January 10, 2014

Analysis: Corp Fin’s New “Section 13(d) Groups” CDI

From Skadden’s Josh LaGrange & Brian Breheny, here’s some analysis of the new Rule 13d-3 CDI that Corp Fin put out last week:

The new Compliance & Disclosure Interpretation reverses a widely-held presumption of practitioners concerning Section 13(d) beneficial ownership of issuer equity securities by members of a group, and offers additional insight into the staff’s view of the scope of Section 13(d) beneficial ownership in the context of certain voting agreements.

Exchange Act Rule 13d-5(b) provides that the “group” formed by certain agreements among two or more persons in respect of the equity securities of an issuer “shall be deemed to have acquired beneficial ownership … of all equity securities of that issuer beneficially owned by any such persons.” Previously, on the basis of guidance issued by the SEC in connection with Exchange Act Section 16, practitioners generally (and at least some courts) believed that each member of such a group was also to be treated as the beneficial owner of all such equity securities. The new CDI clarifies the SEC staff’s view that for purposes of Section 13(d), the creation of a “group” only establishes that the group itself, as a new “person,” becomes such a beneficial owner (i.e., an individual member does not acquire beneficial ownership of the issuer equity securities beneficially owned by the other members).

The new CDI expressly acknowledges the conflicting position expressed in SEC guidance concerning the same topic for purposes of Section 16, but makes no attempt to resolve the conflict, notwithstanding that the relevant Rule 16a-1 provides that “the term ‘beneficial owner’ shall mean any person who is deemed a beneficial owner pursuant to Section 13(d) of the Act and the rules thereunder … .”

Of course, any group member who actually acquires voting or investment power over the equity securities beneficially owned by other group members will become the beneficial owner of such securities as a result of acquiring such power. While that point is relatively clear in regard to holders of an irrevocable proxy to vote shares in an election of directors, the staff has now affirmatively expressed the view that a party to a voting agreement who has the right to designate one or more director nominees for whom the other parties have agreed to vote thereby becomes a beneficial owner of the issuer equity securities beneficially owned by the other parties, on the basis of having the power to direct the voting of the other parties’ securities. Note that the new CDI does not assert that a voting agreement pertaining to other matters (e.g., an agreement to vote in favor of a particular transaction or against other transactions) similarly establishes “voting power” and the consequential “beneficial ownership.”

The new CDI will not have any impact on who is required to file a Schedule 13D or who will be subject to Section 16 as a “10% beneficial owner,” and we do not expect it to have a significant general impact on secondary applications of the Section 13(d) beneficial ownership standard, such as under rights plan triggers, credit agreement change-of-control provisions or Rule 144 “affiliate” analyses. However, this new guidance will alter how issuers calculate certain investors’ beneficial ownership for disclosure in proxy statements and registration statements and consideration of 1933 Act Rule 506(d) disqualifications, and may be relevant to analyses of “conversion caps” or “blocker provisions” in convertible instruments..