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Four Crucial Implications of the SEC's Revised Beneficial-Ownership Regulations

The U.S. Securities and Exchange Commission (SEC) recently approved amendments that will significantly modify the filing requirements and deadlines for Schedules 13D and 13G. These SEC disclosure forms, required under Section 13(d) of the Securities Exchange Act of 1934, are used by investors to report their beneficial ownership in publicly traded companies.

The amendments come after years of deliberation and market consultation by the SEC, and are intended to modernize beneficial ownership reporting rules that have remained largely unchanged for over 50 years. According to SEC Chairman Gary Gensler, “[t]oday’s adoption updates rules that first went into effect more than 50 years ago … I am pleased to support this adoption because it updates Schedules 13D and 13G reporting requirements for modern markets, ensures investors receive material information in a timely way, and reduces information asymmetries.”

While the new rules do not completely overhaul existing requirements, they do contain major changes that will impact how and when investors disclose significant share accumulations and arrangements that may influence corporate control. This aims to reduce information asymmetries among market participants.

The key amendments include:

- Shortened filing deadlines for initial Schedules 13D and 13G, as well as amendments

- New requirements regarding group formation and collective share ownership 

- Clarified disclosure rules around derivative securities

- Introduction of structured data reporting

Additionally, the SEC opted not to adopt some originally proposed amendments after considering public feedback. These include expanded definitions of beneficial ownership and group coordination for passive investors.

The approved changes will take effect following publication in the Federal Register, likely within the next few months. Adoption periods are staggered over the next year, with full compliance required by end of 2024.

This aims to give market participants sufficient time to update internal processes and controls to adhere to the new requirements. Companies and investors should review the amendments in detail and prepare for their implementation in the period ahead.

Reduced 13D and 13G Filing Deadlines

One major change in the new rules is the introduction of hard deadlines for submitting initial and amended Schedules 13D and 13G.

Previously, investors were required to file within 10 days of crossing the 5% beneficial ownership threshold. However, the deadline for amendments was vague, simply requiring "prompt" notification upon material changes.

The SEC has now imposed stricter timeframes to ensure more timely information is available to markets. This aims to prevent potential delays or information gaps.

Initial 13D Filings

For initial Schedule 13D disclosures, the deadline has been shortened from 10 calendar days to 5 business days after passing the 5% threshold. This applies when an investor acquires beneficial ownership of more than 5% of a voting class of equity securities.

The same 5 business day deadline will apply to submission of the initial Schedule 13D for any event causing loss of eligibility to file a Schedule 13G instead. This includes situations such as where an institutional investor's beneficial stake passes 10% ownership.

Amended 13D Filings

For amendments to existing Schedule 13D disclosures, the SEC has imposed a firm deadline of 2 business days following any material change.

This is significantly stricter than the previous "promptly" requirement, ensuring markets are notified of major changes by 13D filers within a consistent timeframe.

Initial 13G Filings

Timing requirements for initial Schedule 13G disclosures have also been tightened, however deadlines vary based on filer type:

- Qualified Institutional Investors (QII) and Exempt Investors: Reduced from 45 calendar days after year end to 45 calendar days after the quarter ending in which 5% ownership was exceeded

- Passive Investors: Shortened from 10 calendar days to 5 business days after crossing the 5% threshold

- QIIs: For holdings above 10%, reduced from 10 calendar days after month end to 5 business days after month end

This enhances transparency by requiring more frequent snapshots of major share accumulations by institutional filers.

Amended 13G Filings

For amended Schedule 13G disclosures, the deadline is now 45 calendar days after the quarter in which a material change occurred.

Previously filers were required to submit changes within 45 days of year end regardless of materiality. The SEC has aligned the amendment deadline with other quarterly reporting requirements.

For QIIs and Passive Investors with over 10% ownership, the existing obligation to report increases or decreases over 5% remains unchanged. However, the deadline is shortened from 10 calendar days to 5 business days after month end for QIIs, and from prompt notification to 2 business days for Passive Investors.

Group Formation and Collective Ownership

The amendments also introduce new requirements in relation to investor groups under Section 13(d)(3) of the Exchange Act. This aims to address ambiguity on how groups calculate collective ownership.

Previously, group members were only considered a "beneficial owner" if they individually crossed the 5% threshold. The new rules make clear that once a group is established, any subsequent acquisitions will accumulate at a group level for determining filing obligations.

Specifically, under the new Rule 13d-5(b)(1)(iii), if total group ownership exceeds 5% of a voting class, any additional purchases by individual members after the formation date will be attributed to the group as a whole. This means the group must file promptly as their collective stake increases.

Similarly, Rule 13d-5(b)(2)(ii) states that additional buys by group members increase the ownership to be reported by the entire group in Schedule 13G disclosures.

This looks to prevent group members structuring acquisitions in a way that deliberately avoids triggering filing requirements. Members cannot individually stay under 5% while the group collectively creeps above this level.  

While increasing obligations, the SEC believes this better aligns with the spirit of Section 13 - to provide transparency on stakes that may influence corporate control.

The amendments aim to clarify formal coordination required to constitute a group, an issue that has historically caused confusion. However, concerns were raised during consultation that the original proposals went too far by capturing typical investor engagement activities.

