Monday, September 28, 2020

Reasons to Oppose the SEC's New 13F Proposal

The U.S. Securities and Exchange Commission (SEC) has proposed amendments to 13F filings.  Currently, investment managers with holdings of US securities totaling $100 million or more are required to file a 13F each quarter.  The proposal seeks to increase that level 35x to managers holding $3.5 billion or more.

The result?  A 90% reduction in the number of 13Fs filed.  This would reduce the number of hedge funds that file from 800 down to less than 100.  It would decrease total filers from around 5,283 to a mere 549.   $2.3 trillion in investment holdings would no longer be disclosed.

The proposal lays out the pros of making this change, so herein we'll examine the counterpoints to their arguments and the cons of making such a drastic change.  

There's also information at the bottom on how you can provide feedback to the SEC.  The deadline to submit comment is tomorrow (September 29th, 2020).

Counterpoints to the SEC's 13F Proposal

1) 13F Filing Costs For Managers Are Negligible

The SEC's main rationale for the proposal is that it would provide relief for smaller managers.  It argues that smaller managers that would no longer file 13Fs would save direct compliance costs that "could range from $15,000 to $30,000 annually per manager."

One hedge fund told us that at worst they see around $3,500 in costs per quarter to file a 13F, or around $14,000 per year, just below the low-end of the SEC's estimates.  Another hedge fund noted that costs and time associated with filing 13Fs are negligible.  Any 'relief' that would fall to smaller managers is de minimis, at best. 

Examining a hypothetical scenario of firms currently most impacted showcases this: a firm managing $100 million with only a 1% management fee and no performance fee theoretically earns $1 million in revenue a year.  Taking the SEC's highest estimate of yearly filing costs ($30,000) and dividing that by the firm's hypothetical yearly revenue ($1 million) means that annual filing costs would be only 3% of revenue.

And using the SEC's own estimates, that's the worst case scenario since it's the smallest firm required to file a 13F.  A $500 million firm in the same scenario would only spend 0.6% of its revenue on 13F filings a year, while a $1 billion firm would only spend 0.3% of revenue on 13F filings a year, and so on.   

Given the technological advancements implemented by the SEC such as XBRL and automation, it's easier and cheaper than ever to submit a 13F.  Filings are straightforward and not time consuming.

2)  It's Hard To Front-Run Someone 6 Weeks Later 

The proposal argues that there are also "indirect costs faced by smaller managers, such as those associated with potential front-running."

A frontrunner is defined as: one who trades “in front of an expected trade by another investor, thereby making the same trade on the terms the other investor would otherwise have got.” 

13Fs are filed with the SEC 45 days after quarter-end.  It's hard to front-run someone if you're receiving the information of their actions six weeks later.  This argument does not hold weight and would only apply to unique situations such as illiquid shares.  The time-delayed reporting of holdings via 13F filing already nullifies the vast majority of any potential front-running.


3)  Negative Consequences for Smaller Managers

The SEC must also consider the negative ramifications for smaller managers who would no longer file 13Fs.  Many limited partners utilize 13Fs to corroborate portfolio level details of managers they're invested in.  This helps prevent another Madoff situation and furthers transparency.

It would also reduce small manager discovery.  One institutional allocator told us that under the proposal, it would be increasingly difficult for them to consider investing in smaller managers due to the lack of transparency that otherwise aides in monitoring of potential managers to allocate capital to.

4)  Drastically Reduces Transparency & Limits Future Academic Research 

The loss of 90% of 13F filers and $2.3 trillion of investment holdings will drastically reduce market transparency and should be reason enough to reject the proposal.  It would also hinder academic research about markets and securities.  In a world that's becoming more data-driven by the day, going in the opposite direction is not progress.

5)  Capital Formation Exists in Current Setup

An argument can be made that the fact that X respected investor invests in Y stock leads to capital formation because other investors are then more inclined to examine and potentially invest in a company they might otherwise not have known about or bothered to look at.  This is particularly the case in small caps, where there's less sell-side coverage and less eyeballs on the companies in general.  

So capital formation can be achieved in the current structure because these managers are disclosing stakes in said companies. And again, due to the 45-day lag for disclosure, they are insulated from front-running.

And as far as we're aware, most investors want other people to be interested in and to buy the stocks they've already built stakes in.  Increased demand can lead to an increase in share price, thus benefiting the investor that already built a position, not burden them with increased costs as the proposal suggests.  

Idea sharing will happen regardless of the proposal or not via idea dinners, conferences, passing around quarterly letters, instant/direct messages, email, word of mouth, etc.  Humans by nature are mimetic beings.

6)  Investors & Companies Won't Know The Shareholder Base; Public Companies Will See Increased Costs & Time

Removing 90% of 13F filers drastically reduces the data available to companies as to who their shareholder base is, especially in small and mid cap names.  While major holders are revealed via 13D, 13G, and Form 4 filings, the rest of the shareholder base would become opaque.

