At 12:01 a.m. this morning, the Securities and Exchange Commission pushed out a new “emergency” disclosure rule that requires hedge funds and other large investors to disclose their short positions. The mandate is one of three new SEC investor protection rules that went into effect early this morning in response to widespread drops in stock prices in the wake of a liquidity crisis exacerbated by this week’s Lehman Brothers bankruptcy and sale of Merrill Lynch.
In a joint statement, SEC chairman Christopher Cox and SEC Enforcement Division director Linda Chatman Thomsen said that the rule, which is designed “to ensure transparency in short selling,” will affect funds with more than $100 million invested in securities. Those fund managers, who are currently reporting their long positions, will now be required to “promptly begin public reporting of their daily short positions.”
To be sure, given the fast pace of hedge-fund trading, the information provided by current disclosures is often outdated by the time they are filed. For example, a hedge fund that manages more than $100 million in stocks could purchase a company’s stock over several days in mid-December, only to sell it in early February, before it is required to inform the SEC of the purchase. In mid-February, filings about the December stock purchase will make the hedge fund appear to be a shareholder of that company, even though it has sold its stake.
The SEC also said it is expanding ongoing investigations into market manipulations, including illegal short selling practices. Other rules issued are aimed at stopping traders from driving down stock prices through abusive “naked short selling.” Illegal naked short selling is a transaction in which a seller doesn’t actually borrow the stock it plans to sell, and then fails to deliver the stock to the buyers.
But the SEC was not the only organization scrutinizing hedge fund activity on Wednesday. The Conference Board Working Group, which comprises corporate and institutional investors, released a report on activist hedge funds, concluding that it takes an activist to fight one. Activist hedge funds are a new twist on the corporate raiders of the 1980s. Today, they use their stakes to pressure management for dividend payouts, buybacks, and other actions.
In the report, the group issued recommendations for how corporations should deal with hedge-fund activists. “In the boardroom or C-suite of a company, the very phrase ‘hedge fund’ seems to impede rational thinking,” says group co-chair Jon Lukomnik, formerly managing director of a hedge fund. “People make assumptions that prevent them from approaching the situation logically.” Lukomnik now serves as managing partner of Sinclair Capital, a consulting firm, and was recently named director of the Investor Responsibility Research Center Institute for Corporate Responsibility in Washington, DC.
The guidelines advise companies to pay close attention to unusual patterns in the trading of its securities, any balance-sheet vulnerabilities that might attract value-seeking activists, and the potential existence of abusive practices that could affect the integrity of the proxy voting process.