The Ferocious, Effectively-Heeled Battle Towards the SEC’s New Guidelines on Hedge Fund Activism

Fenika Bench

After Gary Gensler was tapped to go the Securities and Change Fee final yr, it shortly turned obvious that beneath his watch the SEC would pursue an aggressive agenda in contrast to something the world of finance had skilled in a long time. One end result has been a wave of recent rule-change proposals that has shocked Wall Avenue insiders who worry the tip of the simple cash enabled by years of lax regulation.

Take, for instance, two proposed guidelines that cope with the disclosure of shareholder activists’ inventory and swaps positions — together with the SEC’s try and broaden the definition of buyers performing as a bunch, forcing much more public disclosure. 

Elliott Administration Corp.’s Richard Zabel, the agency’s basic counsel and former deputy U.S. lawyer for the Southern District of New York, set the stage for hedge fund activists’ outrage at these proposals with a 32-page remark letter criticizing the SEC’s new guidelines with arguments from constitutional points to conflicts with judicial precedent.

“The fee has inexplicably determined to pursue new rules that may successfully smother activism within the U.S. capital markets,” Zabel wrote.

Along with writing letters, Elliott’s Zabel has met with SEC officers to press his case. So have executives from Third Level, Millennium Administration, ExodusPoint  Capital Administration, D.E. Shaw, PDT Companions, Tiger Hill Companions, Marshall Wace, and Citadel, all of whom have met with the SEC as representatives for the Managed Funds Affiliation and the Different Funding Administration Affiliation, the 2 hedge fund lobbying teams.

However the hedge funds aren’t combating the SEC alone: A brand new group, which Institutional Investor has realized has no less than one hedge fund backer, has enlisted dozens of teachers to argue towards the proposals, creating one thing of a firestorm of criticism.

That effort is the brainchild of Frank Partnoy, a regulation and finance professor on the UC Berkeley College of Legislation, who determined the SEC’s new aggressiveness was an excellent motive to create a nonpartisan, nonprofit institute — he named it the Worldwide Institute of Legislation and Finance — that would affect coverage by convincing different professors to signal on to remark letters that he, and his colleague Robert Bishop, would draft. 

“There’s a niche by way of teachers connecting with policymakers,” says Partnoy, a extremely regarded tutorial and prolific author, whose work consists of a number of nonacademic books, together with F.I.A.S.C.O., his first-person takedown of the derivatives enterprise through which he as soon as toiled as a salesman at Morgan Stanley. Partly, that hole exists as a result of there is no such thing as a incentive for teachers to become involved. 

Wonky tutorial feedback on proposed SEC rule modifications usually fly beneath the radar. However Partnoy made them his mission. Now his work — in remark letters signed by himself, Bishop, and different teachers — is taking some warmth. Partly, that’s as a result of the financing of his institute, which pays Partnoy and Bishop for his or her letter writing, has been shrouded in secrecy. 

In consequence, the brand new institute has been thrust into an even bigger brawl with the SEC concerning the activist shareholder proposals.


For the activists, the brand new guidelines come at a time when their technique has turn out to be much less common. Final yr, shareholders supported solely 28 p.c of director candidates proposed by activists within the U.S., down from virtually 50 p.c within the prior 4 years, based on Insightia, which tracks activism. Insightia additionally discovered that settlements with administration forward of proxy votes had additionally declined. In the meantime, it famous that activist corporations are managing more cash than ever.

One of the vital vital, and longest-debated, SEC rule modifications that would have an effect on activism is a proposed shortening of the interval after which an activist investor who amasses a 5 p.c management stake in an organization’s shares should file a 13D disclosure type. Underneath the brand new rule, that window would shrink from ten days to 5 — and provides the hedge fund fewer days to purchase extra shares or swaps earlier than letting the world comprehend it intends to agitate for change, usually on the board stage and within the C-suite. 

As soon as activists disclose their place, shares of the goal firm rise on common about 10 p.c, so the hedge funds wish to be sure their shopping for is full. “If the place is disclosed at a really early stage, it removes quite a lot of the financial incentive to do activism,” says a person at one of many hedge funds that has criticized the proposals. “Some activist corporations might go away the area fully.” Those that goal smaller corporations are particularly prone to leaving the enterprise, activists say. 

However proponents of the brand new rule say that in the present day’s world of instantaneous digital communication makes the lengthy lead time pointless, and some advocates of shareholder activism say privately that they now not oppose the change, because it’s extensively considered as a problem of market equity. Furthermore, hedge fund activists are fairly busy in Europe, the place not solely are there decrease disclosure thresholds, however as soon as the brink is reached, future purchases are forbidden till such disclosure is made.

