An individual who acquires more than 5 percent of a company’s stock can’t be sued for failing to file a detailed disclosure form with the Securities and Exchange Commission, a federal appeals court has ruled, finding that such disclosure is only required when there is a tender offer or an accumulation of stock that affects corporate control.
The SEC had argued in a friend-of-the-court brief that the detailed-disclosure requirement applies to all 5 percent shareholders even outside the tender offer/control contest context.
But the Chicago-based 7th Circuit said Congress did not intend the disclosure burden in Section 13(d) of the Securities and Exchange Act to apply to a situation where control of the company is not at stake.
“Our review of §13(d) leads us to the conclusion that it was designed to provide information to the investor when faced with a tender offer that could affect corporate control,” the court said in affirming a judgment in favor of the CEO and chairman of Chinadotcom Corp., a Hong Kong-based software provider that trades on the NASDAQ.
Cauley
Defense lawyer Thomas Cauley Jr. of Chicago told Compliance Week the court was “writing on a clean slate—there isn’t much law out there.” Although the SEC “took a very broad view,” the 7th Circuit was correct in finding that §13(d) was “not intended to apply in situations like this,” said Cauley, a partner in Sidley Austin Brown & Wood.
Giangrossi
The plaintiff’s attorney, David Giangrossi, did not respond to a request for comment. But Giangrossi, a partner with Chicago’s Schuyler, Roche & Zwirner, had argued in his brief that the rejecting his client’s suit would mean that “a management-stockholder of a publicly-held company … can conceal any purpose to utilize his, her or its voting power to change control of the issuer by filing a [less onerous] Schedule 13G disclaiming any intent to oppose incumbent directors, and then surreptitiously voting against them without making the required Schedule 13D filing—secure in the knowledge that the deposed directors have no standing to complain of the federal securities violation so committed.”
Ousted After Questioning Motives?
The 7th Circuit case, Edelson v. Ch’ien, et al., was filed by Harry Edelson, a former director of Chinadotcom. Edelson claimed that, while on the company’s board, he questioned the motives of the CEO, Peter Yip Hak Yung, and the board’s executive chairman, Raymond K.F. Ch’ien, concerning a company-sponsored stock repurchase program.
In June 2003, Edelson and the only other independent, non-management United States-based director were not reelected to the board. Yip and Ch’ien voted their shares to defeat Edelson, which was more than enough to seal his removal.
Edelson, in his capacity as a shareholder, sued Yip, Chi’en and Chinadotcom seeking to have the election voided on the ground that Yip had violated §13(d) when he purchased 4.3 million shares of the company in January 2003 without disclosing his plan to influence the control of the company by voting his stock to change the composition of the board.
Section 13(d), which was adopted as part of the Williams Act in 1968, states that any person who acquires ownership of more than 5 percent of any class of registered securities must notify the SEC within 10 days “if the purpose of the purchases … is to acquire control of the business of the issuer” or “to make any other major change to the business or corporate structure.”
An individual acquiring 5 percent of a class of stock may fulfill the §13(d) obligations by filing either a more detailed Schedule 13D or a Schedule 13G, a shorter form that simply states that the shares were not acquired to change or influence the control of the company. In the Chinadotcom case, Yip filed the shorter Schedule 13G, rather than the more onerous 13D.
Limited Reading “Nonsense”
After a federal judge in Illinois dismissed the suit, the SEC urged the 7th Circuit to reinstate it.
“While the increase in cash tender offers was the genesis of the Williams Act, [the] assertion that Section 13(d) only applies to tender offers or contests for control of the issuer is nonsense. The Williams Act’s coverage is very broad. The statute itself is broadly written and contains no restriction of its coverage to accumulations of stock made as part of a tender offer,” wrote SEC attorney Allan Capute.
Rules adopted by the Commission under §13(d) “also make clear that the disclosure requirements of the provision extend beyond the tender offer context,” the SEC lawyer argued. “In addition to long-form Schedule 13D, which reflects the disclosure required by Section 13(d)(1), the Commission has adopted short-form Schedule 13G for passive investors who ‘[have] not acquired the securities with any purpose, or with the effect of, changing or influencing the control of the issuer.’ … If a person cannot certify that the acquisition was made without the purpose nor the effect of influencing control or cannot continue to do so after filing a Schedule 13G, that person must file a Schedule 13D.”
The SEC also took issue with the trial court’s determination that Edelson, as a former director of the company, couldn’t bring suit to enforce §13(d). “There is no justification in the text of Section 13(d), its legislative history, or the rules promulgated under it to deny a shareholder a private right of action simply because he or she also is or was a member of the board,” Capute wrote.
But the 7th Circuit was not persuaded by the SEC’s arguments, siding with the defendants’ assertion that “the legislative history of the Williams Act shows that the sole purpose of the Act was the protection of investors confronted by a tender offer.”
The court concluded that “Yip’s action in voting against [Edelson] simply is not the type of activity which Congress intended to regulate through private enforcement under §13(d).”
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