SEC Proposes Sweeping Changes to Beneficial Ownership Reporting Requirements

On February 10, 2022, the Securities and Exchange Commission (the "SEC") proposed¹ amendments to Regulation 13D-G and Regulation S-T governing the reporting requirements of greater than 5% beneficial owners of shares of public companies.² The proposed amendments include shortening the time periods within which statements on Schedule 13D and Schedule 13G, as well as amendments to such statements, are required to be filed. The proposed amendments also treat the holder of certain cash-settled derivative securities as the beneficial owner of the reference securities of such derivatives. In addition, the amendments dramatically alter the criteria for determining whether a "group" has been formed for Schedule 13D or Schedule 13G reporting purposes and provide new exemptions for specified group activity.

The comment period for the proposed rules will end on the later of April 11, 2022 and the 30th day following publication of the proposing release in the Federal Register.

Current Schedule 13D and 13G Filing Requirements

Under SEC Rule 13d-1(a), any person who acquires beneficial ownership of more than 5% of the shares of a registered class of equity security is required to file a statement on Schedule 13D within 10 calendar days after the acquisition that results in such person having greater than 5% beneficial ownership. Certain qualified institutional investors ("QIIs"), such as registered broker-dealers, banks, registered investment advisers, registered investment companies and insurance companies, may report their beneficial ownership on the short-form Schedule 13G within 45 days of the end of the calendar year in which such acquisition occurs,³ provided that the institution has acquired the securities in the ordinary course of business and without the purpose or effect of changing or influencing the control of the issuer. If such institution acquires greater than 10% beneficial ownership prior to the end of the calendar year, the initial Schedule 13G is required to be filed within 10 calendar days after the end of the first month in which such ownership level is attained. Further, certain passive investors ("passive investors") who otherwise are not QIIs may report their beneficial ownership on Schedule 13G within 10 calendar days of attaining greater than 5% beneficial ownership if such investors have not acquired the securities with the purpose or effect of changing or influencing the control of the issuer. Such passive investors are not eligible to file on Schedule 13G if their beneficial ownership reaches 20% or more of the outstanding class. A fourth category of beneficial owners, referred to as "exempt investors," also may make their initial filing on Schedule 13G within 45 days of the end of the calendar year in which their beneficial ownership exceeds 5%. Such category is comprised of investors who acquired their beneficial ownership prior to the issuer registering the class of equity security under the Exchange Act, such as pre-IPO investors, investors who have not acquired 2% or more of the outstanding class within a consecutive 12-month period and investors whose beneficial ownership increased to above 5% as a result of issuer share repurchases or other issuer transactions.⁴

The current obligations for filing amendments (as well as initial Schedule 13D filings for QIIs and passive investors who lose Schedule 13G eligibility) under SEC Rules 13d-1 and 13d-2 are based on the category of filer. Schedule 13D filers are required to file an amendment "promptly" if any material change⁵ occurs in the facts set forth in the Schedule 13D. QIIs, passive investors and exempt investors who remain eligible to file on Schedule 13G are required to file an amendment within 45 days after the end of each calendar year if there are any changes⁶ in the information previously reported. In addition, QIIs are required to file an amendment to their Schedule 13G within 10 days of the calendar month end if their beneficial ownership exceeds the 10% level and thereafter within 10 days of the calendar month end if their beneficial ownership increases or decreases by more than 5%. Passive investors are required to file an amendment to their Schedule 13G promptly after their beneficial ownership exceeds the 10% level and thereafter promptly if their beneficial ownership increases or decreases by more than 5%. A QII who ceases to be a QII or ceases to hold the shares in the ordinary course of business must file within 10 calendar days a Schedule 13D or, if such person qualifies as a passive investor, an amendment on Schedule 13G. QIIs and passive investors who change the purpose or effect of their acquisition to a "control" purpose or effect are required to file a Schedule 13D within 10 calendar days of such change.⁷ Passive investors whose beneficial ownership level reaches or exceeds 20% also are required to file a Schedule 13D within 10 calendar days of reaching such beneficial ownership level.⁸

The current filing obligations are summarized in the following table:

Proposed Schedule 13D and 13G Filing Requirements

The SEC's proposed amendments to the Schedule 13D and 13G filing requirements are designed to modernize the beneficial ownership requirements and to address concerns that the current deadlines create information asymmetries in the trading of securities. The proposed amendments would make the following changes:

