The SEC Staff recently issued new guidance (C&DI 103.12) on how a shareholder’s engagement with a company’s management could disqualify the shareholder from using the SEC’s short-form Schedule 13G.

Key Takeaways

• Companies and large institutional investors are reviewing how the new guidance will affect their future interactions, some of which could force them to switch to the more demanding Schedule 13D.
• We expect C&DI 103.12 will change shareholder engagement practices, dampening engagement between companies and their large shareholders who benefit from short-form reporting.
• Shareholders with reportable positions should pay careful attention and may rely increasingly on public materials describing their positions, rather than specific and targeted engagements.

Shareholders who own more than 5% of a class of voting equity securities of a public company must report their beneficial ownership on long-form Schedule 13D or short-form Schedule 13G.

Shareholders who hold their shares:

• with the intent to influence or control management of the company must file a long-form Schedule 13D (with an exception for some pre-IPO holders, such as founders); and

• for investment purposes only may file a short-form Schedule 13G as a passive investor.

Schedule 13D and Schedule 13G require different levels of information and different reporting deadlines, with the long-form Schedule 13D requiring more onerous reporting.

We discuss the basics of Schedule 13G here, and the recently amended filing deadlines for Schedule 13D and Schedule 13G here. Below we summarize the new guidance and answer frequently asked questions about its implications. Finally, as a contextual postscript, we also provide some of the historical background that led to this new development.

NEW C&DI 103.12

Under C&DI 103.12:

• A shareholder who merely discusses with management the shareholder’s views on a particular topic and how its views may inform its voting decisions, without more, would not be disqualified from reporting on a Schedule 13G.
• In contrast, a shareholder who goes beyond such a discussion and exerts pressure on management to implement specific measures or changes to a policy may be “influencing” control over the issuer, requiring that shareholder to report on Schedule 13D.

In particular, C&DI 103.12 says that Schedule 13G may be unavailable to a shareholder who pressures the issuer by:

• explicitly or implicitly conditioning the shareholder’s voting support of one or more director nominees upon the company’s adoption of the shareholder’s recommendation that the 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; or
  • undertake specific actions on a social, environmental, or political policy; and/or
• stating or implying, during a discussion of how the company fails to satisfy the shareholder’s voting policy on a particular topic, that the shareholder will not support one or more of the company’s director nominees at the next director election unless management makes changes to align with the shareholder’s expectations.

C&DI 103.12 also says that Schedule 13G would be unavailable to a shareholder who engages with management to advocate for changes that involve control-related matters, such as a sale of the company, a sale of a substantial portion of the assets, a restructuring, or the election of director nominees other than the company’s nominees, regardless of whether the shareholder puts pressure on the company by indicating that it will vote against one or more of the company’s director nominees if the company does not adopt the changes.

FAQs

1. The Staff states in C&DI 103.12 that a shareholder may not be eligible to report beneficial ownership on a Schedule 13G if it “explicitly or implicitly conditions its support of one or more of the issuer’s director nominees at the next director election” on the issuer’s adoption of its recommendation on a matter. However, the Staff did not define what “implicitly” means in this context, nor did it provide an example to illustrate what it means. What does it mean for a shareholder to “implicitly” condition its support?

We believe that a shareholder that engages with a company and takes actions or makes statements that suggest it will vote against one or more directors standing for re-election if a company does not adopt its recommendation may amount to implicitly conditioning its support. Even without making a direct statement to a company to that effect, such actions or statements may put pressure on a company to take certain actions or changes.

For example, an asset manager that engages with a company about adopting a specific measure may implicitly condition its support by publishing a voting policy stating that it will vote against incumbent directors at companies that do not abide by its policy relating to the same measure. Likewise, an asset manager that has a record of consistently voting against directors at companies that do not abide by its voting policy on a specific topic, that then specifically engages with a company on that same topic, may implicitly condition its support when engaging with a particular company.

2. What does the new C&DI mean for a company’s investor relations department? How will this affect shareholder engagement?

Initially, we expect large institutional investors to pause their engagement activities with companies until they have had an opportunity to consider the new guidance and its implications. Many institutional investors will tread very carefully to avoid the risk of reporting their beneficial ownership on Schedule 13D and will likely revise their internal guidelines and approaches to engagement. Some institutional investors may decide to express their views and voting policies as general principles rather than in absolute terms, decline to indicate how they will vote on directors, or reserve the opportunity to consider a company’s particular situation when considering how to vote. Others may stop engaging with companies entirely or at least not initiate engagement efforts. As a result, IR departments may need to adopt a more proactive approach to outreach with their largest institutional investors.

3. Can a company ask one of its Schedule 13G filers what it thinks about specific governance measures and get feedback without jeopardizing that filer’s Schedule 13G status?

Yes. Shareholders cannot lose Schedule 13G eligibility due solely to the actions of others because loss of eligibility requires a disqualifying “purpose or effect of changing or influencing control of the issuer.” A shareholder that merely responds to an inquiry from a company about its views on a particular governance measure would not jeopardize its Schedule 13G eligibility, provided that the shareholder’s response does not condition its vote on company behavior (e.g., indicating that the shareholder will vote in a particular way unless the company changes a governance practice). Even so, the new C&DI could dampen shareholders’ willingness to provide their candid feedback.

4. How does the new C&DI affect institutional investors who publish voting policies or annual letters regarding their views on governance matters?

Institutional investors who publish voting guidelines or annual letters expressing their views on governance matters, without more, should not be disqualified from using Schedule 13G. The C&DI makes clear that only those institutional investors who are actively taking part in targeted engagement activities with a particular company may hold the subject securities with a purpose or effect of influencing control of the company and be disqualified from using Schedule 13G.

