The SEC’s Division of Corporation Finance recently published a new Compliance and Disclosure Interpretation (CD&I) 103.12 regarding shareholders’ engagement with issuers’ management in the context of eligibility to report on Schedule 13G versus the more onerous Schedule 13D under Rule 13d-1 of the Securities and Exchange Act of 1934 (Exchange Act). The new CD&I clarifies under which circumstances shareholders may be disqualified to report on Schedule 13G due to their engagement with issuer’s management. Specifically, it addresses which engagements could result in a shareholder being deemed to hold the subject securities for a “purpose or the effect of changing or influencing the control of the issuer” and for such reason, lose eligibility to report on Schedule 13G, which is typically used for passive investments.
Background: Section 13(d) and 13(g) of the Exchange Act require that shareholders (or certain groups of shareholders) who beneficially own more than 5% of a publicly traded company’s voting class of securities report on their beneficial ownership on a Schedule 13D or Schedule 13G, if eligible. Schedule 13D requires more detailed disclosure than Schedule 13G, mainly due to the potential active involvement of the shareholder in the issuer’s management. Shareholders may report on Schedule 13G only under certain exemptions, if they hold the subject securities with no intent to influence or control the issuer; however, they must certify that the securities were not acquired or held with the purpose of influencing the control of the issuer.
Key Issue: The key issue addressed in CD&I 103.12, is under what circumstances a shareholder’s engagement with issuers crosses the line and disqualifies them from eligibility to file Schedule 13G. This may be critical to shareholders who seek to qualify for the simplified filing requirements of Schedule 13G, generally intended for passive investors.
Disqualifying Engagement with Issuer’s Management: CD&I 103.12 expands upon the nature and scope the SEC may view as “influencing control”. It emphasizes that the determination of whether a shareholder may be disqualified from filing a Schedule 13G is dependent on the facts and circumstances surrounding their engagement with issuers. The key factor is whether the engagement could be seen as having a purpose or effect of influencing the control of the issuer. Such determination should be made based on the subject matter of the shareholder’s engagement with the issuer, and the context in which it occurs.
Subject Matter of the Shareholders’ Engagement with the Issuer’s Management
Shareholders may lose eligibility to report on Schedule 13G if their engagement with the issuer’s management involves, for example, actions which specifically call or advocate for the sale of the issuer or significant amount of its assets, the restructuring of the issuer, or the election of director nominees other than the issuer’s nominees.
Context in which the Engagement Occurs
While engagements that are focused on a specific topic and how the shareholder’s views may inform its voting decisions are generally not disqualifying, the SEC has clarified that if a shareholder goes beyond expressing views and actively pressures the issuer’s management to implement specific measures or change a policy, it could be seen as an effort to influence control over the issuer. For example, Schedule 13G may be unavailable to a shareholder who recommends that an issuer remove its staggered board, switch to a majority voting standard in uncontested director elections, eliminate its poison pill plan, change its executive compensation practices, if the shareholder discusses how the issuer fails to meet their expectations and when a shareholder conditions its support of the issuer’s director nominees on the issuer’s adoption of their recommendation. In addition, if a shareholder recommends the issuer to undertake specific actions on social, environmental or political policy as a means of pressuring the issuer to adopt its recommendation, this may disqualify the shareholder from Schedule 13G.
Possible Implications: The examples provided in CD&I 103.12 may have significant impacts on institutional and other investors’ engagement relating to a variety of matters, including both environmental, social and governance, and traditional corporate governance topics. While advocating for changes in corporate governance practices or other actions does not automatically disqualify shareholders from filing Schedule 13G (provided that the engagement is part of a broad, non-specific initiative, rather than targeting control), if the engagement suggests a specific change to the issuer’s control or structure, or if the shareholder engages with issuer’s management on environmental, social and governance matters and conditions voting support on certain changes, Schedule 13G may no longer be available.
Conclusion and Next Steps: Investors and asset managers should carefully assess the nature and scope of their engagements with issuers’ management as the determination of whether to file a Schedule 13D or 13G will be fact specific and may require some difficult determinations, particularly under the new C&DI. By publishing this new guidance, the SEC signals that the line between passive and active investing can be unclear and highlights the critical importance of shareholders’ intentions and the context of their engagements with issuers. Shareholders seeking to maintain eligibility for Schedule 13G must ensure that their activities and strategies do not cross into efforts to influence or change control, or adjust their engagement strategies, if necessary. As these matters may be complex, shareholders should consult legal advisors to ensure they are in compliance with the SEC’s new guidance.