Provides former SEC Commissioner Robert Jackson: “In the event you’re able the place your online business mannequin is so rickety that going from ten days to 5 turns you from a worthwhile activist to an unprofitable one, perhaps it’s not such a foul factor so that you can discover one other enterprise.”

The a part of the proposed SEC rule that has turn out to be probably the most controversial, nonetheless, is its try and broaden the definition of a bunch of buyers working collectively, triggering disclosure when the buyers’ mixed stake goes above or under 5 p.c. Hedge funds say such a change would forged a chill on the complete activist market.

Underneath the present guidelines, buyers have to succeed in some form of an settlement — formal or casual — to be thought-about a bunch performing in consort for 13D submitting functions. Underneath the proposed rule, no express settlement want be reached, making the group definition considerably nebulous. Buyers might be deemed a part of a bunch just by shopping for securities after receiving info from one other investor, based on a remark letter submitted by Pershing Sq. Capital Administration.

“Buyers could be extraordinarily unwilling to speak to one another,” says the aforementioned hedge fund activist. “On a 13D they must report that buying and selling each 1 p.c up or down as soon as the whole reaches 5 p.c. They’re not going to do it.”

The third main difficulty is well timed public disclosure of swaps positions — a rule that Gensler has said publicly is a response to the 2021 blowup of Archegos Capital Administration, which secretively used complete return swaps to amass $160 billion value of stakes in corporations, finally leading to billions of {dollars} in losses for its counterparty banks and different market individuals when Archegos collapsed.

Archegos is an excessive instance of how undisclosed swap positions can wreak havoc within the markets. However hedge fund activists use swaps to present themselves an financial stake in an organization with out really proudly owning the shares on the time of their activist campaigns. The truth is, they often don’t even must disclose a 5 p.c stake as a result of many of the economics are within the type of the swaps. However since going public with their place usually causes the inventory to pop, they wish to accomplish that — when they’re completed shopping for.

Nevertheless, if the swaps are disclosed because the SEC has proposed, a hedge fund’s intentions might be recognized even earlier than it hits the 5 p.c stock-ownership threshold requiring disclosure, as soon as once more limiting the potential for revenue.

The SEC’s intent is logical, says former Commissioner Jackson, who’s now a professor at New York College College of Legislation: “I don’t assume that it is best to must be clear in one thing you do in shares and be capable of conceal one thing you do with swaps.”

Whether or not the brand new guidelines are logical or not, the hassle to cease the SEC is rising — with the opposition even spreading to Congress. A letter that quotes a kind of drafted by Partnoy’s institute criticizing the proposed guidelines has been making its means by means of the Home of Representatives in hopes of garnering congressional opposition to the SEC’s effort.

“We’re deeply troubled by the issues raised by advocates of company accountability and social accountability relating to not too long ago proposed guidelines on the fee which will impair the power of engaged shareholders to hunt necessary modifications at America’s public firms,” states the letter, a replica of which II has obtained. “As David Webber, revered labor scholar at Boston College College of Legislation and writer of The Rise of the Working-Class Shareholder: Labor’s Final Finest Weapon, famous in his remark letter, ‘No matter issues we might face in America, we must always all agree that an overabundance of company accountability shouldn’t be one in every of them.’” The Webber letter was drafted by Partnoy’s institute.

Rep. Ritchie Torres, a Democrat from New York’s South Bronx — one of many poorest districts within the nation — whose prime donors embrace Elliott, has been circulating the letter, based on a person accustomed to the hassle. (Torres, whom OpenSecrets says is a prime recipient of hedge fund money within the present election cycle, didn’t return a number of requests for remark, nor did Elliott.) 

Feedback from hedge fund activists are par for the course, as is lobbying Congress. “You’re closing a worthwhile loophole, so there’s no shock that we’re seeing the kind of pushback that we see proper now,” says Andrew Park, a senior coverage analyst at investor advocacy group People for Monetary Reform who was not too long ago named to the SEC’s investor advisory committee and has written in assist of the SEC’s new rule proposals.

However Partnoy’s Worldwide Institute of Legislation and Finance is attempting to set itself above the fray by focusing largely on teachers. The truth that 85 teachers signed on to the letter about swaps and 65 signed the letter that offers with the 13D rule modifications is commonly talked about by hedge funds as unbiased proof that their criticisms are legitimate.

On the very least, the tutorial letters don’t oppose the hedge fund stance. Take the difficulty of shortening the 13D disclosure window, which is anathema to many activists. Though Partnoy advised II that he personally helps closing the window to 5 days, the quite a few letters Partnoy and Bishop have written are likely to hedge their bets. 

