Jones Day Talks: Broken Window – The SEC’s Schedule 13D 10-Day Filing Period
The SEC requires anyone who acquires more than 5 percent ownership of any class of registered securities to file a Schedule 13D within 10 days, thereby disclosing their holdings and intentions. But the process has come under persistent criticism, as activist hedge funds and similar investors have used the 10-day window to conceal their accumulations.
Lizanne Thomas, leader of the Firm's corporate governance team, talks about the current wave of shareholder activism and explains why the SEC’s Schedule 13D 10-day filing window is in need of reform.
This podcast was produced as an accompaniment to Lizanne's article, Leveling the Hunting Field, a Reuters Breakingviews article, which can be found on JonesDay.com.
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Read the full transcript below:
Dave Dalton:
Shareholder activism, that's where an investor or group of investors uses ownership stake in a company to put pressure on management, has existed in one form or another for almost as long as companies have issued publicly traded stock. But activists agendas have changed, so have their strategies. And the advancements in technology and communication methods have accelerated. This leads some to argue that certain U.S. Federal securities regulations, notably the Schedule 13D filing window, are in need of updating. Jones Day's Lizanne Thomas is here to explain. I'm Dave Dalton. You're listening to Jones Day Talks, Corporate Governance.
Dave Dalton:
Lizanne Thomas is a Jones Day M&A partner based in Atlanta and New York. She practices, teaches and lives corporate governance as the head of the firm's corporate governance team and participates in about 100 board meetings per year as counsel to a number of public companies. Lizanne represents special committees in control and conflict transactions as well as internal investigations. Lizanne is also the author every Reuters Breakingviews guest column titled Leveling the Hunting Field. You can read that at jonesday.com on our publications page. Lizanne, thanks for being here.
Lizanne Thomas:
You're welcome. Happy to be here.
Dave Dalton:
And congratulations on a fine piece and a very well articulated op-ed at and Reuters. It was compelling.
Lizanne Thomas:
Thank you.
Dave Dalton:
Let's talk about shareholder activism for a while. I've got to believe that shareholder activism has been around in one form or another, as long as there have been public companies, likely. How has it changed in recent years and what are the consequences and repercussions for our public multinational corporations?
Lizanne Thomas:
So there've been a number of changes over the last two or three decades. So I'm going to leap from the '80s to current times, but in the '80s, what we had were corporate raiders who sought to get control of companies without necessarily paying full value. Those raiders have long since disappeared, frankly, because there are legal and financial constructs that make that not such a successful game plan. And so-
Dave Dalton:
Now, you're talking about the Ivan Boeskys, the Michael Milken era back then, right?
Lizanne Thomas:
Precisely, precisely.
Dave Dalton:
Okay great.
Lizanne Thomas:
And many of them went down in fairly spectacular flames. And so what we found now is that activists are finding that they don't need to get control, as such, to have a good outcome for their investors or for their egos. And so what we have now are shareholder activists that sort of two generations. There's the senior generation of Nelson Peltz, and Carl Icahn, and folks like that. And then there's the junior generation of the Jeff Smith's of Starboard, and a number of others, Keith Meister at Corvex and things of that nature. Those shareholder activists are taking a decidedly different perspective. It's short-term still, just like the corporate raiders of the '80s, but they're using different tactics. And, in recent years, especially in the last decade, they've really lifted their game. But what we want to do is we want to focus on the fact that their interests are really short term. What they need to do, because remember these fellows have raised money in funds that have a life of, oh, let's call it five years and they've got to produce out-sized return for their investors.
Lizanne Thomas:
And so what they look for are quick opportunities to get earnings, to get value, to get cash back in a way that will allow them to declare victory for their shareholders, for their fund investors. And that's the theme that I think we ought to really dive into today. So most of the time those investors, those activists, will say, "Give me my money. I'm going to buy 3% of your stock. And then I'm going to start agitating and publicly saying that you, the company, are sitting on too much cash. And what I want you to do is I want you to either do a share repurchase program or a dividend to give me back my money." And the result of that is when a company feels forced to pay a dividend or something like that, that yields an immediate increase for those activists. So plan A has always been "Use your assets to give me cash back in the form of a dividend or a share repurchase."
