Section 13 – Beneficial Shareholder Reporting Requirements – Part II

2024-05-06

The amendments update Sections 13(d), 13(g) and Regulation 13D-G to accelerate filing deadlines for both initial and amended reports; expand the timeframe within a business day in which filings may be timely made; and require that Schedule 13D and 13G filings be filed using XBRL.

The final rules do not adopt proposed changes to determine beneficial ownership where a person holds cash settled derivative securities but rather refer to guidance on the subject.  Likewise, the final rules do not adopt many changes that had been proposed to clarify the circumstances under which two or more persons have formed a “group” that would be subject to beneficial ownership reporting obligations; or to provide new exemptions to permit certain persons to communicate and consult with one another, and jointly engage issuers.   However, the SEC did issue guidance intended to provide clarity on the circumstances in which a person may be deemed to have formed a group with another person or persons within the meaning of sections 13(d)(3) and 13(g)(3). The SEC also adopted several amendments clarifying group obligations when executing certain transactions after a group has been formed.

Compliance with the revised Schedule 13G filing deadlines will be required beginning on Sept. 30, 2024. Compliance with the XBRL requirements for Schedules 13D and 13G will be required on Dec. 18, 2024. Compliance with the other rule amendments will be required upon the new rules’ effectiveness which is February 5, 2024.

In Part I of this blog series, I delved into the changes to the initial and amendment filing deadlines for Schedules 13D and 13G (see HERE).  In this Part II, I am covering derivative securities and the new SEC guidance on “groups.”

Derivative Securities

In general, the Exchange Act does not define the term “beneficial ownership.”  To provide clarity for purposes of complying with Section 13 when a person owns derivative securities, Rule 13d-3 provides that a person is “deemed” a beneficial owner of a covered class if that person holds a right to acquire the covered class, for example, through the exercise of an option or warrant or conversion of a security, that is exercisable or convertible within 60 days.  In addition, if a right has been acquired for the purpose or with the effect of changing or influencing control of the issuer of securities, that person is treated as a beneficial owner of the underlying class of equity securities regardless of when that right may be exercisable, exchangeable or convertible.

On the other hand, holders of derivative securities settled exclusively in cash do not have enforceable rights or any other entitlements with respect to the reference security and as such have not been included in beneficial ownership calculations.  The SEC believes these holders may have both the incentive and ability to influence control over the company, including through contracts with counterparties, and accordingly proposed they be included in ownership calculations.

However, in response to numerous comments the SEC determined not to adopt the proposed rule changes but rather have referred to published guidance related to security based swaps.  The SEC believes the same reasoning can apply to an analysis of any cash settled derivative, and in particular, that a holder may be deemed a beneficial owner if the cash settled derivative security: (i) confers contractual voting and/or investment power (or a person otherwise acquires such power based on the purchase or sale); (ii) is used with the purpose or effect of divesting or preventing the vesting of beneficial ownership as part of a plan or scheme to evade the reporting requirements; or (iii) grants a right to acquire an equity security.

Groups

The proposed rules made several changes to Rules 13d-5(b) and Sections 13(d)(3) and 13(g)(3) regarding determining when two or more persons are acting as a group.  Neither the statute nor rules provide an actual definition of a “group.”  Sections 13(d) and 13(g) provide identical language regarding groups, to wit: “[w]hen two or more persons act as a . . . group for the purpose of acquiring, holding, or disposing of securities of an issuer, such . . . group shall be deemed a ‘person.’”

In response to comments, the SEC did not adopt most of the proposed rules but rather issued guidance on the operation of existing Rule 13d-5(b) and sections 13(d)(3) and 13(g)(3) that clarifies and affirms that, among other matters, two or more persons who “act as” a group for purposes of acquiring, holding, or disposing securities may be treated as a group.

The SEC’s objective with the proposed changes was to provide clarity on whether a group is formed if, among other things, a person shares information about an upcoming Schedule 13D filing that the person is or will be required to make and not to change the SEC’s views on what is meant to “act as a group.”  That is, the SEC’s view is that “the determination of whether two or more persons are acting as a group does not depend solely on the presence of an express agreement and that, depending on the particular facts and circumstances, concerted actions by two or more persons for the purpose of acquiring, holding or disposing of securities of an issuer are sufficient to constitute the formation of a group.”

On the other hand, a group does require some evidence of an agreement, arrangement, understanding, or concerted action. The determination depends on an analysis of all the relevant facts and circumstances and not solely on the presence or absence of an express agreement, as two or more persons may take concerted action or agree informally. Clarifying further, the evidence must show, at a minimum, indicia, such as an informal arrangement or coordination in furtherance, of a common purpose to acquire, hold, or dispose of securities of an issuer.

The SEC rule release continues its guidance by providing a question and answer format as to some common scenarios (much like C&DIs).  A summary of the questions and answers include:

  • Communications between two or more shareholders regarding a company or its securities, including related to improving long term performance, changes in practices, potential submissions or solicitations in support of a non-binding shareholder proposal, joint engagement strategy or even a “vote no” campaign against an individual director, does not result in the formation of a group without more. An exchange of views and any other type of oral or written dialogue not involving an intent to engage in concerted actions or other agreement with respect to the acquisition, holding, or disposition of securities, standing alone, would not constitute an “act” resulting in the formation of a group.
  • Similarly, a group is not formed when two or more shareholders engage in communications with a company’s management without taking any other action.
  • A group is not formed when shareholder jointly make recommendations to a company regarding the structure and composition of the board of directors where: (i) there is no discussion regarding expanding the board or of individual directors; and (ii) no commitments are made, or agreements or understandings reached among the shareholders regarding the withholding of votes.
  • A group is not formed if shareholders jointly submit a non-binding shareholder proposal pursuant to Exchange Act Rule 14a-8 (see HERE and HERE for more on Rule 14a-8). The non-binding nature of the proposal is key here.
  • A communication or meeting between a shareholder and an activist investor that is seeking support for its proposals would not, without more, constitute the formation of a group. If on the other hand, the shareholder agreed to act with the activist investor or engaged in joint activities, a group may be formed.
  • An announcement or communication by a shareholder of an intention to vote in favor of an unaffiliated activist investor’s director nominees, would not, without more, constitute the formation of a group.
  • Where a shareholder that will be required to file a Schedule 13D intentionally communicates with other shareholders to encourage their purchases of the company’s equity, and such other shareholders proceed to make purchases as a direct result of the communications, a group may be formed. In such a case, it is possible that the communications were for the purpose of enticing group action and did indeed entice such action involving the acquisition of securities.

In addition, the SEC adopted several amendments to Rule 13d-5 including: (i) specifying 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 group’s formation; (ii) carving out intra-group transfers under both Sections 13(d) and 13(g); and (iii) a group regulated by Section 13(g) shall be deemed to acquire any additional equity securities acquired by a member of the group after the group’s formation.