More than 2,000 individuals have answered the Securities and Exchange Commission (SEC)'s request for comments on a new proposal that would raise the reporting threshold for 13F forms from $100 million to $3.5 billion. (A 13F form is a publicly filed tax form on which investment managers of a certain size must report all their equity holdings every quarter.)
The proposal, which would eliminate the filing requirement for roughly 90% of investment managers that currently must file, is highly controversial, to say the least.
The vast majority of commenters have sounded off against it, arguing that a higher reporting threshold reduces transparency, hampers due diligence efforts and academic research, and leaves small and midsize companies more exposed to activist investors. (For more on this read, "Yes, Transparency Is Still A Good Thing.")
But the furor over the proposal's substance masks what ultimately may be the more relevant question: Does the SEC have the legal authority to raise the 13F reporting threshold?
According to several legal experts—and at least one SEC commissioner—the answer is no.
"If I were the one who'd featured this particular justification for this rule change, I would be losing a lot of sleep right now," said one securities law expert. "I'd feel like I royally screwed up."
Current Law Allows 13F Threshold To Be Lowered, Not Raised
The crux of the matter is a turn of phrase from Section 13(f)(1) of the Exchange Act, the provision from which the quarterly 13F form originated.
As the law is written, institutional investment managers are required to file regular reports with the SEC if their equity holdings have an "aggregate fair market value on the last trading day in any of the preceding twelve months of at least $100,000,000 or such lesser amount (but in no case less than $10,000,000)."
The exact wording here is significant—particularly "or such lesser amount," which clearly establishes the 13F reporting threshold at $100 million, then gives the SEC the authority to lower that bar, if necessary.
In its new proposal, however, the SEC chops up the wording of Section 13(f)(1), including only some of the law's complete text. The same law is cited thusly: "Section 13(f)(1) authorizes the Commission to set the reporting threshold in an amount 'of at least $100,000,000 or such lesser amount' by rule."
The edited version now seems to imply that the SEC has the authority to establish a reporting threshold of at least $100 million—or the exact opposite of what the law on the books actually says, writes SEC Commissioner Allison Herren Lee in her public statement dissenting to the proposal.
"The enabling statute, at section 13(f)(1), provides no support for increasing the reporting threshold," she wrote. "The text is clear: Congress set a statutory reporting threshold at $100 million, and the Commission has the authority to lower it." (The SEC could not be reached for comment.)
'Lesser' vs. 'Other': One Word Makes A Difference
As further legal justification for its authority to raise the reporting threshold, the SEC cites a report from 1975 in which the Senate Banking Committee evaluated various amendments to the Exchange Act. In that report, the committee included language stating that the SEC would "have authority to raise or lower" the 13F reporting threshold.
But this committee report wasn't the final say on the matter, says Alex Platt, an associate professor at the University of Kansas School of Law. In fact, it was more of a first draft.
"The Senate Banking Committee was analyzing an earlier and very different version of the statute than the one that actually got enacted," said Platt, who recently published a letter in the Yale Journal on Regulation on this very topic.
In the version of the bill that the Senate Banking Committee was looking at, explains Platt, the SEC would have had the authority to set a 13F reporting threshold of "at least $100 million or such other amount" [emphasis added]. In essence, the SEC would have had free rein to set the reporting threshold to wherever it might like.
This version never became law, however. A companion bill, H.R. 4111, passed through the House of Representatives at the same time as the Senate version. When the two bills went to conference, it was the House's version, which contained the phrasing "or such lesser amount" instead of "or such other amount," that was adopted into law.
"That change from 'other' to 'lesser' was everything. It was the whole ballgame," said Platt, because it converted the $100 million threshold from a suggestion to a hard ceiling, at which the SEC couldn't go above.
Legislative History ‘Very Bad For The SEC's Case’
In its current proposal to lift the reporting threshold to $3.5 billion, however, the SEC relies on the draft version of the statute that went before the Senate Banking Committee, essentially arguing that the agency has the authority to lift the threshold because it was given that authority in the earlier version—notwithstanding what the Exchange Act may say now.
