July 21, 2020
We are respectfully submitting our comments against the central proposed change set forth in S7-08-20, Release No. 34-89290. This refers to the change in filing threshold proposed by the SEC for holders of 13F securities. It is our humble contention that the cost/benefit analysis presented by SEC for said change misses the mark on both sides of the equation.
In our view, SECs focus was aimed at providing regulatory relief to smaller asset managers, which on its face is welcome. However, it is our contention that it does an incomplete job of accurately reflecting the de minimis cost associated with said filing.
It is our belief that the methodology presented in the proposal to estimate cost is inflated and hard to reconcile with tangible experience. Our belief was already articulated by SEC Commissioner Lee in her public retort (July 10, 2020) to said proposal. As Commissioner Lee so eloquently described, SECs estimation of per manager cost associated with 13F filing represents a nearly 400% cost inflation versus their prior robust analysis, conducted less than 2 years ago. This is a curious development.
Furthermore, it contradicts a reasonable expectation of cost deflation associated with an easily automatable task. Such automations need not be the job of the investment manager and have been made readily available by numerous counterparties (e.g., brokers, custodians, administrators), largely for free. These innovations have only accelerated in recent years since the SECs migration to XML filing for Form 13F in 2013.
Given our belief that the task of generating a Form 13F is both simple and easily rules based, it is reasonable to expect this filing cost to follow most commodity-function cost curves. This is our central point of disagreement with the purported cost-benefit of regulatory relief.
Far more importantly, the diminished transparency proposed by SEC levies a huge cost that is bizarrely unaccounted for in the proposal. It is our central contention that SEC did not adequately address the costs borne by various members of the domestic equity capital market ecosystem. Principally, institutional investors (LPs), corporates, academics, and the public writ large will be harmed by this change. To summarize each:
Direct Harm to LPs and academics
- The proposed change damages the LP community, which uses 13F transparency as a tool for oversight and diligence for non-transparent managers
- The proposed change damages the LP and academic community by eliminating an analytical lens of aggregate hedge fund manager behavior across US equities, for which there is no ready substitute
Indirect Harm to Capital Markets (GPs and Corporates)
- the proposed change damages capital market efficiency, notably for small and mid-sized corporates – which on average have more active ownership and rely on 13Fs for visibility into their own shareholder base
- the proposed change damages active managers who benefit from coordinating with other shareholders to improve corporate governance habits through their shareholder rights
Given an incomplete analysis of both purported savings and added costs, we are respectfully but vehemently against the heart of the proposal.
There are several other minor changes proposed by SEC, to which we provide comments and feedback in our itemized responses to their questions. To summarize, these ancillary changes are net beneficial.
Respectfully,
Michael Perlow Faryan Amir-Ghassemi - Epsilon Asset Management
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1. Should we, as proposed, adopt an amendment to rule 13f-1 that would initially adjust the reporting threshold under rule 13f-1? Is the proposed threshold of $3.5 billion appropriate? If another threshold would be more appropriate, what should the threshold be and why?
It is our belief that an upward adjustment for the reporting threshold under rule 13f-1 has significant costs associated with it, as it pertains to the transparency afforded to institutional investors, as well as publicly traded corporates. When these costs are appropriately accounted for, the value of an upward adjustment is quite bleak.
We further believe the reporting burden as purported by SEC is vastly inflated given the plethora of technological tools available to simply export a list of long equity holdings through XML. As such, the decision behind a threshold increase seems specious at best.
2. Would raising the reporting threshold for Form 13F to $3.5 billion negatively affect the utility of Form 13(f) data or investor confidence in the integrity of the U.S. markets? If so, how? And if so, is there a different threshold that would be more appropriate? Are there any additional effects of raising the Form 13F reporting threshold that we have not considered?
It is our firm belief that raising the threshold for Form 13F to $3.5 billion will negative affect the utility of the data as well as investor confidence in the integrity of U.S. Markets. We believe so for several reasons:
- Investors (namely qualified purchasers) of non-transparent investment firms (namely private partnerships) will lose a key form of oversight as to the investment activities of these firms. This will damage the LP community which uses this information source to strength the principal / agent relationship between GPs and LPs.
