SEC Provides Relief from "Group" Requirements for Derivative Contracts
Commentary by Steven Lofchie
The Division of Corporation Finance confirmed that financial institutions acting as dealers do not become part of a "group" with its counterparties by virtue of entering into derivative contracts with such counterparties, provided the dealing institutions retain sole discretion over hedging and voting decisions.
In response to a financial institution's request for interpretive guidance on the “group” provisions of Exchange Act Section 13(d) ("Reports by persons acquiring more than five per centum of certain classes of securities") and Section 13(g) ("Statement of equity security ownership"), the Division's Office of Mergers and Acquisitions stated it would not object if the inquiring institution determines that it does not "act as" a "group" with a counterparty solely by entering into a derivative contract. Consequently, the requesting institution is not required to aggregate its beneficial ownership as a result of entering into such contracts.
The relief is predicated on the contracts being arms-length commercial transactions between financial institutions and sophisticated counterparties with each side acting for distinctly different objectives. The SEC noted the financial institution's representation that it enters these contracts in the ordinary course of its regular securities and banking business. While the institution may hedge its exposure by purchasing securities, the contracts expressly acknowledge that the institution hedges at its sole discretion and the counterparty has no right to control that activity. Further, the contracts do not permit the counterparty to vote, or direct the voting or disposition of, any securities the institution holds in its hedge position.
The Division's relief is also conditioned on the fact that the institution acts alone in making risk management decisions for narrow commercial purposes, the parties do not act in concert for a common purpose, and under no circumstances would the institution enter into a contract for the purpose of changing or influencing control of an issuer.
Commentary
It is difficult to say whether this no-action letter is "significant." On the one hand, no one in the market believes that the answer is anything other than the one that the SEC gave. That said, if the SEC had given a different answer, the SEC would have blown up a good part of the financial markets. So, disaster avoided; in that sense, the letter is significant.