In a letter submitted yesterday to the Securities and Exchange Commission, we provide a detailed analysis of the policy issues relevant for the Commission’s ongoing examination of changes to its rules under Section 13(d) of the Securities Exchange Act of 1934. These rules, which govern share accumulation and disclosure by blockholders, are the subject of a recent rulemaking petition submitted by Wachtell, Lipton, Rosen and Katz, which proposes that the rules be tightened.
We argue that the Commission should not view the proposed tightening as merely “technical” changes needed to modernize its Section 13(d) rules. In our view, the proposed changes should be examined in the larger context of the beneficial role that outside blockholders play in American corporate governance and the broad set of rules that apply to such blockholders.
Our analysis proceeds in five steps. First, we describe the significant empirical evidence indicating that the accumulation and holding of outside blocks in public companies benefits shareholders by making incumbent directors and managers more accountable and thereby reducing agency costs and managerial slack.
Second, we explain that tightening the rules applicable to outside blockholders can be expected to reduce the returns to blockholders and thereby reduce the incidence and size of outside blocks—and, thus, blockholders’ investments in monitoring and engagement, which in turn may result in increased agency costs and managerial slack.
Third, we explain that there is currently no empirical evidence to support the Petition’s assertion that changes in trading technologies and practices have recently led to a significant increase in pre-disclosure accumulations of ownership stakes by outside blockholders.
Fourth, we explain that, since the passage of Section 13, changes in state law—including the introduction of poison pills with low-ownership triggers that impede outside blockholders that are not seeking control—have tilted the playing field against such blockholders.
Finally, we explain that a tightening of the rules cannot be justified on the grounds that such tightening is needed to protect investors from the possibility that outside blockholders will capture a control premium at other shareholders’ expense.
We conclude by urging the Commission to pursue a comprehensive examination of the rules governing outside blockholders and the empirical questions raised by our analysis. In the meantime, the Commission should not adopt new rules that tighten restrictions on outside blockholders. Existing research and available empirical evidence provide no basis for concluding that tightening the rules governing outside blockholders would satisfy the requirement that Commission rulemaking protect investors and promote efficiency, and indeed raise concerns that such tightening could harm investors and undermine efficiency.
Our letter to the SEC is available here.