• shorten the filing deadline for the initial Schedule 13D under Rule 13d-1(a) to five calendar days after the date on which a person acquires more than 5% of a registered class of equity security;
• shorten the filing deadlines for the initial Schedule 13D required in cases where a QII or passive investor loses Schedule 13G eligibility to five calendar days after the date of the loss of eligibility;
• shorten the filing deadline for amendments to Schedule 13D to one business day⁹ after the date on which a material change occurs;
• shorten the filing deadline for the initial Schedule 13G for QIIs and exempt investors to five business days after the last day of the month in which the investor's beneficial ownership first exceeds 5% of a registered class of equity security;
• shorten the filing deadline for the initial Schedule 13G for passive investors to five calendar days after the date the passive investor acquires more than 5% of a registered class of equity security;
• shorten the filing deadline for amendments to Schedule 13G applicable to QIIs, passive investors and exempt investors to five business days after the end of the month in which a reportable change occurs, and change the triggering event from "any change" to a "material change;"¹⁰
• shorten the filing deadline for amendments to Schedule 13G applicable to QIIs whose beneficial ownership increases to greater than 10% (and thereafter increases or decreases by more than 5%) to five calendar days after such event, and measure such changes at any time during a month (versus the current month-end measurement requirement);
• shorten the filing deadline for amendments to Schedule 13G applicable to passive investors whose beneficial ownership increases to greater than 10% (and thereafter increases or decreases by more than 5%) to one business day after such event; and
• amend Regulation S-T to provide that Schedule 13D and 13G filings and amendments thereto made on or before 10:00 p.m. Eastern time on a given day are deemed to be have been filed on the same business day.

The proposed amended filing obligations are summarized in the following table:

Rationale for Proposed Changes to Filing Deadlines

Congress and the SEC have faced calls to revise the beneficial ownership reporting regime for decades,¹¹ principally as a result of technological changes and changes in the financial markets since the adoption of the Williams Act in 1968. For Schedule 13D filings, the 10-day window affords activists additional time to mount a campaign against a public company, as well as to acquire additional shares, prior to being required to disclose its plans. Likewise, for Schedule 13G filings, the various time periods afforded for filers enable such investors to acquire or dispose of shares without alerting the marketplace on a timely basis of significant accumulations or dispositions of positions.¹² These delays result in information asymmetries that may disadvantage investors. In proposing the amended filing deadlines, the SEC noted that Congress had sought to strike an appropriate balance between, on the one hand, providing adequate disclosures to investors and, on the other hand, not unduly burdening those engaging in change of control transactions.¹³ Noting that the legislative purpose was to provide information to the public and the subject issuer about accumulations of a registered class of equity security by persons who had the potential to change or influence control of the issuer, the SEC determined that amendments to Regulation 13D-G were necessary to support the regulatory objectives. In striking a balance with the proposed amendments, the SEC noted that shortening the filing deadline could have a chilling effect on an activist's ability and incentive to effect changes that may benefit shareholders, including increasing the costs of activist campaigns. Nevertheless, the SEC expressed concern that, given the rapid pace with which trading activities and large accumulations of beneficial ownership can occur in the financial markets today as compared to when the Williams Act was enacted in 1968, the delay in reporting market-moving information raises investor protection concerns. By shortening the filing deadlines, the SEC is seeking to increase transparency and the corresponding assurance to investors that transactions are not being made based on mispriced securities caused by a prolonged delay in the dissemination of market-moving information.

Proposed Amendments to the Treatment of Cash-Settled Derivative Securities¹⁴ and Disclosure Requirements Regarding Derivative Instruments

Under Rule 13d-3(d), a person is deemed to be the beneficial owner of securities if the person has the right to acquire beneficial ownership within 60 days through, among other means, the exercise of any option, warrant or right or through the conversion of a security. If a right has been acquired for the purpose or with the effect of changing or influencing the control of the issuer, the holder is treated as the beneficial owner regardless of when the right may be exercisable, convertible or exchangeable. Derivative securities that, by their terms, only entitle the holder to economic exposure with respect to the reference security,¹⁵ typically are not considered to vest the holder with beneficial ownership. Proposed Rule 13d-3(e) would deem holders of certain cash-settled derivative securities to be the beneficial owners of the reference securities.¹⁶

The SEC notes that the proposed changes address the commercial relationship in such cash-settled derivatives. An investor in a cash-settled derivative may be positioned, by virtue of its commercial relationship with a counterparty, to acquire any reference securities that the counterparty may acquire to hedge the economic risk of that transaction, including any obligations that may arise in connection with settlement. Such cash-settled derivative instruments may, in any case, result in a rapid accumulation of the reference security by a counterparty that could contribute to a change in control of the issuer. The SEC further notes that holders of these derivatives may have economic power that can be used to influence the control of an issuer.

