Under current law, an investor who has accumulated in excess of 5% of a public company’s
outstanding stock must disclose such ownership and intent on a Schedule 13D within
10 calendar days of crossing the 5% threshold. The Dodd-Frank Wall Street Reform
and Consumer Protection Act was signed into law by President Obama on July 21, 2010
and, in part, empowers (but does not require) the SEC to establish rules to shorten
this 10 day deadline. There has been great debate over this provision. Wachtell,
Lipton, Rosen & Katz (“WLRK”) has been the law firm at the forefront of advocating
for a shortening of the 10 day period and JANA Partners is one of the investors
who has joined together to oppose the WLRK proposal. In our first installment of
our Point/Counterpoint column, David Katz, corporate partner at WLRK, will argue
for shortening the 10 day period, and Charlie Penner, Partner and Chief Legal Officer
of JANA Partners, will argue against the WLKR proposal.
DAVID A. KATZ
Recent maneuvers by activist investors both in the U.S. and abroad demonstrate,
yet again, the extent to which current reporting gaps in the Schedule 13D compliance
regime are being exploited, to the detriment of issuers, other investors, and the
global financial markets. The current ten-day window for the initial filing of a
Schedule 13D results in the investment community trading on an underinformed basis,
without the benefit of material information, while encouraging acquirers and other
opportunist investors to engage in “stealth” acquisitions of significant positions
to the detriment of their counterparties and issuers, and contrary to the purposes
of the Williams Act. It is time to require that an initial Schedule 13D filing be
made no later than one business day following the crossing of the 5% ownership threshold.
The crossing of the 5% threshold is at least as material as amendments to existing
Schedule 13D filings, which the SEC requires to be made “promptly” – within one
The ten-day reporting lag after the Section 13(d) ownership reporting threshold
is crossed facilitates market manipulation and abusive tactics. While ten days might
have been reasonable in 1968 when the Williams Act was enacted, when SEC filings
had to be mailed or put on a plane and there were no fax machines or electronic
filings, that is not longer the case. Over the last 44 years, it has become common
tactic for aggressive investors to intentionally structure their acquisition strategies
to exploit the gaps created by the current Schedule 13D reporting requirements for
their own short-term benefit and to the overall detriment of market transparency
and investor confidence. There is no reason that purchasers of significant ownership
stakes in public companies should be permitted to hide their actions from other
investors, the financial markets and the issuer.
The purpose of the Section 13(d) disclosure requirements has always been to “alert
investors in securities markets to potential changes in corporate control and to
provide them with an opportunity to evaluate the effect of these potential changes.”
This purpose is no longer being properly served. For almost three decades, the SEC
has observed that the ten-day reporting lag leaves a substantial gap after the reporting
threshold has been crossed during which the market is deprived of material information,
and creates incentives for abusive tactics on the part of aggressive investors prior
to making a filing. Such investors frequently secretly continue to accumulate shares
during this period, acquiring substantial influence and potential control over an
issuer without other investors (or the issuer) having any information about the
acquiror or its plans and purposes at the time a counterparty sells their shares.
This serves the interest of no one but the investor seeking to exploit this period
of permissible silence to acquire securities at a discount to the market price that
may result from its delayed disclosures.
The pragmatic reasons which may have motivated the inclusion of a ten-day reporting
lag in the Williams Act no longer apply. Changes in technology, acquisition mechanics
and trading practices give acquirers the ability to make these types of reports
with very little advance preparation time. The advent of computerized trading has
upended traditional timelines for the acquisition of shares, allowing massive volumes
of shares to trade in a matter of seconds. The increasing use of derivatives has
accelerated the ability of investors to accumulate economic ownership of shares,
usually with substantial leverage. Furthermore, the financial markets rely on the
expectation that material information regarding potential control positions will
be disseminated promptly and widely, in no small part due to the impact of the internet
and online information exchange. In today’s financial markets, ten days is an eternity.
