SEC Proposes No Transparency
"52% of American households are invested in the stock market...
4-in-10 U.S. workers (41%) have access to an employer sponsored
or union sponsored retirement investment plan"
- Pew Research Center
The portfolio is UP +19.43% YTD.
Our benchmark index, the S&P 500 is down -2.21% YTD.
SEC Proposed 13F Rule Change
Did you hear about the latest 13F Rule change proposed by the SEC? (Insert awkward pause here)
This isn't the sort of thing that comes up in daily conversation. Your kids don't ask, hey mom, what's up with that 13F rule change at the Securities and Exchange Commission. Even if you can go to work, this isn't likely conversation at the water cooler...do we still have water coolers?
What's a 13F?
The Securities and Exchange Commission's (SEC) Form 13F is a quarterly report that is required to be filed by all institutional investment managers with at least $100 million in assets under management. It discloses their equity holdings and can provide some insights into what the smart money is doing in the market. However, studies have found that 13F filings also have serious flaws and can't be taken at face value.
What's the SEC Proposing?
The SEC's current proposal would change the Assets Under Management (AUM) threshold that investment managers must meet every quarter from $100 million to $3.5 billion!
To put it in perspective, for the most recent quarter, that would reduce the number of funds that disclosed their holdings to the public from 5,283 to 549 or almost 90% of all filers. $2.3 trillion in investment holdings would no longer be disclosed to the public resulting in loss of transparency and valuable insight. When Congress first adopted Section 13(f) it did so to “stimulate a higher degree of confidence among all investors in the integrity of [the US] securities markets.” Taking this data away will have the opposite effect. Transparency is what gives investors confidence in US markets.
Why Would the SEC Propose This?
The reasoning behind the proposed change is the “possible” reduction in costs and burdens to smaller managers. First of all, $100 million is not a small amount to be managing, and if that $100 million is invested in one or two companies all investors want to know. However, for the SEC to suggest that a fund with $3 billion is a smaller firm, and a fund with 3.5 billion is now big enough to file is absurd. The right course of action is to make the filing more transparent, automated and timely.
Congress and the SEC put forth a number of regulations in the 1999-2002 timeframe that dramatically limited the number of companies that could afford to go to the public markets (stock market) to raise capital. These rule changes were made in an effort to protect us from ourselves and avoid another DOT COM bubble. That hasn't worked out so well has it. What did work was Congress and the SEC took away stock and options from many in the working and middle class. Prior to 1999 the majority of companies that went public had less than $50 million in revenues. Today, it's the unicorn companies that go public and absurd valuations. Workers at those pre-1999 companies were able to accumulate stock in their own company, adding to their personal wealth and the size of the middle class overall. Now the SEC wants to change a rule that will take away the ability of small investors to track what professionals are investing in.
What's Wrong with 13F Filings?
Studies have found the "widespread presence of significant reporting errors" in the 13F submissions. The SEC itself has acknowledged that 13F filings are not necessarily reliable because no one at the SEC analyzes the content for accuracy and completeness. After all, the infamous fraudster Bernard Madoff dutifully filed 13F forms every quarter.
Another major issue with 13F reports is that they are filed up to 45 days after the end of a quarter. And most managers submit their 13Fs as late as possible because they do not want to tip off rivals to what they are doing. By the time other investors get their hands on those 13Fs, they are looking at stock purchases that may have been made more than four months prior to the filing. If the smart money is already fully invested in a stock, smaller investors are likely to be late to the party by the time they learn about it.
Some investor groups are lobbying for 13F filings to be submitted monthly and no later than 15 days after the end of the month. Personally I would argue that 13F's should be submitted electronically by the brokerage firm, 7 days after a transaction occurs. Initially this would lead to crowded trades, but ultimately investors will act selfishly, such as, taking contrarian positions, buying based on personal needs, investment philosophy, fundamentals, technical or whatever strategy they choose to follow.
The primary problem with 13F filings is that funds are only required to report long positions, in addition to their put and call options, American Depositary Receipts(ADRs) and convertible notes. Because funds make most of their money from short selling, this can give an incomplete and even misleading picture. For many funds those long positions may only be hedges against their short selling. The point is, there is no way to distinguish these hedges from genuine long positions on 13F forms.
Reducing 13F filings removes transparency for the bulk of professionally traded stocks. Even with all the faults of 13F accuracy and timing, they are still a valuable tool for all investors, but especially for the small investor that Congress and the SEC keeps attacking. If the SEC is really worried about over regulation and burdensome forms they could easily collect a one-time fee from all 13F filers to put in place an automated 13F filing system that is cheaper and more timely. The SEC and Congress always seem to be more interested in managing personal investment behavior and access to information than making the markets open, transparent and easily available to all investors.
I am urging everyone to please post a comment on the proposal to the SEC site linked below. Why should we care? How are we impacted by this? Below are some issues to raise. Please mention them in your comments to the SEC and to your representative in Congress:
Raising the reporting threshold to such a high number will severely limit future academic research on markets, investing and securities.
Raising the reporting threshold to such a high number will reduce public companies' opportunity to know more about who their shareholders are.
Many managers are known to talk among themselves, sharing ideas and information. They have access to company management that small investors don't. Given the SEC's emphasis on a level fair playing field, this rule change makes no sense.
The “justification” for the rule change is highly questionable.
When is less transparency and less data ever a good thing for the small investor?
Some investors may want to avoid over-owned stocks, believing they have a high level of risk. This rule change greatly reduces individual investors ability to reduce their risk.
In the event of a significant correction the number of reporting managers would be diminished even further. The S&P suffered a 56.4% decline during the 2007-2009 financial crisis. A similar event using the most recent quarter as an example, would have reduced the number of funds by another 31% at a time when such data is needed even more.
SEC Comment Page: https://www.sec.gov/rules/proposed.shtml. Click on “Submit comments on S7-08-20”. Or you can send an email to firstname.lastname@example.org. Include the file number S7-08-20 in the subject. Instructions are at https://www.sec.gov/rules/submitcomments.htm. Full SEC Proposed Rule Change: https://www.sec.gov/rules/proposed/2020/34-89290.pdf