Impact Of SEC’s 13F Change Murky

September 28, 2020

Nobody seems particularly happy with the SEC's new 13F proposal, which would raise the reporting threshold for investment managers filing 13F forms from $100 million to $3.5 billion in assets under management.

Since July, thousands of comment letters have flooded in, the vast majority asking the agency not to lift the threshold.

This includes letters from securities exchanges like the Nasdaq and NYSE; industry advocacy groups such as the Council of Institutional Investors, the National Investor Relations Institute and the National Association of Manufacturers; dozens of research universities, law firms and registered investment advisors; and literally hundreds of individual investors.

At ETF.com, we've already dug deep into the troubling substance of the SEC's recommendations, then examined in closer detail how the proposal itself is based on a questionable interpretation of the law. (Read: "Legal Questions Circle SEC's 13F Plan.")

Now that the comment period is coming to a close—the last day to submit comments is Tuesday, Sept. 29—we take a final look at who stands to benefit most from the proposal's passage.

What Is A 13F Form?

13F forms are tax statements that institutional investment managers of significant size must file every quarter. They list a manager's long equity positions above a certain dollar or share size amount, including shares of stocks, ETFs, closed-end investment companies and some types of convertible debt securities. (Bonds, mutual funds and other nonequity holdings do not need to be reported on the form.)

Should the SEC's proposal go into effect, however, roughly 90% of the current investment managers required to file 13F forms would no longer be forced to do so.

The SEC argues this change benefits small investors, a claim with which Chris Stanley, founding principal of compliance firm Beach Street Legal, agrees.

Unaware Of Being Delinquent

"The filing process isn't exactly a walk in the park to do manually," he said, adding that he usually recommends clients outsource the task to a technology provider or to existing compliance functions within their portfolio management software.

Stanley's clients are mostly small advisory shops of two to five advisors, many of whom just barely meet the current $100 million threshold, or who may be transitioning from mutual funds to ETFs. In many cases, his clients weren't even aware they're subject to the 13F requirement—or that they've potentially been delinquent on filing it. (Some were.)

"I don't think this rule was on their radar, because it refers to 'institutional' asset managers, and your average two-person shop working with mom and pop investors doesn't consider itself 'institutional,'" Stanley added.

SEC ‘Can't Keep Up’

Over the years, few consequences have come to managers delinquent in filing their 13Fs, however, which suggests another motivation behind the proposal: The SEC just can't keep up.

As the equity markets grow in size, and the number of 13F filers rises, the chronically understaffed agency has staggered under the ever-increasing volume of data reported each quarter, says Amy Lynch, former regulator with SEC and FINRA and the founder and president of FrontLine Compliance.

"[The SEC] is getting a huge increase in the number of filings they have to review and process, yet they do not have an increase in the number of people to review those filings," she said. "It puts them in a difficult position."

Collected Data Collected Dust

Ten years ago, a report from the SEC's Office of Inspector General (OIG), titled "Review of the SEC's Section 13(f) Reporting Requirements," found that it was in fact so difficult to process the sheer quantity of 13F filings that the SEC just didn't do anything with the data at all.

The report found there was no division office within the agency tasked with the job of reviewing or analyzing 13F filings, not even for accuracy or completeness. Often, errors in the forms were only spotted in connection with Confidential Treatment Requests—that is, the special exemptions that qualified active managers may request to report their securities confidentially, instead of publicly.

"They're collecting data that's just sitting there, and not necessarily being utilized," added Lynch.

Lifting the reporting threshold would substantially reduce the SEC's workload, and in fact, the OIG recommended the SEC do just that, listing it as one of 12 recommendations for improving the 13F process. However, the SEC has not acted on that recommendation—until now.

(Interestingly, another of the recommendations was to pursue whether "legislative changes" would be necessary to the Exchange Act regarding "increasing the Section 13(f) reporting threshold"—suggesting the OIG had at one time acknowledged that the SEC may not have the legal authority to raise the threshold, as we wrote about earlier this month.)

Do Activists Benefit?

In the comment letters to the SEC's proposal, hundreds of public companies expressed concerns that the higher 13F reporting threshold would lead to significant loss of transparency into share ownership, which would benefit activist shareholders at the expense of companies.

Indeed, one IHS Markit study found that 86% of activist shareholders would no longer be required to file 13F forms.

Without regular insight into which activists are acquiring their stock, or how much, commenters argued that their companies would be unable to plan effective countermeasures and stave off aggressive campaigns.

Yet Alex Platt, associate professor at the University of Kansas School of Law, isn't so sure the SEC's proposal benefits activist investors as much as it may at first appear.

Impact On Activist Investors Unclear

"A lot of people have written things like, ‘The activists are going to be more powerful because they can go dark,' but I have some questions about how true that is," he said.

Platt points out that a higher 13F threshold could make things harder for activists, because "those hedge funds tend to be careful about who they target." When building a campaign, activists first research the composition of the shareholder base in a given company, then try to reach out to and ally with other sympathetic shareholders before they launch. 13F forms are a natural starting point to begin this research.

"So if activists know that this institution or that pension is inclined to support their activism, but then the SEC turns the light out on who's owning these companies, then that could actually have the opposite effect, and deter activism," he added.

Without access to 13Fs, larger activist hedge funds would likely turn to stock surveillance firms to gain insight into a company's current share ownership. But these services don't come cheap: Data packages often run $150,000 to $250,000; some even cost up to $3 million.

Smaller activists, including grassroots campaigns, would likely not be able to afford those services, putting them at a disadvantage.

Limits Small Shareholders

Should the 13F proposal pass, it wouldn't be the only rule change at the SEC making shareholder engagement more difficult for smaller investors.

On Sept. 23, the SEC passed a new rule raising the requirements for shareholders looking to sponsor proxy proposals.

The new amendments now require shareholders to own at least $2,000 worth of stock in the company for at least three years before sponsoring their first proxy proposal, up from just one year.

Shareholders with larger positions in a company will have the ability to sponsor proposals sooner: Those with $15,000 in stock would only have to wait two years, while those with $25,000 in stock could wait one year. Shareholders must also now present their proposals in person to the company representatives; they are no longer allowed to rely on a representative.

The new rules severely restrict the ability to mount grassroots-style shareholder campaigns, particularly those that have become popular in recent years regarding companies' environmental, social and governance risks and exposures.

Combined with the reduced transparency resulting from a higher 13F reporting threshold, activist investors, particularly smaller ones, would be hampered in their ability to organize and engage with companies effectively.

"The new SEC rules will force shareholders to escalate to litigation and other means," said As You Sow's CEO, Andrew Behar, in a press release about the proxy proposal rule's passage.

Opening ‘Litigation Floodgates’

Should the SEC pass the 13F proposal, then litigation may also be inevitable, says FrontLine’s Lynch, noting that SEC Commissioner Allison Herren Lee's public statement highlighting the proposal's questionable legal framework amounts to her "throwing out the litigation card."

"That's asking for the rule to be challenged in the courts," said Lynch. "If it passes, then that could open up the litigation floodgates, based on her statement."

Lynch, however, thinks it's also possible that the SEC could revise its proposal based on the comment letters it’s received; or, more likely given the impending election, it could simply retract the proposal altogether.

"This is not an SEC in rulemaking mode," she said. "If this is something that can be checked off their list they can move on from it, they will."

The comment period for the 13F proposal ends Sept. 29, after which, the SEC will consider its next steps and the final passage of the rule.

Contact Lara Crigger at [email protected]

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