[No. 68] SEC Chairman Schapiro Testifies Before the US Senate

In post No. 64, I referred to TCI’s use of equity derivatives when it sought to gain control over US railroad company CSX. Last year, the US District Court for the Southern District of New York held that TCI had violated US ownership disclosure rules (Rule 13-D) and should have fully disclosed its interest in CSX. In doing so, the court apparently interpreted the scope of Rule 13-D in a broader way than the SEC (the SEC's interpretation is available here).

Now, as part of US Secretary Geithner’s proposals to regulate over-the-counter (OTC) derivatives, the SEC appears in favor of expanding the scope of Rule 13-D to include equity derivatives. From SEC Chairman Schapiro’s testimony before the Senate last Monday (HT Wachtell):

The current regulatory framework has permitted certain opaque securities-related OTC derivatives markets to develop outside of investor protection provisions of the securities laws. These provisions include requiring the disclosure of significant ownership provisions and recordkeeping and reporting (including those that serve as prophylactic measures against fraud, manipulation, or insider trading) that helps to promote enforcement of the securities laws. (…)

Trading in securities-related OTC derivatives can directly affect trading in the securities markets. From an economic viewpoint, the interchangeability of securities and securities-related OTC derivatives means that they are driven by the same economic forces and are linked by common participants, trading strategies, and hedging activities. (…)

The SEC is considering whether reporting under the Exchange Act should apply to security-based OTC derivatives so that the ownership of and transactions in security-based derivatives would be considered ownership of and transactions in the underlying equity security. We are further evaluating whether persons using equity derivatives, such as an equity swap, should be subject to the beneficial ownership reporting provisions of the Exchange Act when accumulating substantial share positions in connection with change of control transactions. (…)

It will be interesting to compare the forthcoming proposals to amend the US ownership disclosure rules to the recently amended UK ownership disclosure rules. In any case, it looks like in drafting its proposals, the SEC will be able to benefit from the expertise of Texas professor Henry Hu, who, in his own testimony before the Senate, revealed that he will begin working soon at the SEC (HT Floyd Norris).