SEC Proposes to Maintain Status Quo for Reporting of Beneficial Ownership of Securities-Based Swaps Under Sections 13(d) and 16

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) added a new provision to Section 13 of the Securities Exchange Act of 1934 (the “Exchange Act”) that provides that a person shall be deemed to beneficially own an equity security through a securities-based swap under Section 13 and Section 16 of the Exchange Act only to the extent that the Securities and Exchange Commission (SEC) “determines, in consultation with the prudential regulators and the Secretary of the Treasury, that the purchase and sale of the securities-based swap … provides incidents of ownership comparable to direct ownership of the equity security .…”[1]  On March 17, 2011, the SEC proposed to readopt current Exchange Act Rules 13d-3 and 16a-1 without change in order to preserve the existing scope of the obligations relating to securities-based swaps contained in those rules.  The SEC took action out of concern that the failure to make rules under Section 13(o) could be interpreted in such a way as to render the beneficial ownership determinations currently made under Rule 13d-3 inapplicable to a person that purchases or sells a securities-based swap after July 16, 2011, when the new Section 13(o) becomes effective.[2]  Many observers believe that the SEC’s action is merely a stopgap measure, as the SEC has announced that it is separately working on a project to “modernize” reporting under Section 13.  It is likely that the rule-making project will clarify, and could possibly expand, the scope of required reporting of swaps. 

The SEC explained that the proposed readoption of the current rules is not intended to change any administrative or judicial interpretation of the rules.  While the SEC did not make any formal changes to its previous guidance, its proposing release provides a useful discussion of the bases for beneficial ownership of securities and derivatives through securities-based swaps, which we summarize below.

Background of SEC Proposal

Pursuant to Regulation 13D-G under the Exchange Act, persons that “beneficially own” more than 5 percent of a class of voting equity securities registered under Section 12 of the Exchange Act are required to file either a Schedule 13D or 13G.  If a person beneficially owns more than 10 percent of such a class of equity securities, that person is also typically required to file reports under Section 16 of the Exchange Act and would be subject to disgorgement of his or her short swing profits.

Cash-settled securities-based swaps typically do not, by their terms, confer the traditional incidents of beneficial ownership under Regulation 13D-G, i.e., investment or voting power.  However, the United States District Court for the Southern District of New York held, in 2008, that entering into a large swap position that might have a potential for shifting corporate control of the issuer of the securities referenced by the swap conferred beneficial ownership under Regulation 13D-G and Section 16 even in the absence of formal investment or dispositive power.  Also, the SEC brought an enforcement action against an investment adviser in 2009, in part, for failure to disclosure securities-related swaps.

In light of concerns over the use of securities-based swaps to potentially influence control of companies, Congress, in the Dodd-Frank Act, is requiring the SEC to revisit the reporting rules for swaps.  With new Section 13(o) becoming effective on July 16, 2011, the SEC has responded by announcing a proposed readoption of the current reporting rules.

Current Swap Reporting Rules

Rule 13d-3 provides the tests for beneficial ownership under Regulation 13D-G and is used to determine who has to file reports under Section 16.  Rule 13d-3 generally defines a “beneficial owner” of a security to include any person that, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise has or shares the power to vote, or to direct the voting of, the relevant security and/or the power to dispose, or to direct the disposition of, the relevant security.  Rule 13d-3 also deems a person to be a beneficial owner of a security if the person—

  • has the right to acquire beneficial ownership (as defined above) of the relevant security within 60 days
  • has the right to acquire beneficial ownership of the equity security within any time period if that person holds that right with the purpose or effect of changing or influencing control of the issuer, or
  • enters into any contract, agreement or device to divest or prevent the vesting of beneficial ownership as part of a plan or scheme to avoid the reporting requirements of Section 13.

The SEC discussed each of the bases of beneficial ownership as it applies to security-based swaps.  First, it emphasized that any agreement, including an oral arrangement, that confers voting or investment power on a person, including through a securities-based swap or understanding related to a securities-based swap, would make the person with such voting or investment power a beneficial owner.  Second, a person that has the ability to acquire significant positions in securities either within 60 days or with the purpose or effect of influencing the issuer would be deemed to be the beneficial owner of those securities and would, if its position exceeded 5 percent following an acquisition, be required to disclose its plans or proposals on a Schedule 13D.  Finally, if a person entered into a security-based swap to divest or prevent the vesting of beneficial ownership as part of a plan or scheme to evade the application of Sections 13(d) or 13(g), the securities-based swap would confer beneficial ownership. 

Rule 16a-1 defines beneficial ownership in two respects—(i) it defines which persons have to file reports under Section 16 due to owning more than 10 percent of a class of equity securities registered under Section 12 of the Exchange Act by incorporating the beneficial ownership concept of Regulation 13D-G, and (ii) it defines what is each reporting person’s beneficial interest that is subject to disgorgement under Section 16(b) pursuant to an separate pecuniary interest test.  Section 16 disgorgement applies to transactions in any class of equity securities of the issuer and any derivative securities, including security-based swap agreements.  Rule 16a-1 defines “derivative securities” to mean “any option, warrant, convertible security, stock appreciated right or similar right with an exercise or conversion privilege at a [fixed] price related to an equity security, or similar securities with a value derived from the value of an equity security.”  Most securities-based swap agreements with a fixed price would have a value derived from the value of the equity securities and, therefore, would be included within the definition of derivative security under Rule 16a-1.

Potential Future Rule–Making Under Section 13

The SEC has stated that its staff is engaged in a separate project to develop proposals to modernize reporting under Exchange Act Sections 13(d) and 13(g).  This modernization will likely clarify the treatment of securities-based swaps in beneficial ownership reports and could change the bases for the beneficial ownership of securities through securities-based swaps summarized above.


[1] A “security-based swap” is defined as any agreement, contract or transaction that is a swap (as defined here) and “is based on (I) an index that is a narrow-based security index, including any interest therein or on the value thereof; (II) a single security or loan, including any interest therein or on the value thereof; or (III) the occurrence, nonoccurrence, or extent of the occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, provided that such event directly affects the financial statements, financial condition, or financial obligations of the issuer.”  This definition includes securities-based swaps in addition to total return swaps.  Total return swaps are generally structured by contract only to confer on the long counterparty the equivalent of economic ownership of shares of stock of an issuer, without the ability to sell or vote such shares.

[2] In general, the portions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to securities-based swaps will become effective 360 days after passage.

Contact Information

If you have any questions concerning this alert, please contact— 

Mark H. Barth        
New York

David M. Billings

J.P. Bruynes
New York

Jason M. Daniel

Patrick J. Dooley
New York

Robert M. Griffin Jr.
Abu Dhabi

Prakash H. Mehta  
New York

Eliot D. Raffkind

Fadi G. Samman  
Washington, D.C.

Simon W. Thomas  

Stephen M. Vine  
New York  

Ying Z. White