The Securities and Exchange Commission (the "SEC") recently adopted Rule 13h-1 of the Securities Exchange Act of 1934 (the "Exchange Act") and related Form 13H, establishing new reporting and filing requirements for "large traders" of securities in U.S. markets. Two essential features make up Rule 13h-1: (1) large traders must register with the SEC on Form 13H and provide identifying information to their registered broker-dealers and (2) registered broker-dealers through whom large traders effect their transactions are subject to recordkeeping, reporting, and monitoring requirements.
The deadline for large traders to file with the SEC is December 1, 2011. The compliance deadline for broker-dealers is April 30, 2012.
This Update summarizes the qualifications and requirements for large traders, who will mostly be companies in the financial services industry, but will also be entities and individuals who manage significant equity portfolios.
Who Is a Large Trader?
A "large trader" is defined as any person that "directly or indirectly, including through other persons controlled by such person, exercises investment discretion over one or more accounts and effects transactions for the purchase or sale of any NMS securities for or on behalf of such accounts, by or through one or more registered broker-dealers, in an aggregate amount equal to or greater than the identifying activity level." NMS securities generally refer to U.S.-listed stocks and options. Large traders include foreign persons that meet the definition above.
- "Identifying activity level" is defined as aggregate transactions in publicly traded securities that are equal to or greater than:
- During a calendar day, 2 million shares or $20 million (determined by fair market value of the shares) or
- During a calendar month, 20 million shares or $200 million.
- "Investment discretion" is broadly defined to encompass a person authorized to determine what securities are to be purchased or sold, as well as a person that makes decisions about such purchases or sales even though some other person may have responsibility for such investment decisions, but does not cover employees who exercise investment discretion within the scope of their employment.
- "Control" includes "controlling," "controlled by" and "under common control with," and is defined as "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of securities, by contract, or otherwise." Control is presumed to exist if a person directly or indirectly has the right to vote, or to sell or direct the sale of 25% or more of a class of voting securities of an entity, or, in the case of a partnership, the contribution of or the right to receive upon dissolution 25% or more of the capital of an entity. Because of the low 25% threshold for the presumption of control, companies must be vigilant about minority positions that could trigger reporting requirements.
- "Identifying activity level" is defined as aggregate transactions in publicly traded securities that are equal to or greater than:
Which Transactions Can Be Excluded?
For purposes of determining whether a person is a large trader, certain types of transactions can be excluded from the calculation of the identifying activity level, including:
- Any transaction that is part of an offering of securities by or on behalf of an issuer, regardless of whether the offering is subject to registration under the Securities Act of 1933 other than an offering of securities effected through the facilities of a national securities exchange;
- Self-tender offers and other stock buybacks by an issuer;
- Stock loan and equity repurchase agreements;
- Any transaction between an employer and its employees effected pursuant to the award, allocation, sale, grant, or exercise of an NMS security, option, or other right to acquire securities at a pre-established price pursuant to a plan that is primarily for the purpose of an issuer benefit plan or compensatory arrangement; and
- Any transaction to effect a business combination.
Despite the above exempt transactions, the following transactions could trigger registration under Rule 13h-1:
- Open market accumulations that often precede an M&A transaction or tender offer;
- "At-the-market" equity dribble out programs, where a company enters into an agreement with a broker to sell its securities directly into the market; or
- Open market sales by a shareholder of, or in connection with, for example, a broker-assisted cashless exercise of stock options or a Rule 10b5-1 trading plan (here, the insider, not the corporation, would be the large trader if the identifying activity level is achieved).
Types of Form 13H Filings
Large traders must self-identify to the SEC by filing an initial Form 13H (the initial compliance date is December 1, 2011), and then they must comply with additional filing procedures in the future. There are six types of Form 13H filings:
- Initial Filing. An Initial Filing identifies the large trader to the SEC and must be filed with the SEC promptly, generally within 10 days after the company meets the definition of a large trader. Once filed, the SEC will assign and issue to a large trader a unique identification number ("LTID"), which the large trader must then provide to its registered broker-dealers.