- While it is true that (as of 12/31/2018), 90.8 percent of the dollar value of the Form 13F holdings data would be retained with this proposal, the vast majority of that dollar value would be associated with passive investment firms, for which the transparency provides relatively limited value compared to that of active private partnerships.
- The majority of dollar value transparency lost will come from active participation in US securities, which act as marginal price-setters of securities. This will have an amplified impact in terms of reducing shareholder and corporate transparency.
- If there is value in this information in lowering the cost of capital formation and improving the functioning of capital markets (it is our contention that there is), this will damage those positive benefits.
- Given the disproportionate participation of active owners in smaller and mid capitalization securities, it will also disproportionately harm those portions of the market.
3. Should we, as proposed, adopt an amendment to rule 13f-1 that would initially adjust the Form 13F reporting threshold based on the growth in the U.S. equities market? Should we, as described above, use the Federal Reserve Boards flow of funds data on corporate equities as a basis for this calculation?
Anchoring a change in threshold to the growth in U.S. equities is not (in our opinion) an appropriate gauge. This is because the nature of complexion of U.S. capital markets have changed tremendously over the last 4 decades, namely through the rise of intermediaries that act as agents on behalf of an increasingly larger institutional ownership base of U.S. equities. If anything, given the increased importance of the financial sector as a function of the US economy, greater regulatory oversight of these intermediaries could be argued.
4. Rather than adjusting the Form 13F reporting threshold based on the growth in the U.S. equities market that occurred between 1975 and December 2018 (a date certain), should we instead use an average rate of growth, which might effectively reflect market growth while minimizing the effects of market fluctuations around the time the Commission is adjusting the threshold? For example, under this approach, we could take the market size as of the end of 2015, 2016, 2017, 2018, and 2019, average those values, and compare that average to the size of the U.S. equities market in 1975. If so, why? Is such a five-year period (or other period) more appropriate for calculating an average growth rate to apply over the 45 years since the threshold was initially set?
We are against such a metric, for the reasons above (e.g., response #3), but also because such a drastic change would adversely impact the expanded benefit of 13F disclosure, causing a net cost to the aggregate ecosystem.
5. Should we instead adjust the reporting threshold for Form 13F using stock market returns as a basis for this calculation? If so, how should we measure stock market returns? For example, would dividends be included or excluded? Is there another measure that we should use as a basis for initially adjusting the reporting threshold?
See #4.
6. Should we instead adjust the reporting threshold for Form 13F to account for consumer price inflation? If so, what measure of consumer price inflation—PCE or CPI—should we use? Is there another measure of consumer price inflation (or other inflation measure) that we should use? If so, what?
See #4
7. Should we adopt a different rounding convention, rather than the nearest $500 million, such as the nearest $1 billion, $250 million, or $100 million? For example, if we rounded to the nearest $100 million, the reporting threshold would be $3.6 billion based on stock market growth. If we should use a different rounding convention, why?
We have no perspective on this matter.
8. Are the Form 13F filing obligations burdensome to smaller managers? If so, how? Are they burdensome in absolute terms, relative terms, or both? Are the burdens on smaller managers different in character from the burdens on larger managers?
We personally do not believe so, given the accumulation of ones exposures is manifold to basic portfolio and risk management for a registered investment adviser. The exporting of such data to the SEC through EDGAR has become trivially easy due to technological integration. For example, Epsilons brokerage platform affords for easy and free export of Form 13F, 13D/G XML securities custodied. It can be customized output based upon selected accounts and accounts for the delineation of key matters such as voting rights.
This tooling is available from other commonly used technology and counterparty platforms, such as custody, administration, and OMS/PMS systems. Given we do not file Form 13F, we asked several peer managers who do, including recent first-time filers. They cited 1-2 hours of time associated with the filing and $250, each. These figures are presented with an abundance of caution according to one, and this anecdotal data is contrary to the SECs estimation of cost.