Certainly, the letter signed by 65 professors that the 2 teachers drafted says there may be disagreement among the many members of the group about that particular a part of the proposal, including that there’s not sufficient knowledge to assist it. Then the letter provides that “it doesn’t appear unreasonable to cut back the ten-day interval considerably.”

These professors additionally say that there’s not sufficient knowledge to assist altering the definition of a bunch (a degree on which Partnoy says he agrees).

The concept the SEC can exit and do extra analysis on these points, nonetheless, was dismissed by former SEC basic counsel John Coates, now a professor at Harvard Legislation College, who wrote in his remark letter that teachers “appear to misconceive the institutional autonomy the company does and doesn’t must conduct unique analysis.”

The obvious groundswell of educational opposition has led supporters of the SEC’s new rule — labor and investor pursuits — to suspect that Partnoy’s institute is representing the views of hedge funds. Largely their furor comes as a result of Partnoy and Bishop tried to painting the criticism of the SEC’s proposals as so widespread that it has captured not simply teachers, but in addition First Modification advocates and what they termed “labor pursuits.” Certainly, the professors wrote “not many” are on the SEC’s aspect. 

That’s one thing of an exaggeration. For one factor, the AFL-CIO has supported the SEC’s proposed rule modifications and is livid concerning the try and counsel labor thinks in any other case.

“I discover any potential confusion concerning the labor motion’s place on hedge fund disclosure shocking provided that even a cursory search of the AFL-CIO’s web site would discover an govt council assertion going again to 2007 that was extremely crucial of activist hedge funds and significantly the secrecy round it,” says Brandon Rees, deputy director of firms and capital markets on the AFL-CIO. 

Greater than a month after the remark interval was closed, the AFL-CIO wrote a second letter supporting the SEC’s proposed disclosure guidelines that was additionally signed by 11 separate unions.

“The proposed guidelines are designed to require well timed and full disclosure of activist hedge fund possession stakes in goal corporations. We view such disclosure as a matter of market transparency and equity to forestall creeping takeovers and different abusive practices,” the letter said. It added that the proposals “will profit employees and long-term buyers, together with employees’ pension funds.”

Some argue, nonetheless, that there’s a unfavourable aspect impact to the dustup. “As a result of you’ve gotten labor and shareholder activists combating towards one another right here, the one winner is company managements,” says a hedge fund and SEC coverage veteran.

Whereas hedge fund activists and the lecturers discuss concerning the significance of holding administration accountable by means of activism, unions have a extra complicated relationship with the technique. Some union pension funds might agree with hedge fund activists and revenue from their actions, however unions have additionally lengthy opposed some types of activism as a result of the company modifications sought by hedge funds are sometimes related to job losses, as talked about within the AFL-CIO letter.

“Activist hedge fund campaigns concentrating on public corporations are related to a discount in jobs, R&D spending, and capital expenditures,” the AFL-CIO wrote. “Certainly, a complete examine of over 1,300 such campaigns performed between 2000 and 2016 discovered that after activist hedge funds purchase possession, the corporate’s workforce experiences a gentle decline — 4.57 p.c within the first yr and seven.66 p.c by the fifth yr.”

Partnoy’s institute did get some labor assist, however that’s now being recanted.


“I made a mistake,” says Andy Stern, the now-retired, once-powerful head of the Service Workers Worldwide Union, who has walked again an April 11 letter he signed that was crucial of the brand new guidelines.

Says Stern, “I received contacted by an acquaintance of somebody I knew who claimed there have been a sure variety of labor teams or advocates who had been involved a couple of small piece of the rule, which was whether or not teams of labor individuals may really talk with activists.”

Stern says he obtained a draft of a letter from somebody at Partnoy’s institute and signed it. “It was such a small favor.”

Now, he regrets his identify being tossed round as opposing the foundations. The institute, he says, “have to be both a entrance for or supporter of hedge funds.”

Partnoy says that Stern is mistaken and that his donors are a “various group of people and establishments.” He additionally reached out to individuals on each side of the difficulty, inviting teachers and legal professionals representing opposing pursuits to take part in a Washington, D.C., convention on the proposed rule modifications. (Partnoy says he additionally invited Stern to the occasion, however he declined to take part.)

The Berkeley regulation professor says the views expressed within the letters are primarily based on greater than twenty years of his revealed analysis in numerous areas of educational scholarship, in addition to that of different teachers. His letters disclose that he and Bishop obtain compensation for drafting the remark letters, however the different teachers who signal the letters don’t. 

However there may be no less than one hedge fund supporter that II can report: Pershing Sq. CEO Invoice Ackman.

