October 11, 2023

More on Section 13(d) Reform: Derivatives and Group Formation

In addition to the revised filing deadlines, the amendments also revise Schedule 13D to clarify that reporting persons must disclose interests in all derivative securities that use the issuer’s equity security as a reference security (including cash-settled derivative securities) under Item 6, and the release provides guidance on the applicability of existing Rule 13d-3 to cash-settled derivative securities (other than security-based swaps). Consistent with guidance provided in its 2011 release, Beneficial Ownership Reporting Requirements and Security-Based Swaps, the release discusses circumstances when the holder of non-SBS derivative securities settled exclusively in cash may have voting or investment power or otherwise could be deemed to be a beneficial owner.

In lieu of adopting the proposed amendments to Rule 13d-5 that would have tracked the statutory text of Sections 13(d)(3) and (g)(3), the release provides guidance on the formation of a group. The guidance reiterates that Rule 13d-5(b) is not designed to define “group” in a way that would substitute the legal standard in 13(d)(3) and 13(g)(3) and that the existence of a group can be established by activities without an express agreement although there must be “an informal arrangement or coordination in furtherance of a common purpose to acquire, hold, or dispose of securities of an issuer.”

Commentators on the proposed rules expressed concerns about a chilling effect on shareholders’ ability to communicate with each other or a company’s management. Accordingly, the release (see pages 133 to 139) contains guidance in the form of questions and responses on common engagement and communication activities. Here’s an example:

Question: Is a group formed when two or more shareholders communicate with each other regarding an issuer or its securities (including discussions that relate to improvement of the longterm performance of the issuer, changes in issuer practices, submissions or solicitations in support of a non-binding shareholder proposal, a joint engagement strategy (that is not control related), or a “vote no” campaign against individual directors in uncontested elections) without taking any other actions?

Response: No. In our view, a discussion whether held in private, such as a meeting between two parties, or in a public forum, such as a conference that involves an independent and free exchange of ideas and views among shareholders, alone and without more, would not be sufficient to satisfy the “act as a . . . group” standard in Sections 13(d)(3) and 13(g)(3). Sections 13(d)(3) and 13(g)(3) were intended to prevent circumvention of the disclosures required by Schedules 13D and 13G, not to complicate shareholders’ ability to independently and freely express their views and ideas to one another.

The policy objectives ordinarily served by Schedule 13D or Schedule 13G filings would not be advanced by requiring disclosure that reports this or similar types of shareholder communications. Thus, an exchange of views and any other type of dialogue in oral or written form not involving an intent to engage in concerted actions or other agreement with respect to the acquisition, holding, or disposition of securities, standing alone, would not constitute an “act” undertaken for the purpose of “holding” securities of the issuer under Section 13(d)(3) or 13(g)(3).

– Meredith Ervine