SEC disclosure change would allow activists to ‘go dark’, lawyers warn

Activist investors in the US stand to be big beneficiaries of a new rule from Wall Street’s top regulator that would allow most hedge funds to keep their equity stakes secret.

For more than four decades, any investor with $100m or more in US-listed securities has been required to detail their holdings to the US Securities and Exchange Commission every quarter. Under proposed new rules, that would step up to $3.5bn, leaving just 550 of the world’s largest investors reporting their bets.

The SEC’s proposed shift, announced this month, would mean companies that depend on quarterly filings by asset managers to keep tabs on their investor base will lose access to reports from 90 per cent of investors, including activists that might be trying to force them into big changes in strategy.

“A foundational aspect of being a public company — for both companies and investors — is knowing who owns the shares,” said Adam Emmerich, a partner at Wachtell, Lipton, Rosen & Katz, who focuses on corporate governance and securities law. “Activists don’t need a lot of money to have an impact, so it’s not only firms with $3.5bn in SEC-registered securities who are relevant.”

While big activists such as Paul Singer’s Elliott Management and Carl Icahn may have enough money invested in equities to put them above that threshold, smaller managers will be able to build stakes undetected, legal experts say. 

That includes Starboard Value, the $6bn-in-assets firm run by Jeff Smith, which is among the most prolific activist investors. In the first quarter of 2019, for example, the New York-based firm launched more campaigns than Elliott, despite having about a seventh of its assets. 

But with just under $2.5bn invested in US equities at the end of March 2020, Starboard Value, which has led campaigns against drugmaker Bristol-Myers Squibb and ecommerce giant eBay, would not be required to disclose its positions to the SEC under the proposed change.

In a report published last week, Mr Emmerich and his colleagues highlighted a number of other notable activist funds, such as Corvex Management, Sachem Head and Jana Partners, which would fall below the new threshold and be able to “go dark”. 

Adopting this revised rule would “make it significantly more difficult to determine whether an activist, or a ‘wolf pack’ of activists, owns a stake in a company”, the report said.

Line chart of Market cap of US-listed domestic companies showing US equity market has expanded since 13F rules were set up

Jim Rossman, head of shareholder advisory at Lazard, said he was “surprised” by the SEC’s decision to limit disclosures, since hedge funds already have the ability to withhold certain stakes — in agreement with the regulator — if they feel a position is too sensitive to disclose. When building a stake in a company, for example, they may use this exception to avoid encouraging other investors to pile in and drive up the price.

But Mr Rossman added the change would provide “another significant shield” around activists given the small proportion of funds that have more than $3.5bn in equities at any one time.

Lazard uses publicly available information, including these so-called 13F filings, to publish a quarterly report on shareholder activism. However, Mr Rossman said the firm encouraged companies to use surveillance firms that track share custodians’ flows to spot patterns in who is buying and selling their shares.

One such information agent, Okapi Partners, said the new rules could be detrimental to activists themselves as well as to companies. 

“Certainly for the companies the lack of transparency is problematic,” said Bruce Goldfarb, chief executive of the firm, which is often employed to drum up support during an activist campaign. “But the investors who think the lack of transparency will help them are missing the point. They will want to find who the other shareholders are to garner support.”

The proposal has come despite widespread calls for greater transparency from investors and companies. Industry bodies have long petitioned to shorten the reporting deadline for 13Fs from the current 45 days.

The SEC said the change — out for a 60-day consultation — was necessary to reflect how much the US equity market has grown since the 13F rules were set up, from just over $1n in total capitalisation in 1975 to more than $35tn today. In a statement, chairman Jay Clayton said the proposal “furthers the statutory goal of enabling the SEC to monitor holdings of larger investment managers while reducing unnecessary burdens on smaller managers”. 

The regulator also recently dropped a requirement that would have forced proxy advisers — led by Institutional Shareholder Services and Glass Lewis — to give companies access to proxy voting materials before they are sent to shareholders. Activists including Elliott and Third Point had fought against the measure.

Allison Herren Lee, the sole Democratic commissioner on the SEC’s panel of four, said that the regulator should have developed a better understanding of how 13F disclosures were used, and by whom, before recommending such a drastic step. 

“We’re reducing transparency without doing a deep enough dive to consider at what cost, particularly when you consider the size of some of the managers we’re dealing with that will be excluded [from the requirement],” she added.