Officers and Directors are NOT considered “Passive” under Rule 13d-1(c) – So if you are an officer or director reporting your beneficial ownership of company shares on Schedule 13G and you are doing so pursuant to Rule 13d-1(c), it’s probably time to reconsider your eligibility to continue reporting on 13G. On December 15, 2004 the SEC submitted an amicus brief to the 7th Circuit Court of Appeals in the case of Edelson v. Ch’ien et al, No. 04-1299. In its amicus brief the Commission stated its view that senior executive officers are generally not eligible to report their beneficial ownership on Schedule 13G pursuant to Rule 13d-1(c).
Rule 13d-1(c), adopted by the Commission in Release No. 34-39538 (Jan. 12, 1998), permits “passive” investors owning less than 20% of a class of securities to report their holdings on Schedule 13G in lieu of Schedule 13D. However, it is has been the staff’s informal position since the adoption of Rule 13d-1(c) that directors and officers are generally not “passive” due to the very nature of their position at the company. The Commission has now memorialized this position in footnote 18 of its amicus brief stating that it would be “difficult, if not impossible,” for a CEO to certify that his or her shares are “not held for the purpose of or with the effect of changing or influencing the control of the issuer of the securities” (emphasis in original). This view would likely extend to all “executive officers,” (i.e., those who perform “policy making functions”), as well as directors.
Officers and directors should not despair! Instead they should consider whether Rule 13d-1(d) might provide an alternative basis upon which to continue reporting on Schedule 13G. Persons eligible to report on 13G pursuant to Rule 13d-1(d) include those who: (1) acquired their beneficial ownership prior to December 22, 1970, (2) are exempt from filing a Schedule 13D by virtue of Section 13(d)(6)(A) or (B) of the Exchange Act, or (3) are “otherwise . . . not required to file a statement.”
— Section 13(d)(6)(A) of the Exchange Act exempts from 13D reporting those persons who became a beneficial owner of more than 5% solely as the result of the issuer’s acquisition of securities pursuant to a registered stock for stock exchange. Unfortunately, the staff has interpreted this exemption as limited solely to the issuer and not third parties. [This exemption does not apply to third-parties confronted with an exchange offer. In other words, if someone goes out and makes a registered “stock-for-stock” exchange offer, and becomes as a result becomes a holder of more than 5% of the securities sought in the offer, they would not have to file an initial Schedule 13D. However, someone who is the recipient of an exchange offer (i.e., third party – not issuer of the securities) gives up existing securities and receives new securities of the issuer, if they were to own more than 5% of the issuer’s securities they would need to file an initial 13D. In short, the exemption applies only to the issuer of securities in a stock-for-stock exchange, not the security holder receiving securities. The legislative history behind this exemption indicates that Congress was comfortable that the disclosure called for in the prospectus would be sufficient to inform shareholders of the accumulation of shares.]
— Section 13(d)(6)(B) of the Exchange Act exempts from 13D reporting those persons who accumulate more than 5% of an issuer’s securities without acquiring more than 2% of the class in any single twelve-month period. Note, however, that the staff has indicated that this twelve-month calculation period should be done on a rolling basis, meaning that the twelve-month period is calculated from the date of an acquisition and is not based upon the calendar year. See Exchange Act Release No. 17353, December 4, 1980, SEC Docket, Vol. 21, No. 10 (p. 776). When calculating the 2% limitation, Section 13(d)(6)(B) does not permit the netting of acquisitions and sales, nor does it distinguish between acquisitions of registered and unregistered securities.
— As for the last category, the SEC has taken the position that persons “otherwise . . . not required to file a statement” include those persons who acquired their beneficial ownership when the securities were not registered (i.e., pre-IPO). See Exchange Act Release No. 15348, November 22, 1978, SEC Docket, Vol. 16, No. 4 (p. 230). In addition, persons whose beneficial ownership increased above 5% solely due to a decrease in the total amount of securities outstanding (i.e., an increase in percentage beneficial ownership due to repurchases by the issuer) would fall within this category.
Therefore, officers and directors should be able to continue reporting their beneficial ownership on Schedule 13G under Rule 13d-1(d) instead of Rule 13d-1(c) if they fall into one of the above categories. Given the SEC’s new guidance on this topic, officers and directors should reconsider their ability to continue relying on Rule 13d-1(c) before filing their next 13G amendment which is due for most filers on Monday, February 14th. If ineligible to report on 13G under Rule 13d-1(c), reporting persons can switch to relying on Rule 13d-1(d) by checking the appropriate box on the cover of Schedule 13G.
Now that is what I call a sweet treat from Jeannine Pao at Gibson Dunn. Happy Valentine’s Day!