SEC Releases Guidance on Sections 13(d) and 13(g) of the Securities Exchange Act of 1934; Related Section 16 Developments

The Securities and Exchange Commission’s (the “SEC”) Division of Corporation Finance recently released a number of compliance and disclosure interpretations (“CDIs”) relating to Sections 13(d) and 13(g) of the Securities Exchange Act of 1934 (the “Exchange Act”).  Although some of these interpretations were previously published, others are new or represent revised positions. The CDIs reflect the views of the staff (the “Staff”) of the Division of Corporation Finance, but they do not have the effect of law as in the case of adopted rules or regulations of the SEC, and the SEC has neither approved nor disapproved of the interpretations.  In addition, these interpretations reflect positions that could change without notice.  Nonetheless, they provide insight into the Staff's current thinking on a number of important issues.  In this alert, we have divided the CDIs that we consider to be most relevant into three categories: those that confirm positions we believe are consistent with the applicable rules, those that are particularly noteworthy in that they have not to our knowledge previously been considered or disclosed by the SEC and those that we believe are troublesome because they are either inconsistent with the rules or raise difficult questions of interpretation.  In addition, we have noted two recent and important developments under Section 16 of the Exchange Act that are consequences of the Section 13 CDIs discussed below, as well as recent case law involving Sections 13 and 16.

Section 13 CDIs Confirming Positions Consistent with Exchange Act Rules

The following CDIs confirm our expectations and are consistent with Exchange Act rules:

• A stockholder that owns over 5% of a class of an issuer’s equity securities at the time such securities are registered pursuant to Section 12 of the Exchange Act (“Registered Securities”) has no “acquisition” and therefore may report its beneficial ownership on Schedule 13G pursuant to Rule 13d-1(d) within 45 days after the end of the calendar year in which the registration occurred, provided that the stockholder must report its entire holdings on Schedule 13D or, if eligible, Schedule 13G, if the most recent acquisition after the effective date of the Section 12 registration, when combined with other acquisitions of the same class in the preceding 12 months, exceeds 2% of the same class of Registered Securities. The Staff further clarified that the stockholder’s control intent is not relevant in determining Schedule 13G eligibility in such a situation. The Staff also articulated this position, as well as the fact that the securities need not be held in the ordinary course of business, in note 9 of In the Matter of Perry Corp., Exchange Act Release No. 60351 (July 21, 2009). (101.01)
• A “group” owning more than 5% of a class of equity securities upon the class being registered under Section 12, and holding such securities with the purpose or effect of influencing control, may report beneficial ownership on Schedule 13G (within 45 days after the end of the calendar year in which such registration occurred).  The group must, however, report its holdings on Schedule 13D upon adding a new group member that owns over 2% of the same class of Registered Securities. (101.03)
• Because there is no “acquisition,” a stockholder owning over 10% of a class of Registered Securities at the time of registration under Section 12 of the Exchange Act may rely on Rule 13d-1(d), which does not contain the requirement that a greater than 10% passive institutional owner file a Schedule 13G within 10 days after the end of the month in which it “acquired” more than 10%, and can instead file within 45 days after calendar year end. (103.01)
• In order for a partnership to be eligible to report beneficial ownership on Schedule 13G as a passive institutional investor, the partnership itself, and not merely its general partner, must qualify as an enumerated institution set forth in Rule 13d-1(b). (103.02)
• In general, the ability to directly or indirectly influence the management and policies of an issuer will prevent directors and officers from certifying as to passive intent, rendering them ineligible to report beneficial ownership on Schedule 13G under Rule 13d-1(c).  (103.04)
• A stockholder has an obligation to report under Section 13 notwithstanding that such stockholder’s beneficial ownership exceeded 5% solely from a change in the aggregate number of outstanding shares. (103.08)
• The filing deadlines for Schedules 13D and 13G are triggered on the trade date of Registered Securities, not the settlement date. (103.10)
• Short sales do not affect beneficial ownership under Section 13 but may trigger requirements to amend Schedule 13D to disclose a material change in the disclosure relating to funding sources (Item 3), a change in purpose of the person’s ownership of shares (Item 4), a “transaction” in the shares (Item 5) and/or a contract, agreement, understanding or relationship with respect to securities of the issuer (Item 6). (104.01)
• If a Section 13 reporting person holds variable-rate securities convertible into a class of Registered Securities, the fluctuations in the right to receive or not receive additional Registered Securities within 60 days that result in a 1% or more change in ownership triggers an amendment obligation on Schedule 13D.  As a result, reporting persons should continually assess whether the 1% threshold has been exceeded based on changes in the floating rate of such convertible securities.  (104.04)
• A conditional right to acquire ownership of Registered Securities does not constitute beneficial ownership under Section 13 of the Exchange Act if the conditions are material and outside the control of the investor.  (105.02, 110.04)
• A stockholder may rely upon a contractual limitation on the conversion or exercise of Registered Securities in order to prevent the stockholder from beneficially owning Registered Securities in excess of such contractual limitation. (105.03)
• Items 4(a) and 6 of Schedule 13D require disclosure of plans or proposals, and contracts, agreements or understandings relating to any securities of the issuer, not just Registered Securities of the same class in which the stockholder owns in excess of 5%.  (110.03) 
• Disclosure in Schedule 13D filings or amendments should be made as of the date of filing, not as of the date that initially triggered the filing/amendment requirement. (110.05)

New Section 13 CDIs

The following CDIs contain guidance that the SEC has not, to our knowledge, previously considered or disclosed:

