Another Dodd-Frank Sleeper Provision Applicable to Large Traders (Including Ordinary Operating Companies that are Large Traders)

News Brief

By Cydney Posner

As part of Dodd-Frank, Congress amended Section 13(h) of the Exchange Act to require that "large traders" file certain reports with the SEC. The SEC has adopted rules to implement that section, , which will require a "large trader" to make certain disclosures to the SEC on Form 13H. The SEC will assign an ID number to each large trader, which the large trader must then provide to its registered broker-dealers. Registered broker-dealers will be required to maintain records of additional data and perform limited monitoring in connection with transactions effected through accounts of large traders (including "unidentified large traders"). The large trader reporting requirements are designed to provide the SEC with useful data to support its investigative and enforcement activities and to assist the SEC in its efforts to identify large market participants, to assess the impact of their activity on the securities markets, to reconstruct trading activity following periods of unusual market volatility and to analyze significant market events for regulatory purposes. Voluntary registration as a large trader is also permitted (for example, if an entity desires to reduce its need to actively monitor its trading levels). December 1, 2011 is the initial compliance date for large traders to begin to identify themselves to the SEC pursuant to Rule 13h-1(b).

Rule 13h-1(a)(1) defines a "large trader" as any person that, directly or indirectly, including through other persons controlled by that person, exercises "investment discretion" over one or more accounts and effects "transactions" (see exclusions below) for the purchase or sale of any NMS security (generally, exchange-listed securities, including equities and options) for those accounts, through one or more registered broker-dealers, in an aggregate amount that equals or exceeds <

  • 2 million shares or $20 million during any calendar day, or
  • 20 million shares or $200 million during any calendar month (referred to as the "identifying activity level").

The definition is designed to focus on the ultimate parent company of entities that employ or otherwise "control" the individuals who exercise investment discretion, aggregating trading activity of all entities "controlled" by the parent company. Importantly, the definition is NOT limited to persons or entities that are primarily engaged in the business of trading securities; the rules can apply to individuals and ordinary operating companies that fall within the definition of "large trader." For example, a selling stockholder in a secondary offering that sells sufficient shares to reach the identifying activity level would be a large trader, even if the stockholder were otherwise an infrequent trader.

For purposes of the rules, "transaction" means all transactions in NMS securities, excluding the purchase or sale of securities pursuant to exercises or assignments of option contracts. Purchases and sales must be aggregated, without offsetting or netting purchase and sale transactions, among or within accounts. For the sole purpose of determining whether a person is a large trader, certain types of transactions are excluded from the identifying activity level calculation because they typically are not characterized by the type of intent associated with arm's-length trading of securities in the secondary market and, therefore, do not usually involve the exercise of investment discretion. The following transactions are not considered "transactions" under the rule:

  • Any journal or bookkeeping entry made to an account in order to record or memorialize the receipt or delivery of funds or securities pursuant to the settlement of a transaction;
  • Any transaction that is part of an offering of securities by or on behalf of an issuer, or by an underwriter on behalf of an issuer, or an agent for an issuer, whether or not the offering is subject to registration under the Securities Act; however, that this exemption does not include an offering of securities effected through the facilities of a national securities exchange;
  • Any transaction that constitutes a gift;
  • Any transaction effected by a court appointed executor, administrator or fiduciary pursuant to the distribution of a decedent's estate;
  • Any transaction effected pursuant to a court order or judgment;
  • Any transaction effected pursuant to a rollover of qualified plan or trust assets subject to Section 402(a)(5) of the Internal Revenue Code;
  • Any transaction between an employer and its employees effected pursuant to the award, allocation, sale, grant or exercise of a NMS security, option or other right to acquire securities at a pre-established price pursuant to a plan which is primarily for the purpose of an issuer benefit plan or compensatory arrangement; or
  • Any transaction to effect a business combination, including a reclassification, merger, consolidation or tender offer subject to Section 14(d) of the Exchange Act, an issuer tender offer or other stock buyback by an issuer, or a stock loan or equity repurchase agreement.

A large trader must file a Form 13H Initial Filing promptly (generally viewed to be within 10 days) after effecting aggregate transactions equal to or greater than the identifying activity level above. Infrequent traders may be eligible for "inactive status" if they have not effected transactions at any time during the previous full calendar year that, in the aggregate, equal or exceed the identifying activity level. All large traders must submit an Annual Filing within 45 days after the end of each full calendar year, unless they are on inactive status. Filings must be amended at least quarterly to correct inaccuracies. Each large trader must disclose to registered broker-dealers effecting transactions on its behalf its large trader ID number and each account to which it applies.

Note that the SEC declined to provide a blanket exclusion for transactions effected on behalf of defined contribution plans, but did provide some additional guidance. In plans where participants select their own investments, the participants (not the executing trustee) are the ones who exercise investment discretion. The SEC, solely for purposes of determining who is a large trader pursuant to Rule 13h-1, considers an employer to not exercise investment discretion merely by establishing investment options for its employees. Other types of defined contribution plans may be structured differently. For example, in some cases, the trustee could be the large trader if it exercises investment discretion but, generally, the plan sponsor or administrator would not be the large trader if neither exercises investment discretion.

For purposes of these rules, "investment discretion," as defined in Section 3(a)(35) of the Exchange Act, comprises persons who are "authorized to determine what securities or other property shall be purchased or sold by or for the account," as well as persons who make "decisions as to what securities or other property shall be purchased or sold by or for the account even though some other person may have responsibility for such investment decisions." Rule 13h-1(a)(4) further specifies that a "person's employees who exercise investment discretion within the scope of their employment are deemed to do so on behalf of such person." In defining "control," Rule 13h-1(a)(3) creates a presumption that any person that directly or indirectly has the right to vote or direct the vote of 25% or more of a class of voting securities of an entity or has the power to sell or direct the sale of 25% or more of a class of voting securities of such entity, or in the case of a partnership, has the right to receive, upon dissolution, or has contributed, 25% or more of the capital, is presumed to control that entity. Hat tip to blog for identifying this sleeper.

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