9. What, if any, are the benefits to investors and markets for the markets to have access to Form 13F data from smaller managers? Do these benefits justify the filing burdens? If so, why?
For institutional investors (LPs) who allocate capital to firms that do not readily provide transparency, 13F acts as a form of monitoring and diligence, improving the working dialogue between principal (LP) and agent (investment manager, or GP), especially with smaller firms. The range of such monitoring and diligence can include improving alignment between the two parties, ensuring IPS compliance, all the way to avoiding / surfacing fraud. An additionally ancillary benefit is the sourcing of investment talent, which can be done by proxy through Form 13F transparency.
Regarding corporates, the increased transparency regarding ones shareholder base is an important tool for ensuring the healthy maintenance of corporate governance, and acts as a leveling playing field versus the expensive acquisition of corporate surveillance services. This is especially the case across smaller and mid-capitalization securities where there is a disproportionate percentage of ownership across what would be non- obliged filers.
For investment managers seeking to effectuate change due to perceived corporate governance issues, the ability to know the identity of peer shareholders is important in catalyzing such change when other forms of disclosure (e.g., 13D/G) are not accessible.
Finally, for academics who perform research on otherwise non-transparent market actors, the benefit to access Form 13F is in being able to form a more complete picture of the activities and ownership patterns of active managers. This benefits all members of the ecosystem.
10. Are the Form 13F filing obligations burdensome to larger managers? If so, how? Is it beneficial to the markets to continue to have access to Form 13F data from larger managers? If so, why? Do these benefits justify the filing burdens? If so, why?
We do not believe so. We believe the regulatory costs associated with Form 13F are de minimis for large managers and already overstated by SEC. The benefit for larger managers is in the ability for the surfacing of their portfolio positions to provide information to the market. The most emblematic case of this is with activist managers who publicize their positions vocally, adding information to capital markets (see Brav et al., 2008, Journal of Finance). This information is beneficial to not only the investment manager but the beneficial owner of the securities through improved price discovery.
11. Who uses Form 13F data? Are these uses beneficial to investors, market integrity, or capital formation? Why or why not? How will these users of the data be affected if the reporting threshold is increased and fewer filers report? Do those users prefer a different threshold? Why or why not? Can those users reasonably find alternative sources of data that meet their needs? Why or why not?
The entire market ecosystem leverages Form 13F, most notably LPs and corporates. GPs also use it (having worked with dozens of hedge funds who consume 13F analysis, we can attest to this). The proposed change of threshold limits the ancillary benefit of increased market transparency into the behavior of non-transparent market actors.
12. We estimate above direct compliance costs that smaller managers incur in connection with Form 13F. Are these estimates accurate? What kinds of costs, and in what amounts, do smaller managers incur in connection with Form 13F? How do the costs differ for larger and smaller managers? How much internal time do managers devote to compliance with Form 13F? What are the external costs, such as the cost of a third-party vendor or external legal counsel, associated with complying with Form 13F? We request comment on the direct compliance costs managers experience in connection with Form 13F, including the estimates in Section III below, and how these costs vary among managers.
We believe these estimates are inaccurate for most investment management firms, specifically single strategy or single-vehicle private partnerships. The export of ones eligible holdings data into a 13F XML format is a commoditized function in 2020. It requires minimal investment of time, experience, or expertise, especially for a firm accustomed to filing.
Where costs may be more onerous include financial advisors or other registered investment advisors that have numerous client accounts with disparate custodial relationships. Even still, aggregation of holdings should already be a basic obligation of sensible portfolio and risk management
13. We also request comment on indirect costs that may be incurred in connection with Form 13F. We discuss above some of these indirect costs, such as the potential for front-running and copycatting. Do commenters agree that these indirect costs are incurred? How do these indirect costs differ for larger and smaller managers? Are there other or different indirect costs that are incurred in connection with Form 13F? What are those and how would they be affected by the proposed amendments?