Proposed Rule 13d-3(e) only would treat the holder of a cash-settled derivative security as the beneficial owner of the reference security where the instrument is held with the purpose or effect of changing or influencing the control of the issuer, or in connection with or as a participant in any transaction having such purpose or effect. The SEC believes that this determination would be relatively streamlined as compared with other potential bases for determining that such instruments constitute beneficial ownership.¹⁷ We expect that, if adopted, the impact of the new rule principally would be limited to activist shareholders who report their positions on Schedule 13D, given the applicable "control" threshold requirement in the proposed rule.

A holder of a cash-settled derivative security would be deemed to be the beneficial owner of the greater of (i) the product obtained by multiplying (a) the number of securities by reference to which the amount payable under the derivative security is determined, by (b) the delta of the derivative security and (ii) the number obtained by (x) dividing the notional amount of the derivative security by the most recent closing market price of the reference equity security, and then (y) multiplying such quotient by the delta of the derivative security. For these purposes, the "delta" means the ratio that is obtained by comparing (A) the change in value of the derivative security to (B) the change in the value of the reference equity security. If a derivative security does not have a fixed delta, the delta needs to be calculated on a daily basis.

In addition, the SEC has proposed amendments to Item 6 of Schedule 13D in order to clarify that disclosure is required of all derivative securities that use the registered class of equity security as a reference security, including cash-settled derivative securities.

Proposed Amendments Relating to the Regulation of "Groups"

Sections 13(d)(3) and 13(g)(3) of the Exchange Act provide that "[w]hen two or more persons act as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding, or disposing of securities of an issuer, such syndicate or group shall be deemed a 'person" for the purposes of this subsection." (emphasis added) Rule 13d-5(b)(1) provides that "[w]hen two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer, the group formed thereby shall be deemed to have acquired beneficial ownership, for purposes of sections 13(d) and (g) of the Act, as of the date of such agreement, of all equity securities of that issuer beneficially owned by any such persons." (emphasis added)

While the statutory provisions do not require an agreement and only require that two or more persons "act as [a group]," Rule 13d-5(b)(1) expressly requires an agreement to act. The SEC notes that Rule 13d-5(b)(1) was not intended to represent the exclusive legal standard for group formation and is proposing to amend the rule to align the wording with the statutory language in order to clarify that no formal or implied agreement is required for group formation. In addition, to further regulate group activity, the SEC has proposed the following additional rules:

• new Rule 13d-5(b)(ii), which provides that if a person, in advance of filing a Schedule 13D, discloses to any other person that such filing will be made and such other person acquires securities in the registered class of equity security for which the Schedule 13D will be filed, those persons shall be deemed to have formed a group within the meaning of Section 13(d)(3) if the information was shared for the purpose of causing the other person to acquire such securities;
• new Rule 13d-5(b)(iii), which provides that a group subject to reporting obligations under Section 13(d) shall be deemed to acquire any additional equity securities acquired by a member of the group after the date of the group's formation; and
• corresponding provisions with regard to group formation and acquisitions subsequent to group formation applicable to groups of exempt investors filing on Schedule 13G.

In the Proposing Release, the SEC sets forth its views on group formation, referencing the legislative and regulatory history. Importantly, a number of courts have required an express or, at minimum, an implied agreement in order to determine that a group exists for purposes of Section 13(d).¹⁸ The SEC states that there is no indication that Congress intended that the determination of whether or not a group has been formed should be based upon the existence of an express or implied agreement among two or more persons. According to the SEC, the operative "act as" standard in the statutory provision "encompasses not only agreements in the classic contractual 'offer' and 'acceptance' sense of the term but also pooling arrangements, whether formal or informal, written or unwritten." Whether or not a group exists is dependent on the facts and circumstances, and requiring the existence of an agreement would place a burden on any party alleging the existence of a group that was not intended by Congress. Accordingly, the SEC has proposed the amendments to eliminate the potential for the rule to be misconstrued and used as a basis to narrow the application of Sections 13(d)(3) and 13(g)(3). Further, proposed Rule 13d-5(b)(iii) would clarify that the group remains subject to the reporting requirements subsequent to the date of the group's formation. Finally, because information that a person will make a Schedule 13D filing may be material information, the SEC is proposing Rule 13d-5(b)(ii) to subject so-called "wolf packs" to group regulation under Section 13(d).¹⁹

