Corporate Governance

Regime Change and the SEC's Corporate Governance Agenda: #3 Beneficial Ownership Disclosure

By J. Robert Brown

As the CSX case illustrates, it is time to reform the disclosure requirements under Section 13(d) to address some of the more exotic methods of acquiring shares, particularly in connection with derivative transactions.

There is an increasing recognition that derivatives securities play a role in determining the influence of shareholders.  TCI v. CSX involved allegations that shares acquired by counterparties as part of equity swaps should be attributed to the hedge funds creating the swaps. The case involved understandable consternation among swap parties, concerned that they might become members of a group for purposes of the beneficial ownership requirements and Section 13(d).

At the same time, however, the case demonstrated the potential impact of derivatives on a change of control.  The hedge funds in CSX entered into equity swap positions that were hedged by the counterparties (large investment/commercial banks).  To hedge the transactions, the banks acquired the same number of shares subject to the swap.  As a result, the banks ultimately owned approximately 10% of the shares of CSX.  The hedge funds were, therefore, in a place to pick up the block of shares (adding to the approximately 8.7% of the shares already owned) or, given the business incentive, receive the voting support of the banks without any explicit agreement. 

What ever the precise parameters of Section 13(d), ordinary investors would likely find the availability of these shares as material.  Without necessarily attributing ownership to the funds or lumping the banks into a group, the rules should clarify instances when these types of ownership blocks are subject to disclosure.  The matter should not be left to a case by case determination of the courts.

The need for rules is made more critical by the involvement of the Division of Corporation Finance in the matter.  The trial judge in CSX asked for the views of the Division.  The position is not particularly helpful manner and does not necessarily reflect the views of the entire Commission (leaving the weight to be given to the pronouncement unsettled).

The Commission needs to instruct the Division of Corporation Finance to begin developing amendments to the beneficial ownership reporting requirements under Section 13(d) to capture in an objective manner derivative ownership that can facilitate changes in control.

Full post as published by The Race to the Bottom on January 08, 2009 (boomark / email).