daily for 10% threshold would apparently apply only once the QII has filed an initial Schedule 13G.
7 Consistent with the current determination of “beneficial ownership,” only long positions in such derivatives would be counted, and such positions would not be subject to offset by short positions.
8 Rule 16a-1(c) defines “derivative securities” as including certain rights, such as options, warrants, convertible securities, stock appreciation rights, or similar rights “with an exercise or conversion privilege at a price related to an equity security, or similar securities with a value derived from the value of an equity security,” excluding certain enumerated rights, obligations, interests, and options.
9 Separately, the Commission has proposed that owners and sellers of security-based swaps report their ownership, in excess of certain thresholds, on Schedule 10B, to be filed by the next business day on EDGAR. See 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, Exchange Act Release No. 34-93784 (proposed Dec. 15, 2021), https://www.sec.gov/rules/proposed/2021/34-93784.pdf. You can find the Sidley client alert on this proposal here: https://www.sidley.com/en/insights/newsupdates/2022/01/sec-proposes-expansive-and-complex-reporting-regime-for-security-based-swap-users.
10 The proposed rule would define “delta” to mean, with respect to a derivative security, the ratio obtained by comparing the change in the value of the derivative security to the change in the value of the reference equity security. The Commission proposes that the delta, if not fixed, should be calculated on a daily basis, based on the closing market price of the reference security that day.
11 Chair Gary Gensler, Statement on Beneficial Ownership Proposal, SEC (Feb. 10, 2022), https://www.sec.gov/news/statement/gensler-statement-beneficial-ownership-proposal-021022?utm_medium=email&utm_source=govdelivery.
12 Commissioner Hester M. Peirce, Dissenting Statement on Proposed Modernization of Beneficial Ownership Reporting, SEC (Feb. 10, 2022), https://www.sec.gov/news/statement/peirce-13d-20220210.
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