The chairman of the institute’s board is Stephen Fraidin, a company lawyer and associate at Cadwalader who has additionally lengthy labored for Pershing Sq.. He serves on the hedge fund’s advisory board and was the agency’s vice chairman between 2015 and 2018. (Fraidin additionally is aware of Partnoy from Yale College, the place Fraidin can be a part-time regulation professor. Partnoy, it seems, was one in every of his college students.)

Fraidin, who receives no compensation from the institute, declined to remark. 

Ackman advised II that he has donated to the institute — which isn’t required by regulation to reveal its backers — however had no function in its creation. And though Ackman says he has forsworn activism, Pershing Sq. did submit a remark letter of its personal that centered its criticism on the SEC’s proposed new definition of a bunch. That letter was written by Fraidin however signed by Pershing Sq.’s in-house basic counsel.

If Partnoy’s intent was to seek out broad assist for what he considers the deficiencies within the SEC’s proposals, his critics see one thing else. AFR coverage analyst Park complains that the institute is “representing the pursuits of various teams that don’t wish to put their face on what’s attempting to be completed right here. And I feel that’s what’s a bit irritating about this. It strikes me as not a real concern, however slightly one that’s pushed by financial pursuits.”

The one different labor supporter that Partnoy’s institute received onboard was Boston College’s Webber, whose feedback had been quoted within the letter making its means by means of Congress. Individually, the Council of Institutional Buyers — a bunch that features union pension funds — made clear in its remark letter that it broadly helps the proposed modifications, whereas providing one particular suggestion for clarification on the group difficulty relating to communications “made in reference to” a control-related transaction or communications made “as a participant” in such a transaction. “It is perhaps learn too broadly and have an unintended chilling impact of the form of communications that routinely happen in the present day,” the council wrote, suggesting the SEC change the language.

A few of that group’s members are additionally a part of the AFL-CIO, which sought to make clear the difficulty in its current letter, saying that the proposed guidelines “is not going to, as some have argued, intrude with shareholder advocacy on environmental, social, and governance points.” It additionally advised that the SEC can higher clarify what it means by a bunch to keep away from any confusion on the matter.

Whereas the pension funds have been significantly involved about communications they make relating to their assist of shareholder ESG proposals, worries concerning the group definition — which admittedly is complicated — could also be considerably overblown. So long as shareholders are simply placing forth proposals, casting “no” votes, and never agitating for change answerable for administration, shareholders speaking with one another wouldn’t be thought-about a bunch beneath the proposed rule.

Even when they’re demanding a change of management, their joint possession stakes are sometimes so small as to not set off the disclosure. In probably the most distinguished case, activist investor Engine No. 1 mounted an aggressive proxy battle marketing campaign towards Exxon Mobil Corp., and three of the biggest U.S. pension funds — the California Public Workers’ Retirement System, the California State Academics’ Retirement System, and New York State Widespread Retirement Fund — introduced their assist for Engine No. 1’s plans. However they weren’t required to take action — the 4 buyers didn’t collectively personal 5 p.c of the shares of Exxon Mobil.

The teachers’ letters reward shareholder activism and appear to oppose doing something which may restrict it, though the tutorial literature is blended on its advantages. The truth is, Bishop himself was a co-author of 2019 analysis paper that concluded that different shareholders could also be damage by hedge fund activism due to what it known as “leakage” of data — which is exactly what more durable disclosure guidelines hope to forestall.

Ultimately, nonetheless, Bishop and Partnoy counsel that the SEC both scrap the proposed 13D rule fully (and examine the problems extra) or get congressional approval to make the modifications it needs. In addition they assault the swaps rule proposal as missing authorized authority, amongst different issues. And eventually they are saying they’re apprehensive a couple of “wave of litigation” that may finish with the foundations being struck down. Certainly, hedge funds are already threatening, implicitly if not overtly, to sue. 

“There’s no query if the SEC takes actions primarily based on shoddy evaluation, with out explaining what market failure they’re attempting to handle, they might be weak to litigation sooner or later,” says an govt at one of many hedge funds concerned within the lobbying effort. “It will be embarrassing for Gensler particularly to have a rule that he pushed by means of struck down by the courtroom.”

The SEC is used to its guidelines being challenged in courtroom, and it has misplaced a number of necessary circumstances. However supporters of those proposals aren’t too apprehensive, particularly since they consider probably the most controversial of the proposals — the definition of a bunch — can be clarified earlier than the ultimate rule is launched.

“Sure, the foundations will get challenged. There’s little question in my thoughts as a result of the identical large fund method that’s pushing again towards this rule goes to problem this,” says David Katz, a associate at Wachtell, Lipton, Rosen & Katz, which has represented lots of the corporations focused by activists and has lengthy lobbied for the modifications now being proposed. With regard to the litigation, he says, “I don’t consider that they’re going to achieve success.”

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