When asked if the proposal would result in increased costs and time for their publicly traded company, one head of investor relations at a small cap replied, "Definitely." 

They also noted they're "not entirely sure how to prove who is actually a (share)holder" for companies that don't pay a dividend, while companies that do pay one can glean some potential insight.

Another investor relations professional said that the proposal would add costs for their company each year because they'll have to pay a firm to analyze trading activity in their shares to figure out the rest of the shareholder base.  And even then, this data wouldn't be accurate or even complete.

Investors also often want to know who their fellow shareholders are, particularly when it comes to hedge fund 'crowding.'

Also, the National Investor Relations Institute (NIRI) submitted a letter on behalf of 237 publicly traded companies, 26 investor relations consulting firms, and five industry associations.  All of them oppose the SEC's proposal.  This includes the likes of Sherwin-Williams, Mastercard, Chipotle, FedEx, Procter & Gamble, Marriott, Delta Air Lines, among many others.

Lastly, the NYSE along with 381 undersigned public companies also sent a letter opposing the proposal.

7)  Commissioner Allison Herren Lee Opposes the Proposal

Via a statement published on the SEC's website here, she writes:

"I am concerned that the projected cost savings in today’s proposal are greatly overstated and wholly inconsistent with the Commission’s past analysis—and, importantly, that the actual cost savings do not justify the loss of visibility into portfolios controlling $2.3 trillion in assets. Additionally, the Commission’s assertion of authority to raise the threshold conflicts with the plain text in the Exchange Act that requires us to collect the information. Specifically, section 13(f)(1) withholds authority from the Commission to raise the threshold, and the proposal fails to address that conflict."


8)  Negative Public Response

In a poll asking if the SEC's proposal was a good idea or not, 75% of respondents said it was a bad idea and 25% said it was a good idea.

A follow-up poll asked what the 13F filing threshold should be if the SEC is deadset on raising the limit:

62% of respondents said $500 million

29% of respondents said $1 billion

5% of respondents said the proposed $3.5 billion

4% of respondents said $5 billion or higher

Not to mention, the overwhelming majority of public comments the SEC has received thus far regarding the proposal have vehemently opposed it.  Here's a link to all the comments.

Additionally, here are a just a few of the headlines/articles reacting negatively to the proposal:

- Financial Times: SEC disclosure change would allow activists to 'go dark', lawyers warn

- Bloomberg: Goldman warns SEC proposal could shroud hedge fund crowding

- Nasdaq: President of Nasdaq says transparency is at risk with proposed changes to form 13F

- Harvard Law Forum on Corporate Governance: Adoption of the SEC’s current proposal would impede companies and their shareholders from promptly identifying the company’s institutional investors, hinder shareholder/public company engagement, and increase the potential for market abuse by sophisticated investors who wish to accumulate shares on a stealth basis

- Columbia Law School Blog on Corporations and the Capital Markets: Why the SEC's proposal to amend rule 13f-1 should fail

- National Investor Relations Institute: An average company would lose visibility into 55 percent of its current 13F filers and 69 percent of the hedge funds on its 13F list

- IHS Markit: An astounding 86% of (activist investors) would no longer be required to file 13F's

- CNBC: Jim Cramer rips SEC's proposed rule change for institutional investors

9)  Proposal Goes Against Original 13F Goals & SEC's Own Mission

Here are the original goals of the 13F (from page 9):

"The section 13(f) disclosure program had three primary goals. First, to create a central repository of historical and current data about the investment activities of institutional investment managers.  Second, to improve the body of factual data available regarding the holdings of institutional investment managers and thus facilitate consideration of the influence and impact of institutional investment managers on the securities markets and the public policy implications of that influence.  Third, to increase investor confidence in the integrity of the U.S. securities markets."

A higher reporting threshold resulting in a drastic reduction in the amount of data does not 'improve the body of factual data.'  It does the exact opposite.  Reduced transparency as a result of the proposal would decrease investor confidence, not increase it as the original goal states.  And the repository of historical data would be severely impaired going forward.

The SEC's own website lists its mission as:  "The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC strives to promote a market environment that is worthy of the public's trust."

The proposal severely reduces transparency, which does not protect investors.  Such reduced transparency also erodes the environment of public trust that the SEC aims to achieve.

If the SEC is deadset on raising the filing threshold for the sake of modernization or to reduce its own burden, utilizing the inflation metric and setting the threshold at ~$500 million would reduce the number of filers by 50% (thus reducing any burdens on both the SEC & the smallest managers) while maintaining more transparency.  The poll above also shows this is more palatable than the proposal's $3.5 billion threshold. 

Simply put though, the negatives associated with the proposal greatly outweigh any perceived positives.


How to Provide Feedback to the SEC

The SEC is seeking input on the proposal and the deadline for comment is tomorrow (September 29th).  You can submit your feedback via these methods:

- Send an email to: and make the Subject: S7-08-20


- Go to the comment page:  and then click on "Submit comments on S7-08-20"