SEC 13D Regulations: How Long Should Grace Period Last?

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SEC 13D Regulations: How Long Should Grace Period Last?

The corporate world is a democracy. A twisted one though. After all, in this democracy, you can openly buy & sell votes (shares). In fact, they have created a market place for this (stock exchange). If you want more, you can buy more by simply placing an order. If you want too much or a “substantial” number of these votes, you can even bypass the marketplace and go direct to the voters (shareholders). Then you can come up with a tempting, but legal request (tender offer) to lure the voters. The more votes you are able to garner, the more power you command in the company. Consequently, this offer is not so tender for the existing Rulers (board).

They do not take it kindly and feel intimidated by the possible change in “ownership” pattern. They are scared that the chances of getting dethroned increases if someone acquires more than a prescribed limit. This is because a substantial number of votes of a new beneficial owner may get translated into seats in the boardroom (crown court) or even a takeover (coup). Thus, the Rulers want to take precautions as soon as they have a rival center of power emerging. For this, they want to know of any such major acquisition, beyond a certain threshold, immediately. This helps them prepare and hedge their rule against the risk of takeover of their kingdoms (boardrooms). Sometimes, these precautions (e.g poison pills) are even necessary to ward of threats of mala fide takeover bids to disrupt the management of the organization.

Moreover, like in political setups of democracies, the shareholders (voters) also have a right to know who is having how much say in managing the affairs of the company. Since the boardroom is the place where all strategic management decisions are taken, it helps the stakeholders to know who is in charge. They come to know, based on past performance of the Directors, whether the company is likely to be managed well. This helps them decide whether these votes will be worth more in the future or not. Decisions to buy, hold or sell are taken accordingly. The concept of proxy votes is another way by which an entity can exercise influence on the major decisions being taken by a company. Here, rather than buying the votes, the “power to vote” is bought or controlled. It is important to mention that most of these acquirers are “activist” investors who want to shake up “inefficient” boards or the managements by getting their representation on board through increased voting power.

Thus, it seems proper that this change in control, through change in distribution of substantial chunks of votes, is intimated to all shareholders as soon as possible. For this, in USA, a limit of 5% is fixed as a threshold stake level at which the new acquirer has to inform the public and the existing board about his holdings in the company. The disclosure is to be filed with the US Securities and Exchange Commission (SEC) in schedule 13D, within 10 days of reaching the limit. While all agree that this information about crossing the 5% limit is to be filed promptly with the regulator, not all agree with the grace period of 10 days. Many feel that the 10 day time period is a little too much in today’s fast paced electronic trading environment. Nowadays, ownership can be acquired indirectly through fascinating derivate products which were not available in the 70’s. The law firm Wachtell, Lipton, Rosen & Katz filed a petition with the SEC to reduce this grace period from 10 days to one business day. The petition is under consideration by the SEC.

In this regard, the first point is, why 10 days? Why not 8 or 15 or more or less? Though the ten days grace may have had some logic in 1968 when this period was fixed (Williams Act), it is difficult to justify the reason for this figure now. In practice, the ten days period is a clear go-ahead to the acquirer to have his fill before he goes for the kill (tender offer). Therefore, the sanctity of the 5% limit is totally lost if such a large opportunity is given to the acquirer to buy more before he is required to disclose this material information to the stakeholders. Thus, practically, the point where the shareholders come to know about the acquisition is not 5% but could potentially be much higher.

As mentioned in the petition, in cases like acquisition of J.C. Penney Company Inc. (NYSE:JCP)’s shares by Pershing Square and Vornado Realty Trust (NYSE:VNO), the holding had increased to more than 27% by the 10th day. In case of Netflix, Inc. (NASDAQ:NFLX) and Oshkosh Corporation (NYSE:OSK), the disclosure by the acquirer Carl Icahn was at the point when he had around 10% stake. These accumulations, before the disclosure, are actually at a price lower than what they would have to pay had the disclosures been made. The shareholders who sell their stocks at a “discount” during the grace period, lose out because they do not have perfect information about the stock.

However, a deadline of 1 business day suggested by Wachtel, Lipton, Rosen & Katz in their petition is a little too tight. The grace period being allowed is not simply the time required to file the information (filling the forms and submission etc.). It also gives the buyer time to reverse his decision of purchase by selling the shares in case he wants to do so. In such a case, the disclosures related to purchase & sale can be filed simultaneously so that the artificial impact on the share price is minimal.

To give some cushion to the buyer to cover for this and other types of eventualities which may arise (e.g sickness of signatories, time required for board of an acquiring company to meet etc.), a three business day grace period is recommended. This will help create a balance between the need for prompt disclosure for the shareholders and the reasonable opportunity required to be given to the acquirer (who again is a shareholder after acquisition), to cover for miscellaneous difficulties which may arise hindering immediate filing of schedule 13D. The grace period will also be a tacit approval or a window of opportunity for activist investors to get more shares in their bag before the poison pills are activated.

Some have also suggested that some mechanics to put a next threshold (e.g. of 10%) may be decided. Beyond this next level, the acquirer may not be allowed to accumulate before filing the disclosure. This way the effective limit will become 10% even after the three day grace period is factored. This arrangement will help activist investors to acquire a substantial but limited (to 10%) stake before the disclosure is made.

At the same time, the stakeholders will be sure that acquisitions beyond 10% cannot take place without them coming to their notice through the mandatory disclosures.  In fact, accumulation of the next 5% shares within 3 business (trading) days will not be very easy without pushing the prices of the shares up. Thus, the issue of the acquirer quietly hoarding shares at a discount to possible premium within the grace period will also be addressed.

Considering the above, a balance, between interests of the activist investors and the rights of the shareholders to know the major owners, has to be struck. Needless to say, it is impossible to keep all stakeholders happy at all the times. However, one can at least try to keep them all smiling in this capitalistic democratic setup.

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