The US Securities and Exchange Commission recently released updated and consolidated compliance and disclosure interpretations, promulgated under the general statutory framework of Sections 13(d) and 13(g) of the Securities Exchange Act of 1934 (the “Exchange Act”). These disclosure obligations are applicable to significant stockholders of public companies, generally beneficial holders of more than 5 percent of a class of a public company’s outstanding equity securities.
They also contain both restatements of positions previously taken by the SEC as well as new or clarified guidance that may impact disclosure obligations and practices for these stockholders, such as private equity and hedge funds, other private funds and institutional investors that often hold such significant positions. For fund managers and other private and institutional investors that routinely file Schedules 13D and 13G, the consolidated SEC interpretations provide a useful and convenient single source of reference to turn to in connection with any potential filing, and they provide additional clarity and guidance for compliance with the disclosure requirements under Section 13(d) and 13(g) of the Exchange Act.
The updated compliance and disclosure interpretations are consolidated on the SEC’s website. These interpretations were released during a period in which, as SEC chairman Mary Schapiro recently noted, the SEC continues to actively pursue a “meaningful, investor-focused rule-making agenda.” Many of the positions taken in the updated interpretations had been previously advocated by the SEC through various channels (such as no-action letters and amici curiae briefs) prior to this latest round of consolidation and clarification.
Now that many of the SEC’s positions on such issues have been set forth in these updated interpretations, fund managers should, together with their counsel, review and consider such interpretations in conjunction with the codified rules under Section 13(d) and 13(g) of the Exchange Act and continue to follow the SEC’s rule-making initiatives and general reform efforts in this area to ensure ongoing compliance with their reporting and disclosure obligations.
The consolidated interpretations address a broad spectrum of issues relating to many disclosure requirements under these regulations. Below are a few examples of positions taken by the SEC in the updated compliance and disclosure interpretations, which are provided for illustrative purposes only:
Limitations on general language describing investment intent under Item 4 of Schedule 13D
What the rules say: Item 4 of Schedule 13D requires a description of certain plans or proposals of the reporting person which relate to or would result in various actions that, among other things, affect control of the issuer. In response to this requirement, it is common practice for fund managers and other investors with holdings subject to Schedule 13D reporting obligations to include generic disclosure regarding their investment intent, including statements regarding possible future changes to their investment intent and other actions that they might take at any time relating to the issuer. The SEC has clarified that, notwithstanding any such generic disclosure, a Schedule 13D must be amended when a reporting person formulates a “specific intention with respect to a disclosable matter” that is enumerated in Items 4(a) through (j) of Schedule 13D. The SEC elaborated that a specific intention is deemed to exist not only upon execution of a formal agreement to take action that could result in a disclosable matter under Item 4, but could arise and require disclosure earlier, for example, at the time a reporting person hires an investment bank to formulate terms for a potential going-private transaction.
What it means for private equity: Fund managers and other investors with holdings that are subject to Schedule 13D reporting obligations commonly include generic disclosure regarding possible future changes to their investment intent and other actions that they might take at any time in their Schedule 13D reporting to, among other things, preserve and maintain investment flexibility. While such generic language is expected to continue to be included in Schedules 13D disclosure, fund managers and their counsel will need to carefully consider the limited purpose and flexibility that such language may provide, in light of the SEC’s disclosure guidance and general inclination toward requiring more specific and fulsome disclosure.
Certain same day multiple open market purchases or sales may be aggregated on Schedule 13D
What the rules say: Schedule 13D requires reporting persons to disclose each transaction they effected during the 60 days prior to the Schedule 13D filing or since the most recent Schedule 13D filing. The SEC has clarified that this disclosure obligation may be fulfilled by aggregating all same-day, same-way open market purchases or sales effected through trade orders executed by broker-dealers that occur within a one dollar price range on the basis of the weighted average purchase or sale price for such transactions. This guidance conforms to a position taken by the SEC in a June 2008 “no-action” letter in the context of a similar disclosure obligation on Form 4 pursuant to Section 16(a) of the Exchange Act, and supersedes a potentially contrary position taken by the SEC in a 2007 disclosure interpretation. This interpretation usefully harmonizes the Schedule 13D disclosure interpretation with the Form 4 disclosure position described in the SEC’s no-action letter.
