Environmental, Social & Governance Briefs

13F proposal — the SEC can (and should) do better

August 26, 2020

On the ESG Blog, we’re pleased to feature pieces by thought-leaders in our field. The following post by Robert Lamm, an Governance & Sustainability Center Fellow (among the multiple other hats he wears) is worth reading. While those who are not securities lawyers may find their eyes glaze over when they see a reference to Form 13F, as Bob points out, the SEC’s proposal on this topic could have a significant impact on companies being aware of, as well responding to and engaging with, activist investors – especially at relatively smaller companies, which as we’ve pointed out in prior Conference Board reports (Proxy Voting Analytics (2016-2019) and Corporate Governance Challenges in the COVID-19 Crisis) and in our upcoming report on Board Practices, are increasingly susceptible to activism.

(This post originally appeared on The Securities Edge, a blog by the law firm Gunster's Securities and Corporate Governance Practice Group)

From where I sit, the SEC under the chairmanship of Jay Clayton has generally done a good job for public companies.  It has adopted a number of rules and amendments that make disclosure more effective without appreciably adding to – and in some cases reducing – the burdens on public companies.  Examples include streamlining financial disclosure requirements, rationalizing the definitions of “smaller reporting company”, “accelerated filer”, and “large accelerated filer”, and revising the rules governing financial statements of acquired and disposed businesses (although the latter do not take effect until 2021). And let’s not forget the very recent rule changes affecting proxy advisory firms, including a critical requirement that those firms provide companies with their voting recommendations.

While I wish that the SEC had also focused on proxy plumbing, it’s still a pretty good record, and it’s only a partial listing.

However (you knew there would be a “however”), I’m profoundly disappointed in the SEC’s proposal to “fix” Form 13F – the form on which large investment managers report their equity holdings of public companies.  While it’s nice that the SEC has turned its attention to a form that has long been in need of updating, the proposal seems to me to be unacceptable in at least two major respects.

First, it would increase the reporting threshold from $100 million to $3.5 billion.  The proposing release notes that the increase in the reporting threshold reflects “the change in size and structure of the U.S. equities market since 1975,” when the 13F requirement was enacted.  True, but the proposal seems to focus on some changes in the equity markets rather than others.  For example, it notes that “raising the reporting threshold… to $3.5 billion… would retain disclosure of 90.8 percent of the dollar value of the Form 13F holdings data currently reported while relieving the reporting burdens from approximately 4,500 Form 13F filers, or approximately 89.2 percent of all current filers.” Again, true, but what’s not addressed is that raising the reporting threshold will have a significantly disproportionate impact on smaller companies, who are hard-pressed to know who their owners are.

For a great analysis of the proposal, I urge you to read a fascinating Alliance Advisors report on the proposal.  However, I’ll quote some salient details for your convenience:

• “[T]he rule change will have a minimal impact on large-cap companies because it takes a large investment to accumulate a sizable position in large-cap companies…. While the average shareholder visibility among the bottom five market capitalization companies in this segment declined by slightly more than two percentage points than its top five counterparts, the overall impact likewise was non- material.”

• “Without question, the rule change will have the largest impact on shareholder visibility among the small-cap companies. In part, the relatively thinly traded nature of small caps serves as a deterrent of deep-pocketed institutions that worry about the adverse impact on a stock’s price will have if they try to build/unload a large block of stock. In addition, institutions with limited capital can more easily amass a meaningful position in small-caps. Thus, smaller institutions tend to dominate the shareholder bases of these companies” (emphasis added).

Anyone who has experience trying to determine the identities of shareholders – regardless of company size – knows how difficult it is to do so.  As I see it, the proposed amendment not only doesn’t help; in fact, it makes the situation worse for companies that have enough resource challenges as it is.

The Alliance Advisors report also points out that “the most alarming unintended consequence” of the proposed amendment “will be the ‘disappearance’ of the activist investor.”  This is a matter of particular concern to smaller-cap companies which, despite the media coverage of activist campaigns against well known, large-cap companies, are much more likely to be the targets of activism.

Finally, it strikes me as “interesting” (in the worst possible way) that even as the SEC notes the extensive changes in the equity markets since 1975, it seems to have ignored other changes since then, including technology, by failing to propose that 13F reports be submitted sooner than the current deadline, 45 days after quarter-end.

If anyone at the SEC is reading this, please show the leadership and thought that have gone into so many other reforms in the last few years by coming up with a proposal that helps smaller companies in an area where help is very much needed.