The SEC’s proposed increase from $100 million to $3.5 billion as the minimum assets under management (“AUM”) threshold for 13F filings has garnered much attention across the capital markets community. The SEC website is being inundated with comments that refute the notion that this rule change is a good idea, and we are only one-third of the way through the 60-day comment period. In addition, the National Investor Relations Institute (“NIRI”) is urging companies to add their name to its joint letter from corporate issuers and counselors that oppose the SEC’s proposed changes to the filing requirements.
The proposed rule change has significant far reaching impacts, especially for companies with market capitalizations below $5 billion. For example, more than 85% of institutional investors that own companies in the sub-$1 billion market cap range have less than $3.5 billion in AUM, and these investors hold nearly 40% of the value of such companies. Furthermore, according to a Financial Times article from March 2020, M&A activity within the asset management industry has been dominated by smaller deals resulting in a two-thirds decrease in the value of assets moving between managers, which is the lowest point since 2010. However, intense competitive pressure has resulted in consolidation of asset and wealth managers in the sub-$3.5 billion AUM range as evidenced by the second consecutive year of a record number of deals in 2019.
We have received mixed opinions about the proposed rule change from our contacts on the sell- and buy-side. While many could support a change in the rule, most believe the proposed change as it stands, raises the threshold too high. There is belief that the implications will significantly reduce market transparency against an already murky market backdrop, especially with the proliferation of dark pools, algorithmic and high-frequency trading, and the 45-day lag with current 13F filing requirements. Moreover, while those we spoke with appreciate the reduced burden for smaller asset managers, at a $3.5 billion threshold, dedicated micro- and small-cap institutional investors would nearly all be exempt from filing. As a result, buy-siders that seek investments with stable shareholder bases and sell-side analysts that look to tailor their research to the right audience and stock will be further inhibited by this new rule change.
If passed, the new rule will undoubtedly change your investor relations strategy and will likely have many unintended consequences that extend beyond significantly reduced transparency. We summarize a few below:
Increased demands on management’s time
Without a method to effectively vet a firm or fund based on its size, current holdings, or turnover, Investor Relations Officers (“IROs”) will have to adopt a new approach to granting investors access to management. In an effort to be “engaged” with Wall Street, you will see an increased drain on management’s time. Theoretically, an investor could relay incorrect information in order to gain access to management, which has already been evidenced among smaller hedge funds that are not required to file 13Fs based on the current rule. Furthermore, if there is no internal resource in place, which is often the case with micro- and small-cap issuers, the C-suite will likely be even more taxed in trying to manage inbound requests for conversations and/or maintain support from current holders.
Heavier reliance on corporate access
Buy-side firms will have to rely more on their corporate access teams, and we estimate only about one-third of the top-100 firms have strong corporate access functions. Oftentimes, the corporate access team will indicate that there is no interest, but a relationship with the portfolio manager says differently, which ultimately becomes a case of “who you know.”
Smaller buy-side firms that don’t have corporate access resources will likely need to expand their relationships, and firms that eliminated sell-side research may bring them back in house, thereby increasing sell-side coverage.
Weakening effectiveness of small-cap surveillance
Small-cap surveillance firms will find it extremely difficult to identify smaller holders and their positions. Although these firms use DTC information and other devices, the core funds added and subtracted comes from the 13F filings. Under this new rule, small-cap surveillance will get significantly worse.
Increased activism by small firms
Activist firms will be able to get into the stock undetected and potentially garner support in a quiet manner. By the time such activists are ready to communicate with the company, they could potentially accumulate an outsized position if 13F requirements are relaxed. Of course, this doesn’t apply if the buyer reaches the 5% threshold. The threat of an increased activist threat could be counteracted by more small-cap companies adopting longer-term poison pills.
So, the question remains – how can IROs or management teams prepare for the rule change?
Adjustments will need to be made to the investor relations strategy, but don’t wait until the SEC officially passes the proposal to do so.
Ask questions, a lot of questions, within current relationships
Cultivate relationships with investors that you believe to be high quality. Those relationships will be critical if the time comes when ownership information becomes scarce. Use every touchpoint as an opportunity to obtain more intel on the firm and fund. Create a standardized list of questions to be asked of every investor at the onset of each meeting and log the data into your CRM such that you can effectively build a proprietary investor database. And ask them specifically about their firm’s corporate access function – particularly at larger firms in which there might be several teams of portfolio managers that could be interested in the company.
For the average small-cap company, even three-to-five new buyside investments will have a material impact on valuation and stock volatility. Investor relations teams should dispose of the mindset that a targeting list should include 100 investors, instead 15-to-20 well considered and pre-qualified investors bring success to your program. Spend the time (and investment) identifying the themes for which your company is the best fit. Does your company have an emerging ESG story that might interest investors? Are you a strong cash flow player in an industry with higher growth, but unprofitable peers? Are most of your customers operating in defensive industries that provide your company with more resilient revenues during this turbulent period? Refresh your investor story and target a refined set of investors to attract new investment.
Make your Investor Relations and Corporate website a better investor story telling tool
Ensure the company or investor relations website contains the most persuasive, and current investor relations materials. And, make sure the materials are effective for investors to get to know the company’s story. Consider a virtual investor day as a means to disseminate the company message and reach both current and prospective investors. Use the investor day as an opportunity to learn more about attendees with a post-event perception study.
In summary, the proposed rule change to the 13F AUM threshold for filing will have a considerable impact on companies of all sizes, but in particular micro-, small- and mid-cap issuers. With no line of sight into its shareholder base, IROs and management teams will have to pivot their investor relations programs and strategy to adjust to the many unintended consequences resulting from this change.