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SEC and beneficial ownership

May 19, 2022

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This article is written by Shivangi Lal pursuing a Diploma in International Business Law. This article has been edited by Zigishu (Associate, Lawsikho) and Ojuswi (Associate Lawsikho).

This article has been published by Sneha Mahawar.

Table of Contents

Overview

SEC Form 3: what is it

In the Securities and Exchange Commission’s Form 3: Initial Statement of Beneficial Ownership of Securities, corporate insiders or substantial shareholders declare their beneficial ownership of securities.

It’s a big step toward regulating insider trading, which is when someone buys or sells a stock based on substantial nonpublic knowledge. Form 3 is used to reveal who these individuals are and to keep track of any questionable conduct.

What is a SBO – A significant beneficial owner

An Indian company’s “significant beneficial owner” is defined under the Companies Act, 2013, as amended (the “Companies Act”) and the Companies (Significant Beneficial Owners) Rules, 2018, as amended (the “SBO Rules”) :

As Individuals or entities possessing one or more of the following “rights or entitlements” in the Company:

10% or more of the company’s shares, voting rights, or compulsorily convertible preference shares (compulsorily convertible debentures and global depository receipts are included in the term “shares”);
does have the right to obtain or take part in not less than 10% of the overall distributable dividend or other distribution in a financial year through indirect holdings alone, or together with any direct holdings; or
has the right to exercise, or does exercise, considerable influence or control in ways other than via direct ownership.

According to the SBO ( significant beneficial owner) Rules, an individual is considered to have a ‘right or entitlement’ directly in the Company if the shares indicating such right or entitlement are held in the individual’s name; or (ii) the individual having or obtains equitable interest in the shareholdings and has made the necessary declarations to the Company under the Companies Act.

Money Laundering Prevention Act of 2002 – SBO

A “beneficial owner” is defined as an individual who ultimately owns or controls an individual who engages in a financial transaction or activity with a reporting entity (such as a bank, financial institution, intermediary, or a person carrying on a designated business or profession under the PML Act) or the representative of an entity under the Prevention of Money Laundering Act, 2002, as amended (the “PML Act”). The term also applies to an individual who exercises ultimate effective control over a legal entity.

The Money Laundering Prevention (Record-Keeping) Rules, 2005, as amended (the “PML Rules”) define “control” as the right to appoint a majority of the board of directors or to direct management or policy choices, whether through ownership or management rights, shareholders agreements, or voting agreements.

In the US if stockholders control over 5% of the existing securities of a publicly traded company in the United States, beneficial ownership must be declared. Many states in the United States do not collect, verify, or update information on “beneficial ownership” of businesses since each state has its own set of laws. Additionally, the Customer Due Diligence Rules, which apply to banks and mutual funds, clarify and reinforce customer due diligence duties and assist in identifying beneficial ownership arrangements at the federal level.

According to the Securities Exchange Act of 1934 (the “SEC Act”), beneficial owners who own more than 5% of a U.S. company’s stock must meet certain other criteria to file Schedule 13D or 13G until their holdings drop below 5%. It was enacted to close a loophole in the securities act and to require disclosure when securities owners accumulated large blocks of equity securities of the same company through cash tender offers. The Williams Act (the Williams Act) amended the SEC Act to include section 13(d) in the SEC Act as a reaction to the growing use of cash tender offers for corporate takeovers.

Form 3 Disclosure is required by the Securities and Exchange Commission (SEC). The information on the form is intended to reveal the beneficial ownership of registered corporations by directors, officials, and beneficial owners. As a result, this information enters public record and may be inspected by anybody

Learn

A corporate insider or large shareholder must submit Form 3 with the Securities and Exchange Commission.

The information given on the form becomes public record and is intended to reveal the holdings of directors, officials, and beneficial owners of registered corporations.

After an insider gets linked with a corporation, the form must be submitted to the SEC within 10 days.

USA and SEC Form 3

After being associated with a corporation, the corporate insider must file Form 3 with the SEC within 10 days.

