The SEC’s Failure to Regulate Leading Investment Managers and their Assets
In 1975, the financial markets saw an ‘increase in the concentration of institutional ownership’ alongside an absence of publicly available ‘trading data’. Consequently, Congress was worried that the SEC’s ability to maintain ‘fair and orderly markets’ was subsequently hampered. To counteract this, Form 13F, which required investment managers holding 13F securities (such as exchange-traded equity securities, shares of closed-end investment companies and certain convertible debt securities) worth more than USD $100 million was implemented. For the past 40 years, the form has remained unchanged, passively supervising the financial markets, until earlier this month.
On the 10th July, the SEC proposed to amend the threshold of Form 13F, exempting all managers holding less than $3.5 billion of 13(f) securities from filing the form. The proposed amendment, which superficially appears to contradict the original objectives of Form 13F, has received significant backlash. Critics have highlighted all sorts of shortcoming, in particular the loss of transparency in the financial markets. This, critics argue, will allow for activists hedge funds to ‘go dark’. Are these worries justified? Will the amendments to form 13F truly lead to market abuse?
Departure from the original objectives of the Form 13F
The SEC remains adamant that the new amendments will further the primary goals of Form 13F including ‘gathering data about investment activities of institutional investment managers; facilitating consideration of the impact of these managers on the securities markets; and increasing investor confidence in the integrity of the securities markets’. In support of these claims, the SEC highlights amendments included in the proposal, aimed at improving transparency. This includes removing the option for managers to exclude certain smaller holding from the forms, requiring managers to ‘report certain number identifiers, enhancing the usability of the information provided’ and making ‘certain technical improvements to modernise information reported’.
Moreover, the SEC notes how there are alternative sources of holding data, ones which were not present when Form 13F was introduced, available today. An example is Form N-Port, which requires monthly holding reports to be compiled and submitted to the SEC on a quarterly basis, information of which is made public after a 60-day delay.
However, this form does not provide the same degree of transparency as Form 13F, where the information collected through the form is made public after a 45-day delay. Additionally, what the SEC failed to highlight was the alarming drop in the number of investors required to file Form 13F. The proposal will exempt 90% of the current 5,089 investment managers from filing Form 13F, leaving only 550 such managers with the obligation, eliminating Form 13F’s practical value for most investors.
Adam O Emmerich, David M Silk and Sabastian V Niles, partners of Wachtel, Lipton, Rosen & Katz, writing for the Harvard Law School Forum on Corporate Governance, argue that the proposed measures by the SEC actually facilitates ‘market abuse by sophisticated investors who wish to accumulate shares on a stealth basis’, such as activist funds. Moreover, it hinders shareholders and directors from swiftly identifying the company’s institutional investors; all contradictory to the SEC’s claims that the proposal will maintain transparency within the financial markets
Disregarding Investor’s Calls for Increased Transparency
In 2013, NYSE Euronext, the Society of Corporate Secretaries and Governance Professions and the National Investor Relations Institute filed a 13(f)-rulemaking petition, requesting that the 45-day reporting deadline be shortened. This, alongside several calls from Wachtel, Lipton, Rosen & Katz for reforms, demonstrated public sentiment wanting increased transparency of the financial markets. Not only have these demands fallen on deaf ears, however, but the recently proposed amendment also demonstrates a reluctance to acquiesce to public demand on the part of the SEC.
Instead of the regulation of financial markets, the SEC appears to be more concerned for the wellbeing of smaller investment managers, arguing their reforms will save such managers up to USD $136 million in compliance expenditure. Moreover, questionable practices, such as front running and copycatting, which hinders their investment performances, would become less efficient. While true, this consolidates the monopoly which large investment managers, with additional resources and knowledge, have within the market, potentially pathing the road for an increased management fee, harming the investors themselves.
The future and legal impact of the proposal
As the time of writing, the proposal is still in the public consultation phase. While such amendments appear to be unwelcomed by the financial community, all we can do is hope the SEC is receptive to such comments and make any adjustments accordingly.
As a small amendment to the plethora of laws which compliance teams must navigate through, the proposal would have limited impact on the legal industry. However, this reform may create sufficient momentum for further relaxation of current regulatory practices, leading to a greater impact on the compliance team in US firms.
By Marcus Cheung