Last Tuesday, the US Department of Justice announced a record $11 million fine against an activist investment firm for improperly claiming an exemption from Hart-Scott-Rodino’s notification and waiting period provisions reserved for passive investors.  Two days later, in the wake of the DOJ’s announcement, the SEC Staff issued guidance stating that the inability to rely on the HSR passive investor exemption (relating to the acquisition of securities acquired solely for the purpose of investment) does not necessarily disqualify a shareholder from reporting its beneficial ownership on Schedule 13G.  C&DI 103.11 can be found here.

Shareholders in a public company are required to report their ownership on a Schedule 13D or Schedule 13G once they own more than 5% of the outstanding stock.  Exchange Act Rule 13d-1(b) and 13d-1(c) permit a shareholder to file on the shorter form Schedule 13G so long as the issuer’s securities were not acquired with the purpose or effect of changing or influencing the control of the issuer.

The Staff’s guidance relates specifically to the impact that a shareholder’s discussions with management has on that shareholder’s ability to report its acquisitions or dispositions of an issuer’s securities on Schedule 13G.  As the Staff noted, this is a facts and circumstances determination, based on the subject matter and context of the shareholder’s discussions with the issuer.  

Generally speaking, shareholder engagement in the following areas would not, by itself, disqualify a shareholder from reporting its beneficial ownership on Schedule 13G:

  • Executive compensation,
  • Social or public interest issues, or
  • Corporate governance, such as removal of staggered boards, majority voting standards in director elections, or elimination of poison pill plans.

With any of these examples, however, context is critical.  For example, the Staff noted that corporate governance discussions would not disqualify a shareholder from using Schedule 13G, so long as the discussions were “undertaken by the shareholder as part of a broad effort to promote its view of good corporate governance practices for all of its portfolio companies, rather than to facilitate a specific change in control in a particular company.”

Schedule 13G would not be available, however, for use by a shareholder who engages with management on matters seeking:

  • Sale of the issuer to another company,
  • Sale of a significant amount of assets,
  • Restructuring of the issuer, or
  • Contested election of directors.

For shareholders that typically engage with management, the DOJ’s recent action against an activist investment firm for HSR violations raised questions about their status as a passive investor.  The Staff’s new guidance, and particularly the specific examples offered by the Staff, should provide those types of shareholders, and issuers, with more clarity regarding those shareholders’ eligibility to use Schedule 13G.