The 13D rule requires investors to disclose stakes of more than five percent, and the Hart-Scott-Rodino Act requires investors to disclose when they invest more than $60 million. With these required alerts in place for decades, why are public companies surprised when they find a hedge fund or activist fund has taken an enormous stake and is well poised to mount a proxy contest?
Today’s hedge funds and other activists have cleverly found that the law requires them to disclose only when they control more than five percent of the vote, not five percent of the “economics” in a company. These hedge funds and activists have quietly and cunningly been able to get around the rules through complex “swap” agreements with investment banks.
Here’s a simplified version of how the loophole works: An investor calls an investment bank and says, “Please buy 100 shares of company X. You can hold onto those shares in your name — and technically, you can do whatever you want with them. In six months, if the shares have gone up, you’ll owe me the difference. If they go down, I’ll owe you. And for all the cartwheels you’re doing for me, I’ll pay you a ‘small’ fee.”
The banks buy the shares on the investors’ behalf, but technically never transfer full ownership until a predetermined time and price. During the time in which these shares are “parked” in the investment bank’s name, the investors do not own the shares at all, just the “economics” of them, and are therefore not required to file the regulatory notices.
Is this legal? The answer is yes.
Although it may sound absurd, the funds are doing nothing wrong. But given the possibility for abuse and the impact on other shareholders, this loophole should be closed.
A spokesman for the Securities and Exchange Commission said they are looking into the issue — but clearly they are not acting fast enough.
— PondelWilkinson, email@example.com