Blockholder Disclosure, and the Use and Abuse of Shareholder Power

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday September 25, 2012 at 8:48 am
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Editor’s Note: The following post comes to us from Adam O. Emmerich, Eric S. Robinson, Theodore Mirvis and William Savitt, attorneys in the corporate and litigation departments at Wachtell, Lipton, Rosen & Katz. This post is based on a paper they co-authored, titled “Fair Markets and Fair Disclosure: Some Thoughts on The Law and Economics of Blockholder Disclosure, and the Use and Abuse of Shareholder Power,” available here. The paper responds to a forthcoming article by Lucian Bebchuk and Robert Jackson Jr., titled “The Law and Economics of Blockholder Disclosure,” that is available here and discussed on the Forum here.

In our article Fair Markets and Fair Disclosure: Some Thoughts on The Law and Economics of Blockholder Disclosure, and the Use and Abuse of Shareholder Power forthcoming in Harvard Business Law Review, Spring 2012, and available at SSRN, we discuss the debate that has ensued following the March 2011 petition by our law firm, Wachtell, Lipton, Rosen & Katz, to the Securities and Exchange Commission to modernize the blockholder reporting rules under Section 13(d) of the Securities Exchange Act of 1934.

The petition sought to ensure that the reporting rules would continue to operate in a way broadly consistent with the statute’s clear purposes that an investor must promptly notify the market when it accumulates a block of publicly traded stock representing more than 5% of an issuer’s outstanding shares, and that loopholes that have arisen by changing market conditions and practices since the statute’s adoption over forty years ago could not continue to be exploited by stockholder activists, to the detriment of market transparency and fairness to all security holders. Among other things, the petition proposed that the time to publicly disclose such block acquisitions be reduced from ten days to one business day, given activists’ current ability to take advantage of the ten-day window to accumulate positions well above 5% prior to any public disclosure, in contravention of the clear purposes of the statute.

Activist hedge funds and academic commentators have challenged the need for any modifications to the ten-day window, arguing, among other things, that the purported benefits of secret blockholder accumulations mandate that extensive cost-benefit analysis be done before Section 13(d)’s reporting rules are modified in a way that could potentially discourage them. Among them are Professors Lucian A. Bebchuk and Robert J. Jackson Jr., who, in their “The Law and Economics of Blockholder Disclosure,” challenge the need for any modifications to the ten-day reporting window. Bebchuk and Jackson, who have widely promoted the idea that the existing flawed reporting rules promote corporate governance efficiency and benefit participants in the equity capital markets, argue that, given these purported benefits of blockholder accumulations, extensive cost-benefit analysis should be done before Section 13(d)’s reporting rules are modified.

In our paper we rebut these claims. Bebchuk and Jackson offer no sound basis for the cost-benefit analysis they suggest nor any reason to question the need for the modernization of Section 13(d)’s reporting rules proposed in the petition. The bases advanced by the blockholder interests opposing these important changes run directly contrary to Section 13(d)’s underlying purpose — “to alert the marketplace to every large, rapid aggregation or accumulation of securities.” It is widely understood that developments in market liquidity and trading — which allow massive volumes of public company shares to be traded in fractions of a second — have made the Section 13(d) reporting regime’s ten-day window obsolete, allowing blockholders to contravene the purposes of the statute by accumulating large, control-implicating positions prior to any disclosure to the market. Finally, responding to a another of the professors’ themes, we explain how corporate governance developments since the passage of the Williams Act offer no reason to fail to update Section 13(d)’s reporting rules. To the contrary, we note that the blockholder reporting rules in other major capital markets jurisdictions confirm the need to modernize the Section 13(d) reporting regime to ensure that it once again fully achieves the statute’s express purposes.

Activists and their academic supporters seek to mire any call for reform in regulatory bureaucracy. That course blocks needed reform for no good reason and allows activists to continue to abuse the gaps in the current system to their advantage. Further delay is a disservice to the principles of market transparency and fairness to all market participants that are the foundation of Section 13(d). The time to modernize is now.

The full paper is available for download here.

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