Lizanne Thomas:
That's been the traditional move of these activists without them focusing on the actual performance of the company, the actual business, or even strategy. It's just about the near-term game.
Dave Dalton:
This is bizarrely short-term thinking, right?
Lizanne Thomas:
Yeah, it is, it absolutely is. When an activist ends up deciding... but they don't stop there, when they end up deciding that perhaps you're not in a position to do a share buyback or a dividend, they'll go to plan B and plan B is, "Hey, we've looked at your balance sheet." So that's why I call it plan B. And your balance sheet is strong enough that you can go into the debt markets, borrow a bunch of money, and then do the very plan A that we've been talking about, which is a share repurchase or a dividend. Then, of course, there's plan C and plan C is "Okay, I'm in your stock. I'm agitating, you've ignored my request on plan A and plan B. And I think the reason you're ignoring it is because your management is just lousy. So plan C is I'm going to attack your CEO. I'm going to attack your management team."
Lizanne Thomas:
And we see this in the form of white papers, public statements, where they say that the CEO is comfortable, cozy and is really not driving successful performance of the company. That's a little bit more longterm, but the reason that it comes in third out of the different tactics that activists take is because the ability to affect a change in the management ranks, and we see this as CEO tenure continues to shorten and shorten and shorten, is that something that's executable quite readily, just like a share repurchase, just like a share dividend, exiting your CEO is something that your board has complete control over and can do it quickly and yield at least speculatively an increase in value. But, of course, activists don't stop there either. There's plan D and plan D is if you've ignored me about a share repurchase in my plan A, if you've ignored me about levering up your balance sheet, plan B, and you've ignored me about getting rid of your CEO, plan D is I'm coming after your board of directors. D for directors.
Lizanne Thomas:
And that's when we see proxy battles. That's when we see issues regarding settlements of putting a couple of the activist directors on a board. This is the one that board members fear the most, because it ends up being an attack on their very decision-making and their very positions. So plan D is the one that most people hear about all the time in the form of proxy battles. But the important message that I like to get out is it's not the only mischief that can be wrought. That's plan D. Now I opened this by saying that stockholder activists have increased, improved their game. The way they've done that is by taking a slightly longer-term view with respect to plan E. And believe it or not, there's even a plan F. What plan E is, is enterprise related, where an activist will say, "I'm going to prove myself to be more patient capital than you would have expected. And what I'm going to say to the company target is you need to spin off half of your business that's lower margin. You need to acquire some other businesses."
Lizanne Thomas:
Although frankly, they're rarely in favor of acquisitions. They're more in favor of divestitures, again, because that feeds the ability to get cash back to shareholders. But plan E is on the enterprise side. The most interesting thing, and it's been uncovered only recently, is that we're now seeing these activists who have attracted huge amounts of capital, needing to find other ways to deploy their own cash. And so that's where plan F comes in. We're now seeing particularly for smaller high-tech companies that the activists are saying, "Hey, I'm going to be your source of financing. I'm going to force you to use me as your lender." And that creates a whole new dynamic, but that's plan F, "I'm going to be your financier," little bit like the company sore, if you will. But that's a new one. In all of these, the key is that they've lifted their game. They're a lot sharper and more effective than they were the beginning days of activism.
Dave Dalton:
Go back to plan F for a second, the lending part of all this. That's legal? It doesn't seem right whether it's legal or not, but it sounds like a strange sort of extortion almost
Lizanne Thomas:
Well, it's absolutely legal. What will happen is that an activist will come at you dissatisfied with some level of performance or something. And will say, "In order for me not to pursue a proxy battle to unseat your entire board, I'm going to require that you agree to three things. The first thing is you're going to allow my two designees into the boardroom. The second thing is you're going to do some kind of share repurchase. And the third is that you're going to agree that I can either provide 100% of any subsequent financing that you're doing or some percentage." And it's absolutely legal. What I think is most interesting about it, Dave, is the fact that they have capital that they need to spend. This tells us more about the success of the activist in raising funds than it does anything else. That they're just looking for new ways to deploy their own capital.
Dave Dalton:
It sounds like they're more interested in that than actually running a company, that's for sure. Or at least taking even a medium-term view. Let's go back to the board seats situation for a second. What in current law makes it even possible for activists to take positions large enough to dictate who's on the board?