The following people are obliged to submit Form 3 according to the SEC :

Any director or officer of an issuer with a class of equity securities

A beneficial owner of greater than 10% of a class of equity securities

An officer, director, member of an advisory board, investment adviser, or affiliated person of an investment

An adviser or beneficial owner of more than 10% of any class of outstanding securities

A trust, trustee, beneficiary, or settlor required to report

Regardless as to whether or not an insider has an ownership holding in the business at the time, the form should be submitted for each firm in which an individual is an insider. The filer must provide their name, address, and connection to the reporting individual, as well as the security name and ticker symbol.

Related SEC Forms

Along with the Securities Exchange Act of 1934, Form 3 is linked to SEC Forms 4 and 5. (SEA). The Securities Exchange Act (SEA) was developed to regulate securities transactions on the secondary market after they were first issued, in order to provide better financial transparency and less fraud.

Form 4 is used to document changes in ownership. Although restricted transactional categories are exempt from this reporting obligation, these adjustments must be disclosed to the SEC within two business days. Any activities that should be initially reported on Form 4 or were qualified for delayed reporting must be reported on Form 3.

In August 2002, the Securities and Exchange Commission (SEC) announced new regulations and changes to Section 16 of the Securities Exchange Act in compliance with the terms of Sarbanes-Oxley, which advanced the deadline for reporting numerous insider ownership reports. In addition to Forms 3, 4, and 5, the SEC has a number of additional relevant forms. Companies, for example, are required to submit Form 10-K, an annual report that includes a detailed review of their performance. A 10-K is usually divided into five sections:

Business: Details about the company’s primary operations, products, and services are included in this section.

Risk Factors: These are a list of any and all dangers that the firm is currently facing or may encounter in the future, usually in order of priority. Defaulting on debts is one example, as is the potential of additional rules impeding growth.

Selected Financial Data: For research analysts, this is one of the most crucial sections, since it details particular financial facts about the firm during the last five years.

Discussion and Analysis of Financial Condition and Results of Operations by Management: MD&A stands for management discussion and analysis, and it refers to the qualitative information that goes along with the financial results. This allows the corporation to explain its financial results from the preceding fiscal year.

Financial Statements and Supplementary Data: The company’s entire financial report statements, along with the income statement, balance sheets, and statement of cash flows, are included in this section.

What causes a Form 3 to be filed

When a person becomes an insider in a company, the Securities and Exchange Commission requires them to file a Form 3. The person’s ownership of the company’s securities must be disclosed. The goal of Form 3 is to prohibit insider trading. It provides strict standards on what defines an insider.

What are the consequences of insider trading

Insider trading that is done unlawfully through the acquisition of substantial nonpublic information can result in civil or criminal penalties, such as fines and/or prison time.

Schedule 13D

The Schedule 13D is also known as the “beneficial ownership report” and is required when any owner acquires 5% or more of the voting shares in a company. The report must be filed within 10 days of reaching the 5% threshold. It provides the following information:

The acquirer’s name, address, and other background information
Type of relationship this owner has with the company
Whether the person has been convicted of a crime in the past five years
An explanation of why the transaction is taking place
The type and class of the security
The origin of funds used for purchases

Investors should care about Schedule 13D

As part of the Williams Act in 1968, Section 13D was added to the Securities Exchange Act of 1934. This provision was made in response to the growing use of tender offers in business takeovers. Schedule 13D was created to alert individual investors to anticipated changes in corporate control that might have an influence on the company’s future, as a consequence of corporate raiders consolidating voting power

Conclusion

In the Indian market, if an ownership requirement of less than 25% is used in the framework of the FDI Policy, together with a subjective test (e.g., pertaining to control), the number of instances requiring prior regulatory clearance under the 2020 FDI Amendment is anticipated to grow dramatically. While prior Indian media reports indicated that the government intended to speed up the FDI clearance process for instances resulting from the 2020 FDI Amendment, press sources in October 2020 indicate that the government may announce guidelines for beneficial ownership with no floor or threshold.In practise, the FDI clearance procedure under the present regime (where the sectoral ministry is the competent authority) has been more time-consuming than it was under the previous regime (which was repealed three years ago) and thus urgently needs to be simplified to eliminate inefficiencies. As a result, it is unclear whether the government would be able to adequately reconcile the execution of the 2020 FDI Amendment with the finance and other needs of Indian-incorporated firms.

References

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