These changes and trends have been explicitly recognized by the SEC in the context
of other reporting rules, both through the implementation of additional disclosure
requirements and the shortened timelines that have been adopted for other types
of filings, such as Form 8-Ks and Section 16 filings. In perhaps the most extreme
example, following the enactment of Regulation FD in 2000, issuers are generally
required to inform the market broadly of any material, non-public information simultaneously
with its intentional disclosure to any outside party. These changes illustrate a
marked trend by the SEC toward greater transparency and more immediate disclosure
of information material to investors, which should now be applied to the Section
13(d) reporting requirements.
The reporting regime in the United States must evolve if it is to continue to perform
the vital function for which it was initially implemented and to conform to the
current norm for developed markets throughout the world. Shortened deadlines have
been required for years in other developed financial markets, including the United
Kingdom, Canada, Germany, Australia and Hong Kong. The U.S. should, at a minimum,
offer investors an equivalent level of available information on as timely a basis
as other markets, in order to maintain investor confidence in the integrity of the
U.S. trading markets. No special policy or practicality concerns mandate that the
U.S. retain its outdated, overly permissive reporting deadlines. Moreover, the type
of investor who acquires a 5% stake in a public company will almost always be a
sophisticated, experienced investor, with the resources to submit the required filings
promptly, particularly as these forms can be substantially prepared prior to crossing
the 5% threshold.
The prospect of possible closing of the ten-day window has already generated vocal
opposition by the hedge fund activists who have consistently used the window to
their own advantage. One frequent argument is that the tenday window period is needed
to incentivize hedge funds to make sizable investments in companies seeking to force
company actions that generate short-term profits arguably for the benefit of the
issuer’s shareholders. However, the purpose of the 13D window period was never to
grant a hunting license to hedge funds to make extraordinary profits by trading
ahead of the undisclosed, market-moving information contained in their delayed 13D
filings, nor to provide additional inducements to spur hedge fund activity. The
activists’ purported rationale for the window period is directly contrary to the
overall purposes of the 13D reporting requirements – namely, to inform investors
and the market promptly of potential acquisitions of control and influence so that
investors have equal access to this material information before trading their shares.
In enacting the Dodd-Frank Act, Congress specifically authorized the SEC to shorten
the filing window: Congress modified Section 13(d)(1) of the Exchange Act to read
“within ten days after such acquisition, or within such shorter time as the [SEC}
may establish by rule.” This explicit grant of authority demonstrates Congress’
recognition of the need for prompt corrective action, as exemplified by numerous
dramatic abuses of the ten-day window period.
The need for reform could not be clearer.
Examining the arguments behind this proposal makes clear why it has failed to gain
traction with shareholders. While the premise is that shareholders today are harmed
by accumulations during the filing window, no evidence of actual harm arising from
such accumulations has been offered. The truth is that these accumulations only
have an impact to the extent that they create or increase an actively engaged shareholder’s
incentive to propose change (absent such activity such accumulations would be no
different than ordinary purchases). While WLRK claims that shareholder proposals
for change promote “short-termism,” the evidence shows that such proposals typically
generate substantial value creation and enliven shareholder democracy.
If a company’s shareholders support such proposals, it is likely not because they
have suddenly become obsessed with the short-term. It is because the shareholders
who gave up and sold and those who remain and support change do not believe in the
board’s plan to create value, meaning change is likely in order. In addition, because
an active shareholder will only succeed if it has or is expected to win shareholder
support, WLRK’s claims imply that shareholders lack the judgment to choose between
shareholder and company proposals. This runs counter to SEC Chairman Schapiro’s
expressed faith in shareholder wisdom and call for greater shareholder engagement.
Boards with better ideas have ample time (given the proxy rules and lengthy advance
notice provisions) and resources (given that they are using company money and have
better company knowledge) to argue for the status quo, and often successfully do.