Lizanne Thomas:
So it's really about punching above your weight. Shareholder activists, as I've said, we're going to draw distinction between them and the old raiders who did actually look for control. What activists are now able to do in the era of what we now call shareholder democracy is they are able to persuade institutional holders, other funds, proxy advisors, and others that any change is better than no change. And so we find proxy advisors, like ISS and Glass Lewis, going ahead and defaulting in favor of supporting candidates that the activist would promote. There's another important distinction here. And that is that activists are putting in candidates that are respectable. In the early days of activism, what you'd frequently see is the 28-year-old mortgage-broker brother-in-law of an activist. That era has come and gone.
Lizanne Thomas:
What we now see is that activists are affiliating themselves with respected operators in industries. Not exclusively, they're still putting their own staff people in from time to time. But without a doubt, they're nominating directors who are worthy of serious attention. And the reason they're able to do this is simply because they are persuasive to the marketplace that any change is better than no change.
Dave Dalton:
You wrote extensively in the Reuters op-ed about the Schedule 13D 10-day window. Talk about exactly what that is and how it enables these activists to take on boards and place their own people on a board of directors?
Lizanne Thomas:
Sure. So let's start with a principle of what the securities laws are all about. The 33 and 34 Acts that govern all trading in public companies are founded really in two fundamental tenants. If you keep these two in mind, you know everything that you really need to know about the securities laws. The first is that companies that are seeking investors are required to tell the truth, fundamentally. That's what we refer to as the 10b-5 rule, tell the truth, don't make any material omissions. The second tenant that underlies those securities laws is don't take advantage of your insider position. So as long as you remember those two things, every single rule that comes out of the SEC relates to those two. Tell the truth...
Dave Dalton:
Tell the truth and...
Lizanne Thomas:
... and don't take advantage of your insider position.
Dave Dalton:
Advantage of your insider position. Okay. Right.
Lizanne Thomas:
Okay. So once you know that, now let's go into Schedule 13D. 13D, the number is meaningless, it's just the order it showed up in the regulations, says that if an investor gets to the level of 5% and has an intention to influence the operations of the company, then they must reveal themselves to the marketplace. All right. Again, that's very much consistent with what I just talked about in the two tenants. Tell the truth about what your aims are, given that you intend to exercise influence by virtue of the size of your position. The flaws and Schedule 13D is that they were adopted years and years ago in a pre-digital environment in which these filings used to be made literally by snail mail. And so the problem with Schedule 13D is that once an investor has gotten to the 5% threshold, which, of course, they can do in a nanosecond, they have 10 long, aching days in which they can run up additional ownership before their filing needs to take place.
Dave Dalton:
They don't need to tell anybody except for their cronies, I guess, who they're bringing along to the deal, right?
Lizanne Thomas:
Right.
Dave Dalton:
Wow.
Lizanne Thomas:
Not a soul. And that timeframe is tremendously important, because as a company, corporate America doesn't have the luxury of any of that timeframe. We won't find out in advance. We cannot gird ourselves to communicate with the marketplace. We are continuing to operate the company for longterm success and frankly, short-term performance as well, while all of this is happening in the dark. It's antiquated and, in my view, allows those investors to take advantage of the very control position that they wish to have. And that, to my mind, turns the securities laws on its ear. And is why the Schedule 13D window needs to close.
Dave Dalton:
Talk about specifically why this window is unfair and disruptive to companies?
Lizanne Thomas:
Okay. Well, let's start with just the teenager's presumption that all people ought to be treated equally. Here what is important is a public company is always obliged to promptly tell the market about anything material that happens to it. A public company has disclosure obligations with timeframes significantly shorter than 10 days. All right. There are some company obligations that are required to be done in real time, on the same day that a material event happens. That's regulation FD. There are other events that are required to be disclosed within 24 hours. And there are yet even others that have a four-day window. My point being, generally speaking, companies are meeting a far more restrictive disclosure obligation. So one is simply that imbalance.
