When Size Does Matter: The SEC’s New Rules on Large Trader Registration May Snare Private Equity

Winter 2012, Vol. 12, Number 2

As counterintuitive as it may seem for private equity firms to subject themselves voluntarily to SEC reporting regimes, those firms that might otherwise risk inadvertently becoming ensnared in the SEC’s new reporting regime for large traders should consider a protective voluntary filing.

The SEC recently adopted Rule 13h-1 (the Rule) under Section 13(h) of the U.S. Securities Exchange Act.1  The Rule establishes a registration system for “large traders” to assist the SEC in identifying large market participants and monitoring their trading activity. The thresholds are triggered by aggregate trading activity by controlled entities in National Market System securities (basically U.S.-listed stocks and options) in excess of either:

  • 2 million shares or $20 million in value in a calendar day, or
  • 20 million shares or $200 million in value in a calendar month.

Impact on Private Equity

Private equity fund managers may become large traders for purposes of the Rule under a variety of scenarios. For example, the Rule could be triggered by a block trade or a registered secondary offering of publicly traded securities after an initial public offering by a portfolio company. It could also be triggered by the activities of a private equity firm’s capital markets group or the activities of its portfolio companies—e.g., a portfolio company might acquire publicly traded equity securities in connection with an M&A transaction and subsequently sell them. Even if no single such trade implicates the Rule, it may well do so when combined with the trading activity of the entire group, which as discussed below, would include principals who own more than 25% of the GP or manager.

As another example of the potential pitfalls, consider a toehold investment in a public target. The investment might well be below the 5% ownership trigger for reporting under Regulations 13D and 13G, and it may be for passive investment purposes initially. However, Rule 13H makes no distinction based on intentions as to control of the target company. Rule 13H only looks at the size of the transaction. So in this scenario, registration would be required prior to entering the 13D/13G regime. The good news, though, is that the registration and the disclosure of the trading activity is generally not publicly available as is the case with 13D and 13G, so at least there should not be any premature disclosure of the investment to the market, which could jeopardize a subsequent acquisition of the company by the PE firm.

There are also potential issues looking up the ownership chain of the fund manager or GP. For example, if a principal “controls” the fund manager or GP—either in fact or on the basis of presumptions imposed by the Rule (e.g., ownership of 25% or more of the entity)—and if such person has trading activity in NMS securities for his or her own account, that trading activity (as well as the trading activity of the group) would be taken into account for purposes of the Rule when considering thresholds applicable to the controlling person, and such controlling person may end up needing to register as a large trader.

Large Trader Status

The Rule generally requires a person or entity that exercises investment discretion in respect of trading activity in NMS securities to register with the SEC as a “large trader” by filing a Form 13H if trading activity exceeds the stated thresholds.2  A person or entity may also voluntarily register as a large trader, thereby avoiding the need to actively monitor trading levels on an ongoing basis.3  Upon receipt of a Form 13H filing, the SEC issues a Large Trader Identification Number (LTID), which the large trader is required to provide to registered broker-dealers with whom trades are effected. Broker-dealers, in turn, are required to retain and, in some cases, report to the SEC information concerning large trades and the associated LTIDs.

With respect to options, only purchases and sales of options themselves need to be counted; transactions in underlying securities pursuant to exercise or assignment of options need not be counted. For example, when underlying securities are received pursuant to the exercise of a call option, the receipt of the options would not be counted as a purchase when aggregating trading activity in NMS securities.  However, a later sale of those same securities would be counted. The volume and value of options purchased or sold is generally determined by reference to the securities underlying each option.

Certain types of transactions are not counted for purposes of determining whether the thresholds are exceeded. These are transactions that the SEC has determined do not warrant scrutiny because they are typically entered into for reasons other than arm’s-length trading in the secondary market and are not indicative of an exercise of investment discretion. Although not a complete listing, these include (1) transactions that are part of a (primary) securities offering by or on behalf of an issuer (other than offerings effected through a national securities exchange), (2) transactions effected pursuant to a court order or judgment, (3) transactions to effect an issuer tender offer or other stock buyback, a business combination (including a reclassification, merger consolidation or tender offer) or a stock loan or equity repurchase agreement, and (4) transactions between an employer and its employees in connection with the award, allocation, sale, grant or exercise of an NMS security, option or other right to acquire securities at a pre-established price pursuant to an employee benefit or incentive program.

To Invest or Not to Invest—Who has Investment Discretion?

The Rule applies to persons or entities that exercise investment discretion over trading in NMS securities.

The concept of investment discretion picks up (1) a person who is authorized to determine which securities are to be purchased or sold in a given account and (2) a person who actually makes decisions as to which securities are to be purchased or sold in an account (even though some other person may have ultimate responsibility for such investment decisions).

The Rule indicates explicitly that a person’s employees who exercise investment discretion within the scope of their employment are deemed to be doing so on behalf of the employer. So a firm that employs a natural person who, individually or together with others, is a large trader for purposes of the Rule will also be a large trader.

The Trappings of Control

The Rule is focused on the exercise of investment discretion either directly or indirectly, including through other persons controlled by the large trader, such as portfolio companies.

Control is defined broadly for this purpose as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of securities, by contract or otherwise. Notably, a presumption of control is placed on any entity or person that has the power, directly or indirectly, to vote or sell 25% or more of any class of an entity’s voting securities (or, in the case of a partnership, any entity or person that has contributed—or has the right to receive upon dissolution—25% of the partnership’s capital).

Therefore, to determine whether the controlling entity itself needs to register as a large trader, it must aggregate the trading activity of any individuals or entities over which it has, or is deemed to have, control. There is an exception available, however, if the controlling entity does not conduct trades in NMS securities for its own benefit and any trading entities that it controls have separately identified themselves as large traders to the SEC in compliance with the Rule. The Rule also provides that a controlled entity does not need to obtain its own LTID if the person or entity that controls it has registered with the SEC as a large trader and obtained an LTID. In such cases, all accounts held by a controlled large trader with a broker-dealer would be tagged with the LTID of its controlling person or entity.

Sizing It All Up

In the absence of a voluntary filing, the monitoring requirements alone, particularly with the need to look up and down the chain of ownership, may be quite burdensome for a private equity firm and may require a level of coordination not likely to be in place currently, at least not with this particular focus. Policies and procedures would need to be adopted to track the activity of each member of the control group. Private equity firms may, therefore, instead wish to consider simply filing Form 13H on a voluntary basis in order to avoid inadvertently tripping the Rule and failing to comply with the registration requirements. Although the Rule may not drastically impact private equity firms in a truly substantive way, it is yet a further example of the trend towards increased regulation and monitoring.


1. The Rule became effective on October 3, 2011, and initial Form 13H filings by large traders triggering the Rule's thresholds (on or after October 3, 2011) were due on December 1, 2011.

2. As mentioned above, the Form 13H filing is not publicly available. Subject to limited statutory exceptions, the SEC cannot be compelled to disclose information collected from large traders and registered broker-dealers under a large trader reporting system. Furthermore, the SEC indicated in the adopting release from the Rule that it is committed to protecting the confidentiality of that information to the fullest extent permitted by law.

3. Although voluntary large trader registration limits the requirement to monitor trading levels on an ongoing basis, a large trader (whether required to file or filing voluntarily) is generally required to make annual and quarterly update filings. Annual update filings are required within 45 days after the end of each calendar year. Quarterly amendment filings are required by the end of a calendar quarter if any information contained in a prior Form 13H filing has become inaccurate (e.g. adding a new broker or forming a new subsidiary that trades NMS securities, but there is no requirement to continually monitor or report trading levels in NMS securities).