We believe front-running costs are not a sensible fear, as 13Fs are representative of position holdings as of a 45-day lag. How can someone reading stale information front run an investment manager?
Regarding copycatting, investment managers who fear their intellectual property can be copied are in fact symbiotically aided by those that carry out such a strategy. This is because said investment managers can anticipate a bid associated with the disclosure of their portfolio holdings. This is analogous to the common practice of activist investors who publicize their positions and often position their exposure around the disclosure of said information (e.g., through short-dated derivatives).
This dynamic is clearly explained through academic research (see Hirshliefer, Subrahmanyan, et al. 1994, Journal of Finance). Such an equilibrium provides a capital markets information advantage for said managers. Or as the authors say, investors who discover information early trade aggressively in the initial period and then partially reverse their trades in the next trading round, when the trades of the investors who become informed at this later date cause the price to more fully reflect the investors' information. This benefits GPs and their beneficial owners.
14. Rather than the staff conducting periodic reviews of the Form 13F reporting threshold, should we instead adopt a periodic automatic adjustment to the Form 13F reporting threshold? If so, how often should the reporting threshold be automatically adjusted? If we adopt an automatic adjustment, what measure should we use to make the adjustment? Should we use consumer price inflation measures such as the CPI or PCE? Should we use stock market growth or stock market returns instead? Is there a different measure that would be more appropriate? If so, please explain why. If we use any of these measures, how should they be measured and as of what date? If we use an adjustment based on stock market growth or returns, the adjustment could be positive or negative compared with the present level. Would such an automatic adjustment raise any additional issues that the Commission should take into account in considering such an automatic adjustment?
The choice behind an automatic adjustment should be founded upon the implied benefit from altering the filing requirement, which we believe is invalid. It is our belief that additional transparency adds efficiency to capital markets, rendering a systematic recalibration a moot point.
Like any technology cost function, the cost associated with the regulatory burden will only decline over time due to data extraction technologies and automation. It is in fact our contention that such costs have already flattened tremendously, and that SECs analysis is blind to this fact. As such, this seems to be a non sequitur.
15. Should we, as proposed, eliminate the omission threshold? Why or why not?
Given the ease for transmitting holdings electronically, eliminating the omission threshold only makes the filing of 13F easier as there is one less step between the execution and transmission of the extract, as it pertains to review with ones existing portfolio.
16. If the Form 13F reporting threshold is raised to $3.5 billion as proposed, to the extent it is not already reported on a voluntary basis, would investors and the markets find the disclosure of smaller holdings information for larger managers valuable? Why or why not?
We disagree with the premise.
17. Among Form 13F filers with at least $3.5 billion of 13(f) securities under management, is it costly to report small positions? Why or why not? How many of these filers positions have fewer than 10,000 shares? How many of their positions are valued under $200,000? What is the incremental cost of reporting these small positions on Form 13F? Is the incremental cost significant? Are there other costs associated with identifying these specific positions for purposes of excluding them? Are there other reasons that it would be beneficial to keep the omission threshold?
N/A
18. Rather than eliminating the omission threshold, should we increase it? If so, what part should we increase? Should we adjust only the share limit of the omission threshold? If so, to what? Should we adjust only the value limit of the omission threshold? If so, to what? Should we adjust both components of the omission threshold? If so, to what? Should we, for example, increase the share limit to 50,000 and the value limit to $1,000,000?
We disagree with increasing the omission threshold, as it only adds confusion to a straightforward extraction process and doesnt protect intellectual property.
19. Should we mirror the adjustment to the omission threshold proportionately to the adjustment we are proposing for the Form 13F reporting threshold using stock market growth? Would such an adjustment result in a significant decrease in securities reported on Form 13F? Would such an adjustment impede the ability of the public to observe the impact managers have on the markets?
Doing such would arbitrarily harm transparency with limited to no benefit.