What it means for private equity: This disclosure interpretation should be welcome guidance to fund managers and other investors who, typically through brokerage transactions, often execute same-day trade orders in small increments at multiple prices that may be as little as a fraction of a penny apart. The SEC’s guidance provides useful clarity that the Section 13(d) disclosure rules do not require specific line-item disclosure of potentially dozens of same-day, same-way transactions – which could often involve only a small number of shares each – when reporting the execution of a single market order. In addition, the limited aggregate reporting prescribed by this interpretation will likely provide clearer disclosure of pertinent information by aggregating trades within a single large buy or sell order rather than disclosing such trades as a series of small transactions involving numerous small buy or sell orders.
Officers and directors likely ineligible to file on Schedule 13G
What the rules say: Fund managers and other investors subject to Section 13(d) reporting obligations may, in certain circumstances, be eligible to disclose their positions on a less detailed short-form Schedule 13G (rather than the more expansive disclosure required by Schedule 13D) if, among other things, the securities are held without the purpose of changing or influencing control of the issuer. When such reporting persons have appointed – or are otherwise affiliated with – one or more members of the issuer’s board of directors or officers, the SEC has clarified that, notwithstanding the lack of any specific control intent by the reporting person, the existence of a board appointee or affiliation with such person will most likely render the reporting person ineligible to file the short-form Schedule 13G in lieu of the more detailed Schedule 13D. The SEC reasoned that the fact that officers and directors have the ability to influence the management and policies of an issuer will generally render persons in such positions unable to make the certifications regarding lack of control intent required in order to file a Schedule 13G.
What it means for private equity: When investors determine to obtain a board seat and have their nominee director appointed to the issuer board, as is typical in connection with significant investments, such investors should be aware of the more extensive disclosure obligations that would apply to them under Section 13(d), even if they generally intend to be passive investors in such issuer.
Determination of acquisition of beneficial ownership for purposes of Rule 13d-3
What the rules say: Previous SEC guidance has generally provided that the right to acquire beneficial ownership of reportable securities and consequently the requirement to disclose such right, for purposes of Rule 13d-3 (which must, in any event, be capable of satisfaction within 60 days), only ripened so long as there did not exist any contingency to acquiring the underlying securities that is outside of the stockholder’s control. The SEC’s updated interpretations provide additional color with respect to the types of contingencies that would preclude a fund manager or other investors subject to Section 13(d) reporting obligations from the requirement to report the acquisition of beneficial ownership for Section 13(d) reporting purposes. The relevant interpretations include clarifications regarding variable conversion terms and related conversion caps for convertible securities, as well as other contingencies that could be deemed to be outside of a reporting person’s control, thereby delaying or eliminating the requirement to file a beneficial ownership report on Schedule 13D or Schedule 13G.
One such interpretation provided guidance on conversion caps, typically structured as provisions in a convertible security that restrict conversion if doing so would cause the holder to own more than a specified percentage of the issuer’s outstanding equity securities. The SEC noted that, depending on the conversion terms, it is possible that the holder would not be deemed to have beneficial ownership of the underlying securities above the conversion cap and that the analysis would turn on whether the conversion provision that limits ownership is “binding and valid” to effectively eliminate the right of the holder of the convertible security to acquire the underlying shares.
What it means for private equity: For fund managers and other investors investing in convertible securities with such provisions, this is an important interpretation to review with counsel when structuring and negotiating the terms of such provisions in order to determine in advance whether disclosure of a transaction of this type would be required and, if so, its scope.
Doron Lipshitz is a partner and David Schultz is counsel at O’Melveny & Myers, and are both members of the firm’s Mergers & Acquisitions/Private Equity practice group, They reside in O’Melveny’s New York office.