We expect that institutional investors that continue to publish voting guidelines or annual letters may revisit how they express their views in those documents. As discussed above, these investors may choose to state their views as general principles rather than in absolute terms, decline to state how they will vote on directors or simply indicate how they “may” vote, and/or clarify that they may consider voting decisions on a case-by-case basis depending on a company’s particular facts and circumstances.

5. What does this mean for those shareholders who vote based on ISS or Glass Lewis recommendations?

Institutional investors who rely on the recommendations of proxy advisory firms, such as ISS or Glass Lewis, would not disqualify themselves from using Schedule 13G merely by voting in accordance with a proxy advisory firm’s recommendations. However, a shareholder could disqualify itself from Schedule 13G by communicating directly to a company that the shareholder intends to vote against one or more directors unless the company adopts ISS or Glass Lewis recommendations.

6. How does the new C&DI affect an institutional investor who sends a letter to a company advocating specific governance initiatives?

The investor’s ability to use Schedule 13G will depend on the context in which it sends a letter recommending that a company adopt specific governance initiatives.

Normally, a letter advocating governance initiatives would not prevent the use of Schedule 13G unless adoption of the initiatives would have the effect of facilitating a change of control of the company, such as calling for a sale of the company or a significant amount of its assets. However, a letter advocating governance initiatives may have a disqualifying effect if it contains a statement that the investor will vote against one or more directors standing for re-election unless the company adopts its recommendations. As a result, we expect that institutional investors will refrain from stating how they will vote on directors, or they may simply indicate how they “may” vote, when sending these types of letters.

7. How will the new C&DI apply in traditional shareholder activism situations?

An activist shareholder should already be filing a long-form Schedule 13D where their engagement seeks changes that relate to control of a company, such as advocating for changes in the composition of the board or calling for a sale of the company or a significant amount of its assets. The C&DI reinforces the longstanding requirement for an activist to switch from Schedule 13G to Schedule 13D when approaching management to make control-related recommendations.

The C&DI underscores a key defensive strategy for companies and their advisors when contending with an activist: confirm that the activist is correctly reporting on Schedule 13D to report its beneficial ownership. Activists must file a Schedule 13D to report comprehensive disclosure about the activist’s holdings, intentions, and other information that the form requires.

8. How does the new C&DI apply to a large institutional investor, including an asset manager, that wants to express its views on a Rule 14a-8 shareholder proposal? What if the investor states how it will vote on the proposal?

A shareholder that expresses its views on a Rule 14a-8 shareholder proposal and states how it intends to vote on the proposal, without more, should not be disqualified from using Schedule 13G. The SEC previously addressed activities relating to Rule 14a-8 shareholder proposals when it adopted rule changes to expand Schedule 13G eligibility to passive investors who own less than 20 percent of the class of securities:

“For example, voting in favor of an insurgent or making a voting announcement under Rule 14a-1(l)(2)(iv) in favor of a corporate governance proposal, without more, would not cause the loss of Schedule 13G eligibility, regardless of the subject matter. This is true even if the voting announcement supports a non-management shareholder proposal.”

The new C&DI provides examples of what “more” a large shareholder might do to cause the loss of Schedule 13G eligibility. For instance, a shareholder may be disqualified from using Schedule 13G if the shareholder announces how it will vote on a proposal while engaging with the company and indicating that it will vote against incumbent directors unless the company takes the proposed action.

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The new C&DI has emerged from a longer history that preceded this recent development.

In the context of shareholder engagement, previous SEC guidance on a shareholder’s eligibility for use of Schedule 13G previously focused on whether the shareholder’s engagement activities have the purpose or effect of changing or influencing control of the company. The prior guidance noted that corporate governance proposals could disqualify a shareholder from using Schedule 13G, depending on “the specific facts and circumstances,” but concluded it was “not able to provide extensive guidance” on specific interactions that are inconsistent with Schedule 13G reporting.

Concerns About Reporting by Institutional Shareholders

Nearly two decades ago, the SEC’s then-General Counsel, former Latham partner Brian Cartwright, estimated that “America’s 100 largest money managers together now hold 60% of all stocks” and that “their 60% stake in the entire public company universe” enables those 100 decision makers to “wield remarkable influence over all our lives.” Cartwright expressed concern over “governance and collaboration of the largest 100 institutional owners who increasingly will influence and control” most of total U.S. market capitalization, especially if they “have motivations beyond wealth maximization alone.”

More recently, then-Commissioner (now Acting Chair) Mark T. Uyeda delivered a speech in November 2022 highlighting the significant role that asset managers play in corporate governance. Uyeda questioned whether asset managers, despite filing as passive investors on Schedule 13G, engage in activities intended to influence corporate policy. Uyeda pointed out that these activities include setting ESG expectations, engaging with companies that do not meet these expectations, and potentially voting against directors based on ESG criteria. Uyeda also noted that majority voting standards in director elections have increased the impact of asset managers’ voting decisions and amplified the influence of asset managers in shaping corporate policy.

Later, then-Senator J.D. Vance expressed similar concerns about the influence of large asset managers on corporate policy and their eligibility for short-form reporting on Schedule 13G. Vance questioned Uyeda during an October 2023 Senate Banking Committee hearing about how these asset managers, despite filing as passive investors on Schedule 13G, engage in stewardship activities that could influence the management of the public companies in which they invest. Uyeda acknowledged that these managers have significant voting power and often promote their stewardship policies that could blur the lines between passive and active investment. Uyeda also noted that most large asset managers file on Schedule 13G, permitted only for passive investors, and confirmed to Vance that these large asset managers’ Schedule 13G reporting avoided the more extensive disclosure that Schedule 13D requires.

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