Pre-disclosure accumulations by activist investors: evidence and policy.

• Author: Bebchuk, Lucian A.
• Position: Author abstract

1. INTRODUCTION II. THE INCIDENCE AND MAGNITUDE OF PRE-DISCLOSURE ACCUMULATIONS A. The Universe of Schedule 13D Filings by Activist Hedge Funds B. The Timing of Schedule 13D Filings C. The Surprising Incidence of Violations of Existing Rules III. CHANGES OVER TIME IV. THE COSTS OF TIGHTENING SECTION 13(D) V. BEYOND ACTIVIST HEDGE FUNDS VI. THE TIMING OF POST-FIVE-PERCENT PURCHASES VII. DISCLOSURE REFORM AND LOW-THRESHOLD POISON PILLS VIII. CONCLUSION APPENDIX I. DATA A. Dataset Assembly B. Constructed Variables II. ANALYSIS A. Determinants of the Time to Disclose B. Determinants of Ownership Stakes upon Filing C. Activists' Ownership Stakes over Time I. INTRODUCTION

   The Securities and Exchange Commission is currently considering revising the rules governing blockholder disclosure. A rulemaking petition recently submitted to the Commission by the senior partners of a prominent law firm urges the Commission to accelerate the timing of the disclosure of five-percent stock accumulations in public companies. (1) While the Commission's rules have long required public-company investors to disclose their ownership within ten days of crossing the five-percent threshold, the Petition proposed to shorten this period to one day.

   The Commission has since announced a rulemaking project in this area, and members of the Commission's staff have signaled that the SEC is examining the subject. Former SEC Chairman Mary Schapiro, acknowledging the "controversy" surrounding these important rules, has indicated that the Commission is actively considering whether to adopt the changes proposed in the Petition, (2) and the SEC staff recently signaled that responding to the Petition is part of the Commission's regulatory agenda. (3)

   Notably, the Petition offers no systematic evidence on stock accumulations. Instead, the Petition repeatedly refers to several anecdotes concerning recent cases in which activist hedge funds purchased large amounts of stock (or securities convertible to stock) prior to disclosure. The Petition argues that these anecdotes underscore a new, more general, phenomenon of secret stock accumulations made possible by changes in trading technologies that demand immediate changes in the disclosure rules. Recent developments in market practices, the Petition contends, render the existing rules under Section 13(d) of the Securities Exchange Act of 1934, which governs blockholder disclosure, obsolete. And an article published by senior attorneys at the firm that filed the Petition similarly asserts that these developments are widely understood by market participants--but offers no evidence in support of this understanding. (4)

   In two separate comment letters filed with the SEC, the four of us cautioned that the Petition does not rest on a systematic empirical examination of the publicly available data, and that empirical investigation is necessary before any changes to the existing rules are seriously considered. (5) In a subsequent article, two of us stressed the need for such an empirical examination and discussed the empirical issues such an examination should seek to address. (6) In response, in a recent article four senior partners of the firm that filed the Petition dismissed our claim that an examination of the evidence beyond the anecdotes described in the Petition is necessary. (7) The authors expressed concern that such an examination would be difficult and time-consuming and likely delay the "modernization" of Section 13(d) that they view as desirable. (8) Similarly, in a public debate with one of us, Martin Lipton, the senior partner of the firm that authored the Petition, rejected the need for an empirical examination of these questions. (9) In our view, however, given that data on Section 13(d) filings are publicly available, the SEC should not proceed with any rulemaking in this area before examining this evidence.

   In light of the SEC's expected consideration of the Petition, this Article uses data based on Section 13(d) filings to provide the first empirical analysis of this subject. We find that some of the key factual premises of the Petition--such as claims that predisclosure accumulations have increased over time because of changes in market practices and opportunities--are incorrect. Furthermore, our analysis provides empirical evidence that can inform the SEC's consideration and a foundation on which subsequent work, by SEC staff or other researchers, can build.

