Disclosure is an extremely valuable aspect of the current corporate law landscape, and scholars have been increasingly referring to it and engaging with in-depth discussions on the topic. The necessity to improve disclosure is not limited to corporate and financial information, nor is it limited to a precise geographical perimeter, but has recently been extended by several legislative initiatives in the field of environmental, social and governance (‘ESG’) information. After being reiterated in the EU Commission Communication entitled ‘A renewed EU strategy 2011-14 for Corporate Social Responsibility’, adopted on 25th October 2011, this idea has been further developed in the Directive 2014/95/EU as to the disclosure of non-financial and diversity information by certain large companies and groups.
My Article aims to advance this lively debate by evaluating the claim that disclosure requirements adopted under Section 13(d) of the US Securities Exchange Act of 1934 (the ‘Section 13(d)’), which requires ‘a purchaser that beneficially owns 5 percent or more of a class of a Public Target Company’s equity securities […] to promptly disclose its “plans or proposals” to acquire additional securities of the Public Target Company or merge with the Public Target Company’ no later than 10 days following such 5% acquisition, should be amended. Such plans or proposals are regarded as ‘formed’ when they clearly express well-defined plans, not just simple predictions of future behaviour or provisional or early-stage plans.
A few words are in order about the emergence of the view that Section 13(d) is anachronistic and should be updated to the most recent business needs.
The argument that Section 13(d) needs updating initially emerged in a formal petition addressed to the SEC on 7 March 2011 by the law firm Wachtell, Lipton, Rosen & Katz, advising wide-ranging and far-reaching amendments to section 13(d). The petition called for reporting rules to be better aligned with the explicit purposes set out in the statute, and for the closure of loopholes emerging from changing market conditions and practices since the adoption of the statute more than 40 years ago, which were said to be being exploited by purchasers to the detriment of public markets and security holders. Since the section’s introduction, higher trading volumes, electronic trading and use of derivatives allowing to accumulate massive stakes in very short time frame have become the norm. Moreover, activists acquire substantial private information after the trigger day, and might use it to the detriment of dispersed shareholders.
Three years later, in 2014, another prominent rulemaking petition was submitted to the SEC by the same US law firm, suggesting once again the need to warn the market as soon as possible about creeping threats to control. The document heavily emphasized that the current rule, enacted a long time ago by the Congress in the context of the Williams Act of 1968, no longer serves the prime (and sole) purpose for which it was introduced, whereas it does affects prices after the filing of the Schedule 13(d) notice. The Dodd-Frank Act (§766(e)) also suggests to shorten the Section 13(d) window, and to broaden the definition of beneficial ownership—which is essential to invoke the filing requirement—so as to include a wider range of equity derivatives, and former SEC Commissioner Mary Shapiro announced a review of these questions, embracing the position advocating a modernisation of the rule towards transparency, keeping up with rivals. According to the coeval press, in 1987, when a leading piece on the topic was being published, Congress was on the verge of reducing the acquisition threshold percentage to two percent and shortening the window from ten days to two (or even one) day(s), thus accommodating the tech demands, but in 2011, the SEC Commissioner announced that the matter was not on the agenda and that there was still a lot of controversies over the rule. The latest attempt to revise the provision under discussion was prompted by Senators Jeff Merkley and Tammy Baldwin, who introduced the Brokaw Act on 17 March 2016. This proposal stemmed from concern that activist hedge funds would inflate and capitalize on short-term profits at the expense of long-term policies.
My article does not offer any additional empirical analyses or event studies, but relies (and builds) on the data presented in the two key papers on the topic (Alon Brav et al. (2008), Ulf von Lilienfeld-Toal & Jan Schnitzler (2014)), which suggest that shareholders may attach crucial importance to information about a change in corporate control, since, on the one hand, ownership disclosure rules could deprive the market of potentially valuable insights over the reporting period and, on the other hand, a lack of transparency could boost the market for corporate control.
Investors using the entire window at their disposal can accumulate shares that cross the threshold through the purchase of a large number of shares, as Carl Icahn did, exactly when they exceed that ceiling. These situations further clarify that a shorter reporting window can lead to a substantial reduction in the size of the initial disclosure. In addition, modern business dynamics do not provide us with any reason to update the aged Section 13(d) and the practice of almost all major world capital market jurisdictions, from the United Kingdom to Australia, from France to Germany, from Spain to Switzerland, from Hong Kong to Italy, suggest such a change in the reporting window only in order to harmonize playing conditions.
In conclusion, it is clear that activists are largely gaining the advantage of the ten-day window to accumulate shares, aligning their investment strategy with the existing regulatory environment, while the exact effects of a stricter rule are still uncertain.
On the one hand, the reduction of the reporting window could improve price efficiency, so while the SEC maintains the rule unchanged, companies can still protect themselves against acquisitions even slightly above the threshold through (i) a ‘window closing’ pill (if circumstances permit it), stressing that issuers who intend to adopt it should avoid creating a protective pill, whereby shareholders who comply with the rules are allowed to buy additional shares without triggering the dilution mechanism, or (ii) an ‘advance-notice’ pill, whereby investors who do not disclose their holdings within one or two days would trigger such a poison pill.
On the other hand, shortening the reporting window (even if a late disclosure is accepted in return for a deposit fee on block holders) would affect the investors' ability to launch campaigns, reducing the staggering profits accrued as a result of their participation, thus making the accrual of shares more expensive. In addition, this ‘window amendment’ and the associated increased transparency could impinge on the contestability of the market for corporate control, with the sole exception of those cases where investors are actually able to adapt their investment strategy to a new regulatory framework, disrupting the logic of activists and providing early warning to the management. This impact could also be positive in terms of a deeper understanding of the controlling entity and the free float, thereby encouraging competitive bidding to deter bidders who have accumulated undisclosed holdings from turning out to be unprivileged.
In the firm belief that ‘real-time disclosure’ is always ‘the best of all possible worlds’, but that the existing system works without problems, my article identifies the two issues that the SEC should address by changing the rules of the game (Part II and III) and analyses the pros and cons of an extension of the rule (Part IV).
In light of the above considerations, looking at the distinctive features of the US legislative and regulatory environment that mirror the commitment to transparency in domestic stock markets, I conclude that: (i) while stricter reporting rules would lead to greater market transparency, the associated social costs would be unclear; (ii) shortening the reporting window could potentially allow investors to keep holding on to their ability to get a foothold and ensure market fairness at the same time, whilst not neglecting disclosure concerns. But this is an uncertain effect, which needs to be concretely demonstrated (ie tested), while, on the basis of the above mentioned evidence and empirical data, the existing rule works flawlessly.
Maria Lucia Passador is an Academic Fellow at the Department of Law, Bocconi University in Milan.