• A stockholder that was initially ineligible to report beneficial ownership on Schedule 13G and instead reported beneficial ownership on Schedule 13D cannot switch to a Schedule 13G if the stockholder later becomes passive.  (103.07)
• Selling securities after the establishment of a record date for a stockholders’ meeting, but before the meeting occurs, does not constitute a decrease of beneficial ownership with respect to such securities until the meeting occurs, because the stockholder retains the voting rights with respect to such securities until the conclusion of the meeting.  If the stockholder sold more than 1% of the outstanding shares and no longer holds more than 5%, it must file an amendment to its Schedule 13D to report the sale, but would not file a final amendment until the conclusion of the stockholders’ meeting. (104.07)
• A stockholder may divest itself of beneficial ownership under Section 13 of the Exchange Act by delegating the right to vote and dispose of its shares to another party, provided that the stockholder cannot rescind such delegation within 60 days. (105.04)

Section 13 CDIs Raising Issues and Questions

The following CDIs may lead to problematic results due to their inconsistency with current rules and/or yielding difficult interpretations:

• A stockholder that receives over 5% of a class of Registered Securities in connection with a merger cannot rely on Section 13(d)(6)(A) of the Exchange Act and Rule 13d-1(d) to report beneficial ownership on Schedule 13G, and instead must immediately report beneficial ownership on Schedule 13D or, if available, Schedule 13G pursuant to Rule 13d-1(b) or Rule 13d-1(c).  Section 13(d)(6)(A) is available only to an issuer that acquires over 5% of a class of Registered Securities via a stock-for-stock merger. (101.05)
• A stockholder that inadvertently or mistakenly purchases over 5% of a class of Registered Securities cannot reverse the trade or subsequently sell the Registered Securities to avoid reporting beneficial ownership under Section 13. (101.06)
• Rule 13d-1(d) (which permits filing of a Schedule 13G) is not available to a person who becomes the beneficial owner of over 5% of a class of Registered Securities solely as a result of a change in the number of outstanding shares, or the registration of such class pursuant to Section 12 of the Exchange Act in connection with a spin-off, if that person influenced or controlled the change in the number of outstanding shares or the issuer’s decision to effect the spin-off (including officers or directors of the issuer).  Rule 13d-1(d) is only available to stockholders that became beneficial owners as a result of an “involuntary” change in circumstances. (103.08, 103.09)
• Generic disclosure on Schedule 13D that reserves a reporting person’s right to engage in the types of transactions set forth in Item 4 on Schedule 13D must be amended when the reporting person has formulated a specific intention with respect to any of the enumerated transactions even if the reporting person is unsure of timing or price or whether a potential transaction is possible or likely. For example, amendment is required if the stockholder subsequently determines to take the issuer private and engages an investment bank that formulates terms for the contemplated transaction, notwithstanding that the stockholder has not yet approached management of the issuer or taken other steps to commence the transaction. (110.06)
• Disclosure on Schedule 13D may be deemed to constitute soliciting material under the proxy rules and a solicitation by a reporting person is not exempt from the application of the proxy rules solely by virtue of its reporting on Schedule 13D. (110.07)

Other Section 13 Developments

• A stockholder may not rely on Rule 13d-1(b) (which permits filing of a Schedule 13G within 45 days following the end of the calendar year) to report as a passive, ordinary course of business acquisition, more than 5% of a class in circumstances where the sole purpose of the acquisition is to vote the shares in a merger.  Acquiring securities with the purpose of influencing the management or direction of the issuer or affecting or influencing the outcome of a transaction, including acquiring securities or an interest in securities (e.g., securities-based swap arrangements) for the purpose of voting those securities in a merger is not considered by the SEC as being in the ordinary course of an institutional investor’s business.  In the Matter of Perry Corp., Exchange Act Release No. 60351 (July 21, 2009).

Section 16 Developments

• As described above under New Section 13 CDIs, selling securities after the establishment of a record date for a stockholders’ meeting but prior to the date of the meeting does not constitute a decrease of beneficial ownership until the date of the meeting.  Accordingly, a stockholder owning more than 10% of a class of Section 12 registered voting equity securities that sells below 10% after a record date but before the meeting will be deemed to continue to own greater than 10% of the class until the meeting date, and, critically, any transactions in the stock between the record date and meeting date will continue to be subject to Section 16 reporting and matching.
• Section 16 CDI 110.02 cites the Staff’s position that a person will no longer be deemed to be part of a greater than 10% group when the person no longer agrees to act together with the other group members for the purpose of acquiring, holding, voting or disposing of equity securities of the issuer.  This contradicts the Second Circuit’s decision in Roth v. Jennings (2007), in which the court concluded, somewhat perplexingly, that the lower court erred in holding that, for stockholders to constitute a group, their coordinated activities must persist at the time of a purchase and at the time of a sale.
• The SEC’s position in In the Matter of Perry Corp. regarding the meaning of “ordinary course of business” for purposes of Rule 13d-1(b) also has implications under Section 16 because Rule 16a-1(a)(1) permits certain enumerated institutional investors to exclude from the determination of whether the investor beneficially owns, for Section 13 purposes, more than 10% of the class, securities that are held for the benefit of third parties or fiduciary accounts in the ordinary course of business and with passive intent.  Securities that are not held in the ordinary course of business therefore must be counted in determining whether the investor beneficially owns more than 10% of the class and is subject to Section 16 reporting and liability.