Lizanne Thomas:
But the second one and the one that I think is more important is what this allows that investor to do. There are no rules on its conduct in the interim, all right. It hits that 5% and it can run as fast as it can. It can convince its allies, fellow wolves in the wolf pack, to accumulate as well. And they can do this in darkness. So that what will then happen for a company is they'll wake up on a random day, 11 days out and find out that their ownership profile has fundamentally changed. That the goals for those investors... and I would tend not to call them investors, I'd call them speculators, will begin to influence the direction of the company. You made that point earlier, that they aren't really interested in the business. What they're interested in is whether or not they can get a pop in the stock price and declare victory and exit. And so that disparity is the one that concerns me.
Dave Dalton:
Definitely. It seems like this should have happened maybe once. This could have happened once and people in Washington should have said, "You know what? Obviously, times have changed, things have changed. We've got to fix this." How do policy makers let this continue? It's so obvious the way you're explaining this, this is inherently unfair, wrong. It's bad for most companies, I would think, that it puts serious investment and time and resources and planning into a legitimate growth plan for their company. How does this keep going?
Lizanne Thomas:
So a couple of things there. The first boards of directors willingly step into their fiduciary responsibilities, knowing that they will be judged against two, sometimes apparently conflicting, goals. One is to maximize longterm shareholder value and the other is that they must perform on a short-term basis as well. We report our results on a quarterly basis. And I think it's important to recognize that board members are saying, "Okay. I know that's tough, but I sign up for that." And they really have. That's been true since the 33 Act was adopted way back in the day, that boards except that. The problem here is that this particular activity turns that upside down and is problematic. So then you would think, "Well, the SEC," this is a regulation. It's not a law. "So the SEC itself has the power to change this 10-day window and to level this playing field a little bit. Why have they not?"
Lizanne Thomas:
Couple of theories here. If you go back into the '90s and you look the meltdown in the .com world, and then we look at some of the other flagrant investor fraud that took place in Bernie Madoff and Stanford and whatnot. What we found was that the SEC turned its attention away from corporate America and towards protecting investors and thinking about the regulatory environment related to funds and investment advisors and things of that nature. Particularly during the prior administration, there was sort of an obsession with that. The idea of doing anything that would be supportive of corporate America was simply not acceptable. So to the extent that these issues were raised and they were, there was simply no likelihood that we were going to see this kind of movement during the prior administration.
Lizanne Thomas:
Now, interestingly, it's typically not corporate America that says that it's seeking more regulation. But in this particular instance, I think it's fair to say that corporate America would be supportive of a more balanced, nuanced regulatory scheme that would relate to the Schedule 13D disclosure. Not that it's more regulation, but it is simply brought current by the current standards of speed in which investments can be made.
Dave Dalton:
Well, I was going to ask you later, if you had a prediction for where this might go next or what could happen, but maybe I'm going to jump ahead in my notes here. But you mentioned the prior administration, maybe that wasn't a good climate politically to try to fix something like this. What about now?
Lizanne Thomas:
I think there's a chance that there will be some attention on this. I do know that some advocacy organizations are speaking to the SEC about it. The new leaders of the SEC have indicated a certain receptivity, and there is a bill that was presented in Congress on a bipartisan basis about a year ago, referred to as the Brokaw Act that proposed to shorten this 10-day window. That bill has languished for a variety of political reasons beyond the scope of this discussion. But I think this is getting to be recognized as a legitimate area that needs to be fixed. So I'm reasonably optimistic, whether it's going to be a legislative path or a regulatory path, frankly, I'd put my money on the regulatory side of things, but I would expect sometime within the next two years, we should see some improvement in this, as long as corporate America keeps this front and center.
Dave Dalton:
Interesting.
Lizanne Thomas:
What's really interesting is the Brokaw Act, to which I referred, was originally proposed by a Democratic Senator and then joined by a Republican Senator from Georgia, Senator Perdue. I think Senator Perdue is an experienced businessman and he saw the logic of this, but what got in the way of him continuing to support it was politics. And so that's why that one has languished. And there's some resistance to be fair in the traditional investor community, simply out of concern about it being difficult for them to make these filings in less than 10 days. I don't think that argument is credible. We're all doing things with a digital lightening speed these days.
Dave Dalton:
Absolutely. Look at this program we're recording right now. We're doing this about 20 minutes or so. So for goodness sake.
Lizanne Thomas:
Exactly.