   The Article proceeds as follows. Part II describes the universe of pre-disclosure accumulations we study and provides evidence about the incidence and magnitude of such accumulations. We examine the universe of all Section 13(d) filings by activist hedge funds from 1994 through 2007. We find that hedge fund activists do indeed use the opportunity not to disclose immediately upon crossing the five-percent threshold, with over 40% taking advantage of a large part of the ten-day window. Indeed, we find that about ten percent of all filings are made after the specified ten-day window, which suggests that the Commission should consider more effective enforcement of the existing deadline before examining whether the deadline should be shortened. Moreover, our examination of the ownership stakes revealed in Section 13(d) filings indicates that the five anecdotes noted in the Petition are not representative of the magnitude of stakes accumulated by hedge fund activists prior to disclosure. The evidence shows that hedge fund activists typically disclose substantially less than 10% ownership, with a median stake of 6.3%.

   Part III investigates a key claim of the Petition: that changes in market practices have, over time, enabled activist investors to increase the magnitude of pre-disclosure accumulations, making existing rules obsolete and requiring "modernization." We show that the evidence does not support this claim. In contrast to the concerns expressed in the Petition and subsequent work by the Petition's authors, (10) the size of pre-disclosure accumulations of stock have not increased over time. Indeed, the median stake at the time of disclosure has remained relatively stable throughout the 14-year period we study, and more extensive regression analysis does not identify a time trend. Thus, changes in existing rules can at most be justified as necessary to address longstanding policy questions, not as a "modernization" required by changes in the marketplace.

   Part IV examines the costs of tightening the rules under Section 13(d). Requiring activist investors to disclose their stakes in public companies more quickly will reduce these investors' returns by giving them less time to acquire shares before disclosing their presence, and will therefore reduce the incidence and magnitude of outside blockholdings in such companies. This reduction will in turn impose two costs upon other investors in public companies. First, ex post, investors in general will benefit less frequently from the superior returns that have long been associated with the arrival of an activist blockholder. Second, investors can be expected to lose the gains associated with the mere possibility that a blockholder will emerge and reduce agency costs and managerial slack because, ex ante, the probability that such an investor will emerge is reduced by the tightening of the rules under Section 13(d).

   Part V provides data with respect to an aspect of this subject that seems to have been overlooked by the authors of the Petition but that the SEC should take into account when considering changes to the rules under Section 13(d): the actual identity of the investors who disclose under the statute. While the Petition and its authors have focused on activist investors, we show that Section 13(d) filings by activist hedge funds represent only a small minority of all such filings. We document the large number of filings made under Section 13(d) by investors other than activist hedge funds--and show that it is common for these investors, too, to make full use of the ten-day period prior to disclosure to accumulate more than five-percent ownership in the firm by the time they disclose their stakes. Thus, in examining the consequences and costs of the proposed tightening of the Commission's rules under Section 13(d), it is important to take into account that most of the investors to which tightened rules would apply would not be the activist hedge funds on which the Petition has focused.

   In Part VI, we investigate how activists' purchases beyond five-percent ownership are likely distributed in the ten-day window after the investors cross the five-percent threshold. We investigate this subject by identifying abnormal trading turnover during the ten-day period. We find that, even when activists choose to wait the full ten days after crossing the five-percent threshold to disclose their stakes, their purchases are likely concentrated on the day they cross the threshold as well as the following day. Thus, whatever the benefits of the existing ten-day period for activist investors, the practical difference in pre-disclosure accumulations between the existing regime and the rules in jurisdictions with shorter disclosure windows--which the Petition holds out as a model for modern reform--is likely much smaller than the Petition assumes.

   Finally, in Part VII we consider the relationship between the Petition's proposed tightening of the disclosure rules under Section 13(d) and the recent proliferation of low-threshold poison pills in the United States. We present evidence indicating that a significant proportion of poison pills at public companies have thresholds that fall substantially short of a controlling block. (11) We argue that any consideration of reforming the rules under Section 13(d) should take into account the interaction of such reform with the use of these poison pills. In particular, we suggest that the SEC should avoid adopting any reforms that would facilitate the use...