In addition to expanding the regulation of groups under Regulation 13D-G, the SEC is also proposing new rules to provide two exemptions for group activity. Under proposed Rule 13d-6(c), a group would not be deemed to have been formed solely as a result of concerted actions among two or more persons with respect to an issuer's equity securities, provided that communications among such persons or with the issuer are not undertaken with the purpose or effect of changing or influencing control of the issuer and such persons are acting independently and not pursuant to an agreement. The stated purpose of the proposed rule is to exempt communications among shareholders and shareholders' engagement activities with issuers relating to company performance or policy. However, as drafted the proposed rule could be read to cover all manner of group activity, including acquiring, holding, voting or disposing of the issuer's equity securities. We expect that the proposed rule will be revised to limit its application to such communications and engagement activities to more clearly reflect the SEC's intent.

Under proposed Rule 13d-6(d), parties who enter into a derivative instrument in the ordinary course of business will not be deemed to have formed a group, provided that such persons did not enter into the agreement relating to the derivative securities with the purpose or effect of changing or influencing control of the issuer. Given the proposed new rules governing group formation, the SEC is proposing this exemption so that financial institutions acting as derivatives counterparties would not be deemed to have formed a group with the purchasers of the derivative instruments.

Proposed Structured Data Requirement for Schedules 13D and 13G

Finally, the SEC is proposing that reports on Schedules 13D and 13G be filed using a structured, machine-readable data language. Schedules 13D and 13G would be required to be filed in part using an XML-based language specific to Schedules 13D and 13G ("13D/G-specific XML"). For both Schedules, all disclosures, including quantitative disclosures, textual narratives, and identification checkboxes, would be structured in 13D/G-specific XML under the proposal, with the exception of the exhibits to the Schedules, which would remain unstructured. The structured data requirement is intended to improve the accessibility and usability of the reports, allowing investors to access, aggregate and analyze the reported information in a more timely and efficient manner.

Footnotes

[1] Modernization of Beneficial Ownership Reporting, Release No. 33-11028 (February 10, 2022) (the "Proposing Release").

[2] Regulation 13D-G applies to beneficial ownership of equity securities of a class registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and certain equity securities of insurance companies and investment companies. Beneficial ownership of non-voting equity securities is not subject to Regulation 13D-G unless such securities are convertible into shares of a registered class of equity security.

[3] Under Rule 13d-1(b)(2), the QII only is required to file a Schedule 13G if its beneficial ownership exceeds 5% as of the end of the calendar year.

[4] Exempt investors would become subject to Section 13(d) by voluntarily or involuntarily acquiring more than 2% of the registered class of equity security within a period of 12 consecutive months. In such cases, the exempt investor may continue to qualify as a QII or passive investor.

[5] Rule 13d-2(a) provides that "[a]n acquisition or disposition of beneficial ownership of securities in an amount equal to one percent or more of the class of securities shall be deemed 'material' …; acquisitions or dispositions of less than those amounts may be material, depending upon the facts and circumstances."

[6] An amendment is not required if the only change is a change in the beneficial ownership percentage that results solely from a change in the aggregate number of shares outstanding.

[7] In addition, the QII or passive investor is subject to a "cooling-off" period beginning from the time of the change of its investment intent and ending on the 10th day following the filing of the Schedule 13D during which it may not vote its shares or acquire any additional shares.

[8] In addition, the passive investor is subject to a "cooling-off" period beginning from the time of reaching such level of beneficial ownership and ending on the 10th day following the filing of the Schedule 13D during which it may not vote its shares or acquire any additional shares.

[9] The proposed rules define "business day" for purposes of Regulation 13D-G to mean any day, other than a Saturday, Sunday or Federal holiday, from 6 a.m. to 10 p.m. Eastern time.

[10] See Proposing Release at text accompanying Note 70 where the SEC notes that "any disclosure provided by a Schedule 13G filer, in light of the infrequency of the reports and comparatively minimal statements required to be made, is effectively material."

