June 26, 2023
Thank you for considering my input on the proposed rule \"Modernization of Beneficial Ownership Reporting\" (S7-06-22). I wanted to highlight the importance of allowing additional time for public review of this lengthy rule proposal. As a retail investor, I may not have the same level of familiarity or expertise as industry insiders who often shape these rules to suit their own interests, sometimes neglecting the needs of retail investors like myself. Therefore, I kindly request an extension to the comment period, as it would greatly benefit retail investors to have more time to thoroughly review and provide feedback on this important proposal.
Secondly, I am in favor of the proposed amendments to revise filing deadlines. The advancements in technology have significantly increased the speed at which information is disseminated. Shorter deadlines for filing would enhance disclosure, reduce delays, and help address information asymmetries that could potentially harm investors. It is crucial for both the public and all market participants to have timely access to material information, including details about significant equity ownership and accumulation.
Thirdly, I have reservations about the proposed amendments to Rule 13d-3, particularly the addition of new paragraph (e). The background information states that holding derivatives that only provide economic exposure to a covered class has historically not been considered sufficient to constitute beneficial ownership. The proposal aims to address situations where holders of such derivative securities may have the incentive and ability to influence or control the issuer of the reference securities. However, it raises concerns whether it is wise for the SEC to adopt a rule that could allow derivative securities to exert undue influence over the underlying securities. In other words, should the SEC allow the tail to wag the dog?
Dr. Susanne Trimbath raises an important concern regarding the proposed rule, suggesting that it may grant voting rights to derivative holders. The determination of beneficial ownership with voting rights is governed by Rule 13d-3, as acknowledged by the SEC. The broader implications of the proposed amendments to Rule 13d-3, which are not explicitly disclosed in the rule proposal, provide sufficient grounds to reject these amendments.
Additionally, cash settled derivatives often involve cash payments rather than the physical delivery of underlying securities. There is no guarantee that the rights to acquire the underlying securities will be exercised, such as through the exercise of an option. Consequently, deeming certain derivative holders as beneficial owners, without considering whether they possess voting rights or the power to dispose of the underlying securities, risks increasing the number of potential voting shares, diluting shareholder rights, and further complicating an already chaotic voting process plagued by issues like over-voting and empty voting.
A logical solution would be to consider derivatives holders as beneficial owners only if the derivatives directly convey voting rights and/or the power to dispose of the underlying securities. Ownership rights should not be conferred solely based on the right to acquire a security. If market participants seek ownership rights, they can obtain them by directly owning the securities themselves.
Fourthly, I disagree with the proposed amendment to Rule 13d-3(e) concerning the determination of the number of equity securities deemed beneficially owned by holders of cash-settled derivative securities. The proposal suggests that only long positions in derivative securities should be counted, explicitly excluding short positions. This means that short positions, whether directly held or synthetically through cash-settled derivative securities, would not be netted against long positions or taken into account.
This rule amendment, as pointed out by White Case, would require a daily calculation to determine the beneficial ownership of securities for holders of cash-settled derivative securities, focusing solely on long positions without considering any offsetting effect of short positions. This approach creates a significant disadvantage for retail investors, including myself, as more sophisticated market participants could engage in fully hedged long and short cash-settled derivative positions, effectively neutralizing their exposure. They would then be deemed beneficial owners of a substantial number of equity securities based on their long positions, while explicitly instructed not to net the long positions against the short positions.
This proposed rule amendment, when combined with voting rights conferred to beneficial owners, enables more sophisticated market participants to synthetically create unlimited voting rights at the cost of minor cash-secured derivatives transaction fees. In light of this, a straightforward solution would be to consider derivatives holders as beneficial owners only if the derivatives directly grant voting rights and/or the power to dispose of the underlying security. If market participants seek ownership rights, including voting rights, they can simply choose to own the security itself.
Fifthly, I do not support the proposed amendment to Rule 13d-3 that would deem holders of certain cash-settled derivative securities as beneficial owners. While I acknowledge the issues raised in the proposed rule regarding the potential influence of cash-settled derivatives on control and beneficial ownership, I believe that reporting significant derivatives positions separately from conferring beneficial ownership rights would be more appropriate.
I fully endorse rule proposals that require market participants to report and make publicly available their significant derivatives positions, both long and short. This would enhance transparency and allow market participants to properly assess and manage risks. Adequate and timely disclosures of derivatives positions would improve overall disclosure practices and help narrow information asymmetries, enabling market participants to better evaluate the potential risks, such as a short squeeze, that could adversely impact investors.
I also understand the concern that unwinding agreements governing cash-settled derivatives could have a similar adverse impact on stock prices as direct selling of sizable blocks of shares. However, the proposed amendments to confer beneficial ownership rights to derivatives holders, triggering additional disclosures, could lead to unintended consequences and side effects. Simply requiring reporting and making such information publicly available would fulfill the disclosure requirements without unnecessarily conferring beneficial ownership rights to derivatives holders.
Lastly, I want to emphasize the importance of simply reporting and making information publicly available. It is crucial because, in the event of a default, derivative positions can have adverse impacts on counterparties, issuers of reference securities, the markets, and other market participants. The primary goal should be to achieve greater transparency, which can influence counterparties' risk management decisions.
Furthermore, while this comment letter does not address all elements of the proposed rule, it does not imply support or opposition to those elements. For instance, the first point raised earlier highlights the need for additional time to facilitate increased public review, considering the heightened public interest in this proposal. If an extension of the comment period is not feasible, I believe it is in the public's interest to reject the rule proposal instead of adopting it. The potential downsides and risks to the market and investors, as outlined in the proposed amendments to Rule 13d-3, outweigh any benefits derived from revising filing deadlines.
Thank you for taking the time to consider the comments of retail investors.