It may come as a bit of a surprise to investors that the Dodd-Frank Act provides for a review of the rules around Schedule 13D filing. In fact, DFA (Section 766) does ask the SEC to look at the definition of “beneficial ownership” in the context of the multitude of derivatives that investors now buy, and how these derivatives should count toward the 5% disclosure threshold.

On the other hand, it should surprise no one that Wachtell, Lipton has provided a push toward greater regulation of hedge funds in this fashion. That famous corporate lackey sent a helpful memo this past March to the SEC with some suggested updates. While we can’t determine the impact that the memo would have on the current rules, smart investors should at least make themselves aware of what Wachtell has in mind for them.

Current Requirements

As we set forth in an earlier post, investors file Schedule 13D within ten days of owning 5% of a company’s shares. Investors include derivatives within their holdings only if they can use the derivatives to acquire actual shares within 60 days of that filing.

Restrictive Filing Deadilnes

Wachtell first wants to shorten, dramatically, the deadline for initial filing of Schedule 13D. Currently, investors have ten business days to do this. The memo recommends a one-day filing period: “using the same ‘prompt’ disclosure standard that the Commission requires [for] material amendments to existing Schedule13D filings.”

Wachtell also recommends a two-day “cooling off” period, during which a 13D filer cannot acquire any additional shares. They connect this to the current rule that limits investors that switch a Schedule 13G to a 13D to acquiring more shares or voting existing holdings for ten days after making such a switch.

Derivatives Count Toward Beneficial Ownership

This one is simple but significant in its substance. Wachtell would like to include in the definition of beneficial ownership

1. ...any derivative instrument which includes the opportunity, directly or indirectly, to profit or share in any profit derived from any increase in the value of the subject security.
   

And, they would include short positions in a security within this definition, too. Their memo does not explain how a short position would count, since shorts don’t own the shares (they of course borrow them) that they have sold.

Of course, Wachtell would not extend this expanded treatment to Section 16 filings (Forms 3, 4, and 5), as these filings do not “present the same risk of abuse as the Section 13 reporting rules”. Section 16 of course applies mostly to directors and executives of corporations. This approach conveniently excludes reporting of executive hedging of their equity incentive plan awards.

What’s next?

In response to the DFA provisions, the SEC has already proposed to maintain the current treatment of derivatives (i.e., those that the investor can convert to common shares within 60 days). Wachtell offered a comment letter that echoes its petition.

Surprisingly, the SEC received only two other comment letters on its proposal, one supporting their proposal (from the Managed Funds Association) and one opposing (from the American Business Conference, a trade group of mid-sized growth companies). The comment period has closed.

This one is tricky. Given the pressure that the SEC has confronted from corporations on proxy access, they may decide to follow the comment letters and change their proposal. That would clearly hit investors where it hurts.