[11] See Note 28 to the Proposing Release, citing testimony by David S. Ruder, Chairman of the SEC, and Charles C. Cox, Acting Chairman of the SEC, in 1987. The Dodd-Frank Wall Street Reform Act of 2010 amended Section 13(d)(1) of the Exchange Act to grant the SEC the authority to shorten the deadline for the initial Schedule 13D filing, but the SEC did not propose amendments prior to the current proposal. In 2011, Chairwoman Shapiro of the SEC stated that the SEC would begin a broad review of the beneficial ownership reporting rules, including whether to shorten the 10-day initial filing requirement for Schedule 13D filings and whether beneficial ownership reporting should be changed with respect to cash-settled equity swaps and other derivatives.

[12] The SEC also notes in the Proposing Release that QIIs and exempt investors may completely avoid reporting on Schedule 13G by selling down their positions prior to end of the calendar year (and, in the case of QIIs, selling down before the end of the month in cases where their ownership exceeded 10%).

[13] Section 13(g) of the Exchange Act was added to the Exchange Act in 1977. Following the enactment of Section 13(g), the SEC noted in Filing and Disclosure Requirements Relating to Beneficial Ownership, Release No. 34-14692 (Apr. 21, 1978) that requiring reporting by institutional investors who do not have a control intent also serves the legislative intent of requiring disclosure of rapidly accumulated blocks of stock.

[14] Proposed Rule 13d-3(e) excludes security-based swaps. Separately, the SEC has proposed reporting requirements for security-based swap positions. 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, Release No. 34-93784 (Dec. 15, 2021).

[15] The SEC defines the term "reference security" to mean the class of securities into which a derivative security is convertible, exchangeable or exercisable for, or, alternatively, if not convertible into or exchangeable or exercisable for, the class of securities from which the derivative security has economic exposure and has its value determined according to the terms of the derivative's governing instrument. See Note 153 of the Proposing Release.

[16] Proposed Rule 13d-3(e) would not be the exclusive means by which a cash-settled derivative security could result in the determination that the holder is the beneficial owner of the reference securities. In the Proposing Release, the SEC notes that Regulation 13D-G does not define the terms "beneficial owner" or "beneficial ownership." Rather, Rule 13d-3(a) provides standards for the purpose of determining whether a person is a beneficial owner for purposes of Sections 13(d) and 13(g), and that all relevant facts and circumstances need to be analyzed to determine beneficial ownership.

[17] Rule 13d-3(b) provides that "[a]ny person who, directly or indirectly, creates or uses a trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose [or] effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements of section 13(d) or (g) of the Act shall be deemed for purposes of such sections to be the beneficial owner of such security." The SEC notes that if an arrangement or understanding exists outside of the terms of a derivative instrument that enables an investor to acquire the reference securities from a counterparty, the reference securities could be viewed as having been impermissibly "parked" with the counterparty on behalf of the derivative holder. See also Note 97 of the Proposing Release where the SEC observes that application of Rule 13d-3(b) would require an examination of the facts and circumstances surrounding the relationship between the holder of the cash-settled derivative security and the counterparty, the intentions of the parties and the effect of the relationship on the holder's beneficial ownership. In CSX Corp. v. Children's Inv. Fund Mgmt. (UK) LLP, 562 F. Supp. 2d 511 (S.D.N.Y.), aff'd, 292 F. App'x 133 (2d Cir. 2008), and aff'd in part, vacated in part, remanded, 654 F.3d 276 (2d Cir. 2011), a federal district court held that an activist fund was the beneficial owner of shares owned by its counterparties to multiple cash-settled total return equity swaps under Rule 13d-3(b).

[18] Determination of the existence of a group also may be relevant under Section 16 of the Exchange Act because the determination of whether a person is a greater than 10% beneficial owner subject to Section 16 is based on whether a person is a greater than 10% beneficial owner under Section 13(d) of the Exchange Act. See SEC Rule 16a-1(a)(1). The SEC notes in the Proposing Release that the proposed changes to Regulation 13D-G relating to groups and other proposed changes to Regulation 13D-G also would affect the determination of whether a person or group is a greater than 10% beneficial owner for purposes of Section 16, but expresses its view that, given the regulatory purposes of Rule 16a-1(a)(1), it is appropriate to continue to apply the standards of Regulation 13D-G, as proposed to be amended, to determine greater than 10% beneficial owners under Section 16.

[19] The SEC has not proposed that disclosure by a person that it will make a Schedule 13G filing would be subject to this potential group formation criteria. Nevertheless, the SEC states that Rule 13d-5(b)(ii) is not an exclusive basis for determining the existence of a group based on a tipper-tippee relationship. Further, one of the questions that the SEC has sought comment on is whether proposed Rule 13d-5(b)(ii) should be expanded to cover Schedule 13G filers.