- Annual Filings. Within 45 days after the end of the calendar year, large traders must submit an Annual Filing, which requests the same information as the Initial Filing.
- Amended Filings. If any of the information in a filed Form 13H becomes inaccurate for any reason, a large trader must file an Amended Filing promptly following the end of the calendar quarter in which the information became stale. Although not required, a large trader may voluntarily file an Amended Filing more frequently than quarterly at its discretion.
- Inactive Status. A large trader who has not effected transactions that meet or exceed the threshold levels at any time during the previous calendar year may file for inactive status. A large trader on inactive status need not file an Amended or Annual Filing until its transactions again reach the identifying activity level. Inactive status also permits the large trader to request that its broker-dealers stop maintaining records of its transactions by LTID.
- Reactivated Status. This filing is submitted by a large trader who was on inactive status in order to reactivate its status after effecting aggregate transactions that meet or exceed the threshold level. Promptly (generally within 10 days) after reaching the threshold level, the large trader must again file Form 13H and inform its broker-dealers of the need to record its trading activity by its LTID.
- Termination Filings. A large trader may permanently end its large trader status by filing a Termination Filing with the SEC. The Termination Filing can be used, for example, when a company acquires or is acquired by a large trader.
Start Preparing Now for Large Trader Reporting. Persons that anticipate qualifying for large trader status should consider the following steps:
Consolidate Responsibility in a Single Complex Organization with Multiple Large Traders. The definition of large trader is designed to focus on the ultimate parent company of an entity or entities that employ or otherwise control the individuals that exercise investment discretion. To this end, Rule 13h-1 allows a parent company whose subsidiaries meet the definition of large trader to choose to file on behalf of its subsidiaries, thereby removing the obligation of each qualifying subsidiary to file a separate Form 13H. Conversely, a parent does not need to register if all large traders under its control comply with the requirements. Complex organizations should create a system to organize their reporting responsibilities and decide whether to register each large trader individually or streamline reporting through a single entity.
Consider Whether to Assign LTID Suffixes to Facilitate Reporting. Rule 13h-1 permits, but does not require, a large trader to assign LTID suffixes to sub identify affiliates, including persons, divisions, groups, and entities under the large trader's control. A suffix can have no more than three characters, all of which must be numbers. The SEC in the Adopting Release encourages this practice, suggesting that it might be useful to facilitate a large trader's ability to accurately and efficiently track the trading for which it exercises investment discretion and to respond to SEC disaggregation requests.
Voluntary Registration Averts Qualification Calculations. The SEC allows for voluntary filing of a Form 13H to register as a large trader. While this avoids the initial burden of calculating whether you qualify as a large trader, you will be required to comply with the other filing requirements.
Contents of Form 13H
Form 13H is designed to collect basic information about a large trader that will help the SEC monitor the trading activity of the most significant U.S. securities market participants. In some instances, Form 13H also requires information about "affiliates" of the large trader, defined as any person that directly or indirectly controls, is under common control with, or is controlled by the large trader (note definition of "control" above). In other instances, Form 13H requires more detailed information about "Securities Affiliates" of the large trader, defined as affiliates that exercise investment discretion over NMS securities. Six items of information must be provided on Form 13H:
- Item 1requires the large trader to specify, from enumerated choices or in an "Other" category, the types of businesses engaged in by the large trader or any of its affiliates. A large trader is also required to describe, for itself and each of its Securities Affiliates, the nature of its operations, including a general description of its trading strategies. The Adopting Release and the instructions to Form 13H provide guidance regarding the level of detail expected for the trading strategy disclosure, such as "investment adviser specializing in fundamental analysis" or "proprietary trader focusing on statistical arbitrage."
- Item 2requires the large trader to indicate whether it or any of its Security Affiliates already file any other forms with the SEC and, if so, to identify each such Security Affiliate, its CIK numbers, and the forms filed.
