Pershing Square Capital Management LP owes its ability to amass an undetected stake of almost 10 percent in Allergan Inc. (AGN:US) to a regulation it lobbied to preserve three years ago.
Pershing Square, the hedge-fund firm led by Bill Ackman, recruited a group of large investors in 2011 that persuaded the Securities and Exchange Commission to reconsider reducing a 10-day window that investors have to disclose stakes of five percent or more in a company. The SEC had successfully pushed for authority to shorten the reporting requirement in the 2010 Dodd-Frank Act.
“Because there were strong voices of dissent from credible quarters, I think it made everybody pause,” said Scott H. Kimpel, a partner at Hunton & Williams LLP who worked at the SEC until 2012. “If nobody thought it was a bad idea, it probably would have been done by now.”
Pershing Square’s partnership with Valeant Pharmaceuticals (VRX:US) International Inc. to buy Allergan, the maker of Botox, has renewed focus on a single rule that affects the balance of power between public companies and the activists that target them. Laval, Quebec-based Valeant offered last week to buy Allergan in a deal valued at $45.7 billion.
Changing the rule could make it harder and more expensive for activist investors such as Pershing Square to quietly buy up shares in a public company. Ackman says that enables him to influence a company’s management for the benefit of all shareholders.
Corporate groups say the 10-day threshold, which was introduced in 1970, is a vestige of an era when filings were typed and had to be delivered manually to the SEC. It was introduced at a time when corporate raiders amassed shares in secret, then sprung takeover offers and pressured individual shareholders to quickly sell control of a company.
“You don’t have to send a messenger to Washington anymore -- it’s a very simple and computerized and transparent thing,” said Adam O. Emmerich, a partner at Wachtell, Lipton, Rosen & Katz, a law firm that frequently advises corporations in battles with activist investors.
Hedge funds began lobbying the SEC after Wachtell Lipton asked the agency in March 2011 to cut the reporting deadline to one day. The previous month, an SEC official had said at a legal conference that the agency would probably recommend shortening the 10-day timeframe. Aside from the deadline, the hedge funds argued that the threshold for triggering disclosure should be higher than five percent.
Pershing Square and Jana Partners asked other large investors such as BlackRock Inc., T. Rowe Price Inc. and TIAA-CREF to join them in meetings with regulators, said a person familiar with the matter who asked to not be named because the meetings were private. The other institutions, some of which invest through hedge funds, asked the SEC what the case was for changing the rule, said Stephen L. Brown, who was then a senior director at TIAA-CREF.
“There were investor folks in the room other than hedge funds that were very adamant it wasn’t broken, and changing the rules would benefit issuers to the detriment of certain institutional investors,” said Brown, who is now CEO of the Society of Corporate Secretaries and Governance Professionals.
Pershing Square and Jana Partners LLC also hired law firm Wilmer Cutler Pickering Hale & Dorr LLP to argue that a change would hurt their ability to conduct activism that helps shareholders. The attorneys said the SEC should consider that institutional investors, not individuals, now own the majority of corporate shares and can balance out the influence of activists.
“They wanted the SEC to not change the rule and to consider what the Wachtell Lipton firm had said in their rulemaking petition, to have a deeper consideration of that,” Brown said.
Fran McGill, a spokesman for Pershing Square at Rubenstein Associates, declined to comment.
Ackman last week reiterated that activist investors play an important role in holding corporate management to account.
“If you think shareholder activism is a very favorable thing for stock markets, for capitalism, for keeping the balance of power between management and shareholders, then what you do not want to do is restrict activists from buying more than five percent of the company,” Ackman said in an April 23 interview with Bloomberg TV’s Stephanie Ruhle and Erik Schatzker.
The pushback from Pershing Square and other investors convinced the SEC that changing the rule was more complex than they’d previously thought, according to a person familiar with the matter who asked to not be named because the deliberations were private.
In a December 2011 speech, then-SEC Chairman Mary Schapiro said the agency would proceed cautiously “given the controversy surrounding some of the issues.” SEC officials also cited the need to complete other regulations required by the 2010 Dodd-Frank Act before writing a rule that wasn’t required by Congress.
The SEC has fielded other requests to make institutional investors report stakes earlier and hasn’t responded. The National Investor Relations Institute and NYSE Euronext asked the SEC in Feb. 2013 to make money managers such as BlackRock report their holdings two days after the end of a quarter, instead of giving them 45 days.
“They are putting more pressure on companies to engage with shareholders, but they are giving the companies no tool to truly know who the shareholders are,” said Jeffrey D. Morgan, NIRI’s chief executive officer.
Questions remain as to whether certain derivatives, such as swaps that settle in cash and don’t entitle the buyer to shares, should count toward the five-percent threshold. SEC lawyers said in a 2008 lawsuit that, under current rules, such swaps don’t automatically count toward the limit.
The rule, known as beneficial ownership, generally captures investments that grant someone control over a security or the ability to vote in a shareholder election.
Corporate groups say investors can use swaps to mask their intention to acquire large numbers of shares. Wachtell Lipton, in the 2011 letter, asked the SEC to require investors to count derivative positions toward the five-percent threshold.
Swaps shouldn’t count because they don’t confer voting power to the investor, said Andrew N. Vollmer, a law professor at the University of Virginia and former WilmerHale partner who worked on Pershing Square’s and Jana Partners’ communication to the SEC in 2011.
If the SEC embarks on a rule change, it should consider the benefits of activist hedge funds, including claims that their involvement spurs higher stock prices and better management, according to Vollmer, who was the SEC’s deputy general counsel until 2009.
“They will be watching to see if there are developments in the market place that urge them to act,” Vollmer said.
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