So this proposal would not as WLRK has claimed “level the playing field,” but rather
seeks to keep one side off the field entirely by reducing the incentive for shareholders
to propose value-creating change and sparing underperforming boards from having
WLRK next claims that active shareholder accumulations during the window undermine
the intent of the Williams Act. However, this assertion conflates coercive tender
offers, which were the Act’s focus and which have largely disappeared due to the
rise of state and federal antitakeover laws and the advent of the poison pill, with
today’s active engagement, which did not exist at the time (while proxy contests
existed, the Act’s drafters noted that those were already well-regulated). They
are entirely different. A hostile acquirer seeks to share as little value creation
as possible, while an active shareholder only profits along with other shareholders.
Ownership actually changes hands in a takeover, while following an activist campaign
shareholders still own the company but may have new board representatives, typically
a minority. Unlike a hostile acquirer, those representatives have legal duties to
It is true that shareholders who sell during the window do not share in such benefits
(although they do benefit from increased liquidity). It is axiomatic however that
someone must sell in order for someone else to buy. It would be a Pyrrhic victory
for sellers to obtain earlier disclosure of an activity which in turn reduced the
incidences of that activity. It would also be a loss for the far larger majority
of shareholders who do not sell, and it would be a confounding policy decision to
place the interests of shareholders who make the short-term decision to sell (and
are always free to re-invest) ahead of those of the remaining shareholders and the
shareholder proposing change.
WLRK has allowed that “one could perhaps debate” the benefits of incentivizing active
engagement, but claims that the Act precludes such debate and that such arguments
if taken to their “logical extreme” would mean abolishing the Act. No one is proposing
that, only objecting to narrow “updates” that ignore modern realities and only benefit
incumbents. It is highly telling that, while the proposal claims to address supposed
growth in accumulations during the window, it targets accumulations of any size.
Moreover, WLRK cannot argue that a law is frozen in amber while also advocating
“modernization” of that law. If the rules are to be re-opened at all then actual
evidence and defensible policy goals should be employed, which would likely lead
to proposals to encourage, not burden, active engagement.
WLRK also argues that its proposal is consistent with recent changes requiring greater
corporate disclosure. However, they ignore the rationales for those changes, and
that there are a variety of longer (up to 45 days) and shorter deadlines because
each deadline must balance transparency with not overly burdening beneficial activity.
For example, companies must now provide greater compensation disclosure, but this
change was made to enhance accountability and does not burden any activity (other
than overpaying CEO’s for poor performance). Conversely, closing the 10-day window
would have the opposite impact by reducing accountability to shareholders for performance.
The 8-K window was also shortened, but again no legitimate activity was thus burdened.
Contrast this with Section 13(d), whose drafters revised the deadline twice to avoid
overly burdening takeover attempts (which is notable given that presumably even
greater care should be taken to avoid burdening active shareholder engagement given
that it seeks to create more widespread value). WLRK has also pointed to Regulation
FD’s simultaneous disclosure requirement, which borders on non sequitur given that
the very point of that regulation was to address non-simultaneous disclosure by
WLRK advocates a similarly selective and context-free approach to foreign laws.
It is true that in other countries filers must often report earlier (which is nothing
new), but typically they only disclose their name and ownership unless they plan
to acquire the company, because those countries make sensible distinctions between
active engagement and takeovers. Those countries typically also lack most of the
entrenchment devices found in the US including lengthy advance notice provisions,
high thresholds for calling special meetings and dismissing boards, and poison pills,
meaning shareholders can do more with less in those countries. One cannot cherry-pick
their favorite aspects of foreign laws while ignoring the rest.
We do not pretend there is any magic to the 5% threshold and 10 day window as applied
to today’s active engagement forty years later. They nevertheless set the current
balance and no legitimate reasons have been offered to narrowly adjust this balance
in a lopsided manner. Any changes also should acknowledge today’s vastly different
landscape, rather than only select developments since the 1970’s. This includes
acknowledging the virtual disappearance of coercive tender offers, the advent of
active shareholder engagement, and the fact that 5% is no longer even close to a
“controlling” interest given the development of antitakeover laws and entrenchment
mechanisms in the US and the influence of today’s large institutional investors.
WLRK are brilliant management advocates, but to become law their proposal must be
supported by facts and sound policy, and a year later it is clear that it is not.
A fresh start is necessary if any changes are to be made.