20. If we maintain an omission threshold, should we adopt a mechanism for automatic future adjustments of the omission threshold? Should future adjustments be for the share limit, for the value limit, or for both? What is an appropriate mechanism for adjusting the share limit?
We disagree with the premise.
21. Should we require managers to provide their CRD number and SEC filing number, if any, on Form 13F?
We believe this is a strong benefit. This allows market participants attempting to unravel convoluted ownership structures and crosslink CIK with CRD, to do so without liberal assumptions.
22. Should we require managers to provide the CRD number and SEC filing number, if any, of other managers identified in their 13F report?
We believe so.
23. Would this additional identifying on Form 13F be useful information? If so, how?
Yes, because it allows for cleaner segmentation of 13F aggregate filings with structured information provided in Form ADV1.
24. Would disclosing this information be unduly burdensome for 13F filers? No, it would be rather trivial.
25. Are there any other amendments we should make to the information provided on Form 13F? For example, is there any information currently required that is not useful or does not have a beneficial effect for investors, reporting managers, or users of the data? Should we consider omitting Form 13Fs requirement to provide a CUSIP number for each security? Why or why not? Should we permit managers to provide, in lieu of a CUSIP number, other identifiers such as a Financial Instrument Global Identifier (FIGI) for each security? Why or why not? Would permitting voluntary use of an alternate identifier have a beneficial effect for investors, reporting managers, or users of the data?
We believe the current standard of security identification does an appropriate job of balancing unique security identification with the costs associated with a commercial provider of said identifiers.
26. Should we require filers to round all dollar values listed on Form 13F to the nearest dollar and remove the requirement to omit 000? Should we, alternatively, maintain the current rounding conventions? Should we adopt some other rounding conventions? Should we no longer permit rounding?
We have no view on this matter.
27. Are there any other amendments we should make to streamline Form 13F or simplify its instructions? If so, what are they?
There is currently an exclusion clause that allows an entity to avoid filing Form 13F if they do not use US Mail. There is anecdotal evidence of clever foreign asset owners who use this as a loophole to avoid filing. This should likely be addressed before it broadens into a larger problem.
28. Will our proposed technical amendments increase the accuracy of Form 13F data?
We have no view on this matter.
29. Will our proposed technical amendments make Form 13F data easier to understand and more accessible to the public?
We have no view on this matter.
30. Would these proposed technical amendments impose costs or burdens on filers?
We do not believe so.
31. Does the amendment appropriately reflect the effect of the U.S. Supreme Courts June 24, 2019, decision in Food Marketing Institute v. Argus Leader Media on the type of information that is required to substantiate confidential treatment in accordance with Exchange Act sections 13(f)(4) and (5) and rule 24b-2 thereunder?
We have no view on this matter.
32. Would relieving smaller managers from the compliance burdens of Form 13F reduce costs and enhance competition and add efficiency, including enhancing the ability of smaller managers to compete in the market? To what extent, if any, would the benefits be passed on to investors in the form of lower management fees and/or enhanced services? Would the proposed increase in the Form 13F threshold protect smaller managers from harmful behaviors such as front-running? Would reducing this risk for smaller managers promote capital formation by encouraging these managers to invest more in small and mid-size portfolio companies? Would reducing this risk for smaller managers benefit investors?
The net cost of such a change will not add efficiency to the market. One could argue that management fees will to the contrary increase, as investment managers (acting as agents) will have more bargaining leverage against institutional allocators (acting as principals) once transparency is harmed. There is ample evidence of such in principal/agent research. We do not understand how obviating a Form 13F filing will protect an investor from front-running given the inherent lag associated with the filing.
33. Would the proposed technical amendments increase efficiency by enhancing the accuracy of Form 13F data? Are the cost estimates appropriate?
We have no view on this matter.
34. Would the proposed additional identifying information increase efficiency by making it easier to identify a Form 13F filers other regulatory filings and the interrelationships between managers who share investment discretion over 13(f) securities?
Providing a systematic mapping between CIK and CRD is a positive step in providing transparency between the interrelationships between filing entities and registered investment advisors.