|August 22, 2011|
Previously published on August 16, 2011
On July 26, 2011, the U.S. Securities and Exchange Commission (the “SEC”) adopted new Rule 13h-11 (the “Rule”) under Section 13(h) of the Securities Exchange Act of 1934 (the “Exchange Act”). The Rule imposes initial and ongoing filing obligations on “large traders” and subjects the required broker-dealers that service large traders to specified recordkeeping, monitoring and reporting requirements. The Rule is meant to assist the SEC in its efforts to identify, and collect information on the trading activity of, the most significant participants in the U.S. securities markets. Large traders must identify themselves to the SEC by December 1, 2011. By April 30, 2012, broker-dealers must start maintaining the required records, monitoring large trader activity and be able to report required information in response to regulatory requests, including with respect to “unidentified large traders,” as further discussed below.
Definition of a Large Trader and Control
The Rule defines a “large trader” as a person that “[d]irectly or indirectly, including through other persons controlled by such person, exercises investment discretion over one or more accounts and effects transactions for the purchase or sale of any NMS security [generally, exchange-listed securities, including equities and options] for or on behalf of such accounts, by or through one or more registered broker-dealers, in an aggregate amount equal to or greater than the identifying activity level.” In turn, “identifying activity level” (“IAL”) is defined as aggregate “transactions” in NMS securities of at least 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month.3 For purposes of the Rule, all transactions in securities within all accounts over which a person has investment discretion must all be aggregated in order to determine whether such person is a “large trader” (i.e., offsetting or netting transactions in such accounts against each other is not permitted, whether for hedged positions or otherwise). The definition of “large trader” also includes any person who voluntarily registers as a large trader, even if not required.
The requirements of the Rule are designed to collect information about persons that the SEC considers to be “important market participants that exercise investment discretion,” and as such, the Rule is focused on persons who have investment discretion with respect to securities transactions, rather than ownership of the subject securities. For purposes of the Rule, the definition of “investment discretion” is found in Section 3(a)(35) of the Exchange Act, which includes a person who is “authorized to determine what securities or other property shall be purchased or sold by or for the account” as well as a person that “makes 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.”
This definition of “investment discretion” generally will encompass most investment managers (whether registered or unregistered) who have discretionary authority to buy and sell securities for their clients’ accounts. It should be noted that Rule 13h-1(a)(4) provides 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.” As a result, if an investment manager or other entity employs individuals who, either alone or on a collective basis, meet the definition of a “large trader,” then such investment manager or other controlling entity will be a large trader for purposes of the Rule.
In addition, for purposes of the Rule, a person is presumed to be in “control” of another person if it owns 25% or more of the voting securities of such other person. The definition of “large trader” is “designed to focus on the ultimate parent company of an entity or entities that employ or otherwise control the individuals that exercise investment discretion,” with the intention of easing the administrative burden of both the large trader, by allowing the parent company to comply with the registration requirement on behalf of its subsidiaries (or vice versa), as well as the SEC, by allowing it to obtain a comprehensive picture of the enterprises that conduct large trading businesses.4 As a result, a large trader need not comply with the Rule’s requirements if a controlling person complies with the Rule on its behalf. Similarly, a controlling person need not comply with the Rule’s requirements if a large trader it controls complies with the Rule on its behalf and on behalf of all others under common control who trade. However, given that the presumptive control threshold of 25% is somewhat low, it is possible that minority owners of large traders may be in a position where they themselves are deemed to be large traders because of their “control” interests therein, but as a practical or organizational matter they may not be in a position to actually control the compliance of that large trader with the Rule. If a large trader entity fails to comply with the Rule, any minority owner will be required to ensure its own compliance with the Rule instead.
Initial and Ongoing Filing Requirements for Large Traders
The Rule becomes effective on October 3, 2011. Large traders will have until December 1, 2011, to file an initial Form 13H with the SEC.5 A person who does not meet the definition of large trader by the initial filing deadline, but later effects aggregate transactions equal to or greater than the IAL, must file an initial Form 13H “promptly,” which the SEC interpreted in the Adopting Release as within 10 days of meeting or exceeding the IAL threshold, in ordinary circumstances.6
Upon receiving a large trader’s Form 13H, the SEC will assign the large trader a unique large trader identification number (“LTID”). The large trader will be required to provide its LTID to each of its broker-dealers and identify to the broker-dealers all of its accounts to which the LTID applies.
The Form 13H filing will require that a large trader report a significant amount of information regarding itself and its affiliates, including, without limitation: contact information; general information concerning the business and the nature of the operations of both the large trader and any affiliate of the large trader that exercises investment discretion over NMS securities (referred to as “Securities Affiliates”), including a general description of the Securities Affiliates' trading strategies; an organizational chart; a list of the broker-dealers at which the large trader and its Securities Affiliates have accounts; and other information regarding regulatory status, governance and ownership of the large trader. Unlike the proposal, a large trader only has to identify on Form 13H the broker-dealers where the large trader has accounts, but not each specific account number.