Dave Dalton:
But going back to the political component one more time, I can't decide where the economic populous might be on this one. On one hand, if you're pro-investor and "Okay, it's a short-term game," but that's good and it bumps your 401k. Shortly, it looks better for the year. On the other hand, if we're talking about what's really probably best for corporate America, genuine economic growth, a fuller employment, those sorts of things, these guys that run big companies didn't get there by being dumb. They're probably doing good things that would grow a company that does bring about better prospects for populous types in terms of their personal situation. So you can't argue this either way. It's a very interesting situation, I think.
Lizanne Thomas:
You have to decide what you value more. The founder of Vanguard, John Vogel, said, "You've got to draw a distinction between investors and speculators." And I'm not saying that speculators are bad. If what speculators want to do is benefit from short-term gain, more power to them. But if you're only a speculator, you shouldn't have control. You shouldn't have excessive influence. You should only be able to time the market, not affect leadership. That's the fundamental difference. With investors, they've got a dog in the fight, as they say. And I do think they should have a voice regarding leadership of the company, strategy, direction, capital allocation. But in those circumstances, they need to be committed to the longterm. Now, once again, I want to stress that I think boards have excepted the very difficult burden of serving both longterm and short-term. Sometimes it's in conflict. Sometimes it's in alignment, but that's why they're the people at the top of their game. I really believe in their fiduciary exercise of those duties. What I don't want is for them to be in a fight that isn't a level playing field. And that's the issue about 13D.
Dave Dalton:
Absolutely. Absolutely. You've done a very good job, very thorough job, of explaining this. And I think you've given us all a lot to think about, but let's close here on a slightly different note. Just to be fair. Not all activism is bad in terms of corporate, is it?
Lizanne Thomas:
That's absolutely true. And I'm frankly glad you asked that. As I opened by saying that activists have lifted their game, what I will also tell you is that it is fair to discriminate or to distinguish among activists. There are those, and I can name them, but won't, who like to define themselves as constructivists. They tend to take a slightly longer-term view. They tend to focus on industries as opposed to simply low-hanging fruit. That tells you then that they're behaving more like investors and those organizations I think deserve a great deal of credibility. Let's move on from them though and talk about the pure activists. And even those will often elicit a good outcome for companies, because companies themselves no longer have the luxury of being complacent.
Lizanne Thomas:
So what we find part of our advice to the boards that we work with, all across the country and the globe, is look at yourself with a certain amount of skepticism. Look at the company. Are you moving as fast as you can? Are you protecting some sacred cows? Are you really driving outcomes and innovations as hard as you can? And what we have found is that that sort of outside challenge has sometimes yielded better inside development and work. And so not all of them are bad. That kind of internal muscle and discipline is a good idea.
Dave Dalton:
Absolutely. And some introspection can be good for board members. That's for certain.
Lizanne Thomas:
Yeah. Absolutely.
Dave Dalton:
Lizanne, this has been great. You've been terrific. Thank you so much. Again, this is complicated material and I understand it now. So probably anybody listening can, that's for certain.
Lizanne Thomas:
Thank.
Dave Dalton:
You need to write a book about this. I'm serious.
Lizanne Thomas:
I'd love to.
Dave Dalton:
You need to.
Lizanne Thomas:
Been thinking about it.
Dave Dalton:
You need to. I don't think this issue is going away anytime soon. Certainly there'll be progress, but you bring out some very good points I've not heard elsewhere. So thanks so much for your time today.
Lizanne Thomas:
Happy to do it. Thank you, Dave.
Dave Dalton:
You can find Lizanne Thomas' complete biography along with information on the firm's M&A practice and corporate governance work at jonesday.com. Subscribe to Jones' Day Talks on Apple Podcasts, Google Play, Stitcher on Android. And while you're there, check out some of our previous podcasts. I'm Dave Dalton. You've been listening to Jones Day Talks, Corporate Governance. We'll talk to you next time.
Disclaimer:
Thank you for listening to Jones Day Talks. Comments heard on Jones Day Talks should not be construed as legal advice regarding any specific facts or circumstances. The opinions expressed on Jones Day Talks are those of lawyers appearing on the program and do not necessarily reflect those of the firm. For more information, please visit jonesday.com.