Not only does citing the 1975 Amendments Senate Report not help the SEC, "if anything, it makes it worse for them," said Platt. That's because "it shows that the Senate Banking Committee passed a version in which the SEC could raise and lower the threshold—but then the entire Senate agreed to change that language, and very, very clearly," through their vote to adopt the law.
"The legislative history is very bad for the SEC's legal case, and they would have been better off just staying silent," he added. "This is just a mistake in interpretation."
Using Exemptive Authority To Rewrite The Law?
In the middle of the SEC's legal justification for raising the threshold appears a single, curious sentence: "In addition, Section 13(f)(3) authorizes the Commission to exempt any manager or class of managers from the reporting requirements of section 13(f)."
Sandwiched between the "or such lesser amount" argument and the citation of the 1975 Amendments Senate Report, this sentence seems somewhat out of context and out of place. Basically, though, it appears to imply that the SEC can raise the reporting threshold because it has broad authority to exempt whomever it likes from filing 13Fs altogether.
"The SEC's saying that this exemptive authority provision means they have discretion to waive or skip over any of the specifics laid out in other parts of the statute," said Platt.
Commissioner Lee herself had a scathing rebuke for this argument. "Using exemptive authority in this way would vitiate the limit that Congress placed on our authority in the plain language of Section 13(f)(1)," she wrote. "We would, in effect, use our exemptive authority to rewrite the statute to reflect the opposite meaning from its plain language."
Lee also expressed concerns about the seeming randomness of the insertion, concerns echoed by one securities law expert who spoke to ETF.com on condition of anonymity. "They just throw that in there as an 'oh, by the way," said the expert. "Like throwing s--t against the wall and seeing what sticks."
Exemptive Authority Vs. The Chevron Deference
In fact, the SEC's claims of broad exemptive authority may run afoul of a well-known administrative judicial precedent known as the "Chevron Deference."
Essentially, the Chevron Deference prioritizes whose authority matters most when interpreting a given statute of law.
If Congress has spoken unambiguously about the precise matter at hand—if it had, say, passed a law giving a federal agency the authority to lower, but not to raise, a reporting threshold—then whatever Congress said takes precedence over the agency's authority to interpret the law. Only if there's ambiguity in the statute, or silence from Congress, would the agency have the authority to interpret the law as it sees fit.
In light of the Chevron Deference, said the securities law expert, it's fairly clear from an administrative law standpoint that Congressional law overrules the SEC's exemptive authority.
"If there's no ambiguity in the statute and the agency stepped outside the clear language, then the agency didn't have the authority. That's it, really; that's the end of the inquiry," they added.
‘The Courts Will Have To Shut Them Down’
For now, the SEC's proposal remains open to public comment until Sept. 29, 2020. Although the National Association of Manufacturers and the National Investor Relations Institute have submitted comments, few large asset managers or tier-one financial institutions have yet to weigh in. (That said, historically, many parties with a strong interest in a given SEC proposal tend to wait until the last few days of a comment period to submit their perspectives, or alternatively, submit their comments via the mail, where they will be added to the register after the comment period closes.)
Should the SEC's proposal be adopted, however, it would almost certainly face a legal challenge, says Platt, one that the SEC would have low likelihood of winning. "They've reduced their own chances by putting this proposal out there in a sloppy way," he added.
That's not just conjecture: The Institute for Policy Integrity at the New York University School of Law finds that out of 130 court challenges to significant deregulatory rulemaking actions from the Trump administration, 84% have been successful. The Trump administration has only won its legal challenges 18 times.
"I don't see a chance of this surviving a legal challenge, except in this weird new world we live in," said the aforementioned legal expert. "This doesn't read like a case of good faith, where some blinkered regulator lost sight of the ball for a minute and, oops, published something they actually can't do. This is pretty egregious. It's a vast difference in the professionalism, the fact-finding and the analysis."
Still, counters Platt, "It's hard to imagine the SEC saying, 'We got all these comments telling us that [the proposal is] illegal so we're deciding not to proceed.' I don't think that's realistic. So if they do go through with it, it'll have to be the courts that shut them down."
Contact Lara Crigger at [email protected]