After making its initial filing, a large trader is required to submit an annual filing on Form 13H within 45 days of the end of the calendar year. Furthermore, in any calendar quarter during which any of the information contained in the Form 13H becomes inaccurate for any reason (including, without limitation, with respect to changes in trading strategies, lists of broker-dealers at which the large trader has accounts, or descriptions of the large trader’s affiliates), a large trader is required to submit an amended Form 13H promptly after the end of such calendar quarter. If during any full calendar year a large trader does not effect transactions meeting the IAL threshold, the large trader may file for inactive status with the SEC in the following calendar year. During inactive status, a large trader is not required to submit Form 13H filings or disclose its LTID to its broker-dealers. An inactive large trader must reactivate its status by filing a Form 13H if it again meets or exceeds the IAL.
The information provided to the SEC by a large trader is confidential, so it is not subject to public disclosure; however, it is subject to disclosure to Congress, other federal departments and agencies acting within the scope of their jurisdictions, and pursuant to federal court orders in an action commenced by the U.S. government, including the SEC.
Broker-Dealer Obligations Under the Rule
The Rule applies to registered broker-dealers who either i) carry an account for a large trader or “Unidentified Large Trader” as defined below, ii) are themselves large traders and effect transactions through a proprietary or other discretionary account, or iii) effect transactions on behalf of large trader customers whose accounts are carried by non-broker-dealers. Registered broker-dealers are required to treat as large traders any “Unidentified Large Trader” (“ULT”), which is defined as a person who has not registered as a large trader but who the broker-dealer “knows or has reason to know is a large trader.” Accordingly, the Rule imposes an obligation on broker-dealers to monitor trading activity to detect traders who meet or exceed the IAL threshold but who have not provided the broker-dealer with an LTID. However, the Rule provides that a broker-dealer will not be liable for failures in such detection if the broker-dealer does not have actual knowledge that a person is a large trader, and it has established policies and procedures reasonably designed to: i) identify persons who have not complied with the Rule but nevertheless meet or exceed the IAL threshold, ii) treat as large traders all such persons who have not complied with the Rule but nevertheless meet or exceed the IAL threshold, and iii) inform all such persons of the broker-dealer’s obligations under the safe harbor requirement. In addition, the Rule expressly states that a broker-dealer is not expected to know of trades unless they are effected by or through such broker-dealer. A broker-dealer must report to the SEC any ULTs it identifies, but there is no requirement that a broker-dealer cease trading with a ULT.
A broker-dealer that is subject to the Rule must maintain records for all transactions effected directly or indirectly by or through (i) an account such broker-dealer carries for a large trader or a ULT or (ii) if the broker-dealer is a large trader, any proprietary or other account over which such broker-dealer exercises investment discretion. The information a broker-dealer must record is as follows:
- the clearing house number or alpha symbol of the entity on the opposite side of the
- transaction from the large trader;
- the security’s identifying symbol;
- the transaction date, time and price;
- the number of shares or option contracts traded;
- whether the transaction was a purchase, sale or short sale; and, if an option contract,
- whether the transaction was a call or put option, an opening purchase or sale, a closing
- purchase or sale, or an exercise or assignment;
- the account number;
- the exchange or market center where the transaction was executed;
- whether the transaction was effected for the account of a customer or the broker-dealer;
- transfers and other movements of transactions between accounts at the broker-dealer as
- well as transfers and other movements between accounts at the broker-dealer and another broker-dealer;
- the depositary institution processing the transaction, if applicable; and
- the LTID associated with the trading account, unless the account is for a ULT, in which case,
- the ULT’s name, address, date the account was opened and tax identification number(s).
A broker-dealer’s large trader transaction records must be available on the morning after the day the transactions were effected — including Saturdays and holidays — and the broker-dealer is required to maintain the foregoing transaction records in accordance with Exchange Act Rule 17a-4(b). In addition, the broker-dealer must provide such records to the SEC upon request, via the Electronic Blue Sheet infrastructure in machine-readable format.
Broker-dealers must comply with the recordkeeping and reporting obligations of the Rule as of April 30, 2012.7
Impact on Broker-Dealers Servicing Large Traders
Broker-dealers that are subject to the Rule must modify their recordkeeping systems, trade reporting systems and institute monitoring for ULTs by April 30, 2012. As noted above, the Rule only applies to broker-dealers that themselves are large traders, carry accounts for large (or potentially large) traders, or effect transactions for large traders whose accounts are not carried by a broker-dealer. The SEC estimated in the Adopting Release that the number of broker-dealers subject to the Rule will be only 300. Whether that estimate is correct remains to be seen.
In any event, on the positive side for those broker-dealers subject to the Rule, the recordkeeping and reporting requirements are based upon the existing Electronic Blue Sheet reporting regime, with only minor additional fields (i.e., LTID and time of trade) necessary to be recorded and reported. As usual, appropriate time for development, testing and implementation needs to be factored into planning for the new Rule’s deadline.
1 17 CFR 240.13h-1.
2 Exchange Act Release No. 34-64976 (July 27, 2011), 76 FR 46960 (Aug. 3, 2011) (the “Adopting Release”).
3 The term “transaction” is defined to exclude numerous types of transactions such as the purchase or sale of securities pursuant to exercises or assignments of options, securities purchased in most types of offerings, and transactions to effect a business combination.
4 76 FR at 46964.
5 76 FR at 46960.
6 76 FR at 46970.
7 76 FR at 46960.