In response, the SEC opted not to adopt amendments that would have outlined group formation criteria based on sharing of confidential voting plans.

Instead, guidance has been provided noting that these discussions alone do not necessarily indicate group formation, which requires evidence of agreeing to act in concert. The existing legal tests under Section 13 will continue governing group determinations.

Derivative Securities Disclosure

The SEC has also mandated expanded disclosure around derivative securities, such as swaps, options and other instruments. These are commonly used by activist investors and hedge funds to build economic exposure without direct share ownership.

Under the new Rule 13d-101, filers will be required to describe any derivative interests in Item 6 of Schedule 13D that provide the holder with voting or investment power over the underlying securities.

Previously, the scope of instruments captured was unclear, creating potential loopholes to avoid reporting certain arrangements. The amendment aims to close this gap and provide complete transparency.

Disclosure will need to contain all key terms of the instrument that impact voting or economic rights. This includes the counterparties involved, contract expiration or settlement dates, and details on how interests may be settled.

Cash-settled derivatives, which do not involve actual share transfers, are also covered. The SEC believes these instruments can carry equivalent influence to traditional equity holdings, so warrant equivalent disclosure.

While scheduling and quantifying potential future payoffs may be complex, the market benefits from understanding the filer's full economic exposure and incentives. This amendment will prevent opaque derivative activities falling outside the spirit of Section 13.

Structured Data Reporting

Historically, Schedules 13D and 13G have been submitted in a basic PDF or text format. However, the SEC will now require use of a structured XML-based data language.

This brings reporting in line with other major filings such as Forms 10-K and 8-K. Machine-readable data enables automated analysis and dissemination of filing contents in real-time.

The SEC believes this will allow more efficient extraction of disclosure details by investors, media and data aggregators. It also assists internal surveillance efforts to identify anomalistic filing trends.

Filers have the option to either submit directly via EDGAR in the 13D/G XML schema, or use a web-based form that will convert inputs to the required structure. The web form aims to ease the transition for less sophisticated filers.

Structured reporting will be phased in, with initial compliance required by end of 2024. The SEC hopes this provides sufficient time for filers to make necessary software and workflow adjustments.

Proposed Amendments Not Adopted

The final amendments contain notable exclusions versus what was originally proposed for public comment after the feedback period.

Expanded Beneficial Ownership Definition

A proposed amendment to Rule 13d-3(e) would have expanded the definition of beneficial ownership to capture holders of cash-settled derivatives.

This could have designated certain investors as statutory insiders with accompanying filing obligations, based purely on derivative arrangements. 

Critics argued this overly broadened Section 13, which focuses on voting power rather than economic exposure. The SEC agreed this required further analysis, opting to retain the existing interpretative position and definition. 

Group Formation Criteria

As mentioned, proposed rules around group activity and coordination were also mostly abandoned.

Commenters argued the original proposals on sharing confidential information could have unintended consequences. Routine engagement between investors, or an advisor informing clients of voting intentions, may have triggered group designation where no formal agreement existed.

By not adopting these rules as proposed, the SEC aims to avoid a chilling effect on regular shareholder communication and advocacy. However, enhanced guidance reminds filers of aggregating group interests.

Passive Investor Coordination

Proposed amendments deeming cooperative conduct of passive investors as group formation were also discarded. Again, the SEC agreed this may discourage independent shareholders from exercising rights through channels like shareholder proposals. 

Overall, while increasing group obligations in other areas, the final rules took a balanced approach regarding typical investor engagement. This aims to avoid deterring value-adding stewardship activities. 

Compliance Deadlines and Considerations

The raft of amendments will take effect once published in the Federal Register, expected in late 2022 or early 2023. Adoption will be staggered over the following 18 months. 

Key compliance milestones include:

- Q1 2023: Reduced 13D and 13G filing deadlines take effect 

- September 30, 2024: Deadlines for quarterly 13G filings by QIIs must be followed

- December 31, 2024: Structured reporting requirements apply 

This gradual timeframe intends to allow sufficient preparation for filers to update internal systems and controls. However, companies and investors should begin critical path planning now to ensure readiness.

Key steps for issuers and shareholders include: 

Updating Policies and Procedures

- Review and update compliance policies to reflect shortened filing timeframes

- Ensure sufficient procedures and controls to track 5% thresholds and material changes on a daily basis

- Brief board and executives on new requirements

Assessing Systems and Tools

- Identify any enhancements needed to reporting tools and shareholding/NAV monitoring systems 

- Liaise with vendors and advisors to implement structured data capabilities

- Scope integration with EDGAR or alternate web filing platform 

Training and Education

- Conduct training on new rules, timelines and group versus individual obligations

- Provide refresher courses on beneficial ownership concepts

- Set up FAQs and helpdesk support

The compressed filing deadlines will require rapid response protocols when crossing key thresholds. This may necessitate daily position monitoring rather than periodic reconciliation. 

Robust change control procedures are critical to ensure amendments are captured and filed within two business days. Compliance should be integrated into intraday workflows.

While the amendments take effect soon, their impact will take time to materialize. However, enhanced transparency around significant share accumulations will empower more informed analysis and decision making by all market stakeholders over the long term.