- Item 3requires the large trader to disclose whether it or any of its affiliates is registered with the Commodity Futures Trading Commission ("CFTC Affiliates"), and whether it or any of its Securities Affiliates are regulated by a foreign regulator.
- Item 4requires the large trader to provide an organizational chart that, at a minimum, includes the large trader, its parent company (if applicable), all Securities Affiliates and all CFTC Affiliates. For each of these entities, Item 4 also requires the name, market participant identification number, a brief description of its business, and its relationship to the large trader. Further, this item requires the large trader to identify all its affiliates that file a separate Form 13H and provide any LTID suffixes for such affiliates.
- Item 5requires the large trader to provide information regarding its corporate form (e.g., partnership, corporation). Item 5 also requires the large trader to identify each executive officer, director, or trustee of the corporation or, in the case of a partnership, each partner that owns a financial interest of more than 10% in the large trader.
- Item 6 requires the large trader to identify all registered broker-dealers at which it has an account and to disclose whether each such broker-dealer provides prime broker, executing broker, and/or clearing broker services. A large trader must provide its unique LTID (and suffixes, as applicable) to all registered broker-dealers promptly (i.e., within 10 days of receiving its LTID or effecting a transaction with that broker-dealer). The requirement to provide LTIDs to all registered broker-dealers who effect transactions on its behalf (and to identify each account to which it applies) is an ongoing responsibility for large traders.
Although Form 13H is filed on EDGAR, once filed the Form 13H filings will not be accessible through the SEC's website or otherwise publicly available, including through Freedom of Information Act requests. The Adopting Release states that the confidentiality of the information collected pursuant to Rule 13h-1 will be maintained in a manner consistent with Section 13(h)(7) of the Exchange Act, which provides that the SEC shall not be compelled to disclose any information required or to be kept under Rule 13h-1, subject to certain limited exceptions, such as court orders in actions brought by the United States or the SEC, requests from Congress, or requests from other federal departments or agencies.
Duties of Broker-Dealers
Rule 13h-1 imposes the following new recordkeeping, reporting, and monitoring duties on registered broker-dealers:
- Recordkeeping. Registered broker-dealers must maintain records for all transactions by large traders, including the date and time a transaction was executed, the transaction price, the large trader’s LTID, the number of shares traded in each specific transaction and whether each transaction was a purchase, sale, or short sale.
- Reporting. Registered broker-dealers must, upon request from the SEC, report electronically to the SEC the information retained pursuant to the recordkeeping requirements described above for all transactions that exceed the reporting activity level, which is determined on an account-by-account basis, but is generally understood to be transactions in NMS securities of 100 shares or more in a single account in a calendar day.
- Monitoring. For purposes of the recordkeeping and reporting requirements described above, a registered broker-dealer must monitor its customers and treat any unidentified person the broker-dealer knows or has reason to know meets the large trader criteria as an "Unidentified Large Trader." The broker-dealer must inform the Unidentified Large Trader of its potential obligations under Rule 13h-1, maintain its trading information, and report such information along with the Unidentified Large Trader's name and other identifying information to the SEC upon request.
Large Trader Reporting Checklist
Why Did the SEC Adopt Rule 13h-1?
The data gathered by the present system does not include information regarding the time of the trade or the identity of the trader. These new large trader reporting requirements are intended to enhance, in the near term, the SEC's ability to identify and collect information on the trading activity of the most significant participants in the U.S. markets. The SEC hopes that the currently proposed consolidated audit trail will serve as the longer-term solution for monitoring market activity; the information elicited by Form 13H is likely to also be required in the consolidated audit trail.
This Update is only intended to provide a summary of Rule 13h-1 as it pertains to potential large traders. You can find the full text of the SEC's Adopting Rule at http://www.sec.gov/rules/final/2011/34-64976.pdf. You can find discussions of other recent cases, laws, regulations, and rule proposals of interest to public companies on our website.
© 2011 Perkins Coie LLP