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SEC Settles Enforcement Action against Private Equity Firm for Beneficial Ownership Reporting Violations

On September 17, 2020, the SEC announced the imposition of a cease-and-desist order against private equity firm Welsh, Carson, Anderson & Stowe (Welsh Carson), an SEC-registered investment manager, in connection with alleged violations of reporting obligations under Section 13(d) of the Securities Exchange Act of 1934 (Exchange Act).  The SEC alleged that Welsh Carson had failed to timely amend a Schedule 13D report – commonly known as a beneficial ownership statement – after its investment position changed from an intent to acquire and restructure a company to an intent to liquidate its entire position in the company.  In connection with the entry of the SEC’s cease-and-desist order, Welsh Carson agreed to pay a civil penalty of $100,000.

This enforcement action demonstrates the SEC’s continued focus on institutional investors’ Schedule 13D disclosure obligations and emphasizes the need for investment funds to develop and implement appropriate compliance policies and procedures to monitor their reporting obligations.

Schedule 13D Reporting Requirements

When a person or group of persons acquires beneficial ownership of more than 5% of a voting class of a company’s equity securities registered under the Exchange Act, they are required to file a Schedule 13D with the SEC within 10 days.  The Schedule 13D must include the following information:

  • A description of the investment.

  • A description of any plans or proposals that the beneficial owner may have with respect to certain enumerated matters regarding the issuer, including plans to acquire the company or liquidate the investment.

Further, Section 13(d)(2) of the Exchange Act and SEC Rule 13d-2(a) together require a beneficial owner to promptly amend a Schedule 13D when there are material changes or developments in the information previously reported.  “Material” information is anything that creates a substantial likelihood that a reasonable investor would attach importance to it in determining whether to buy or sell the securities.  SEC Rule 13d-2(a) also requires a beneficial owner to amend a Schedule 13D promptly upon any material increase or decrease in the percentage of the class beneficially owned.  An increase or decrease in beneficial ownership of 1% or more is a “material” change that must be accounted for in an amended filing.  (See Admin. Proceeding File No. 3-20020.)  Finally, a “generic, boilerplate disclosure” that indicates that a beneficial owner is reserving the right to engage in certain types of enumerated transactions in the future (including plans to acquire or dispose of holdings in the same security) must be amended promptly when a material change occurs in the facts previously reported in the Schedule 13D.

Factual Background

In July 2016, Welsh Carson filed a Schedule 13D report indicating that it had purchased approximately 6.7% of the common stock of Hanger, Inc. (Hanger), a prosthetics company.  The Schedule 13D indicated that the acquisition of Hanger stock was for “investment purposes” and that Welsh Carson intended to “explore a possible acquisition or restructuring” of Hanger.  Welsh Carson further stated that it did not have any plan to dispose of the Hanger shares, but the Schedule 13D included general statements reserving the right to do so.

Principals of Welsh Carson contacted Hanger’s management concerning an acquisition, but Hanger declined the overtures.  Welsh Carson subsequently abandoned any plan to acquire Hanger and decided instead to liquidate its entire position.  The liquidation was completed in a series of block sales in July and August 2019.  However, Welsh Carson did not file a Schedule 13D amendment disclosing the Hanger block sales until September 2019 – more than two months after the first block sale that triggered an amendment obligation under Section 13(d)(2) and Rule 13d-2.

Violations

The SEC determined that Welsh Carson violated Section 13(d)(2) and Rule 13d-2 when it failed to promptly amend its Schedule 13D after (1) abandoning its interest in acquiring Hanger, (2) formulating a definitive intention to liquidate its Hanger holdings, and (3) taking steps to liquidate its Hanger shares – all of which the SEC concluded occurred prior to the first block sale of stock in July 2019.  The SEC further determined that Welsh Carson violated Section 13(d)(2) and Rule 13d-2 when it failed to timely amend its Schedule 13D after disposing of more than 1% of Hanger’s outstanding common stock in its first block sale.

Takeaways

This recent SEC enforcement action provides several key insights for private equity and other SEC-registered investment funds as they contemplate making changes to any beneficial ownership positions:

  • Is the SEC Actually Focused on Beneficial Ownership Reporting Obligations? Stand-alone beneficial ownership cases are unusual.  It is difficult to tell whether the SEC’s decision to sue Welsh Carson is intended to signal to the investor community that it intends to prioritize this type of somewhat technical violation.  More likely, this is a “one-off” case that does not evidence a programmatic effort to investigate and punish beneficial owners who do not satisfy their reporting obligations.

  • Remediation and Lack of Recidivism Was No Protection against Suit. Interestingly, in the Welsh Carson matter, the SEC elected to file suit and impose a significant penalty even though Welsh Carson did file – albeit late – an amendment to its Schedule 13D and in the apparent absence of a pattern of similar violations by Welsh Carson.  While the SEC has previously signaled an intent to focus on repeat offenders, in recent years the SEC has pursued violations without evidence of recurring delinquent behavior.  (g.,  Admin. No. 3-17847Admin No. 3-16442, and Admin No. 3-16436.)

  • Beware of Boilerplate Language – While commonplace, the use of boilerplate language in a Schedule 13D can be a potential source of future liability.  Investment funds should make prompt and appropriate amendments to boilerplate language once management has decided to modify a previously disclosed investment decision or rationale.

  • Implement Internal Policies & Procedures to Ensure Compliance – Private equity and investment funds, and especially infrequent Schedule 13D filers, should have appropriate policies and procedures in place to ensure securities law compliance, including compliance with, and monitoring of, their beneficial ownership reporting obligations, including engaging qualified securities counsel.

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume X, Number 282
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Michael R. MacPhail Partner Denver Litigation White Collar Crime
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Michael MacPhail defends clients against federal and state government agencies during civil and criminal investigations and litigation, primarily involving the securities industry. He represents public companies, registered investment advisers and broker-dealers.

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Peter W. Baldwin, a former federal prosecutor, defends clients facing white-collar criminal and internal investigations, securities enforcement actions, cybersecurity issues, and other complex civil and criminal litigation matters. Prior to joining Drinker Biddle, Pete spent over eight years as an Assistant United States Attorney in the U.S. Attorney’s Offices for the Eastern District of New York and Central District of California. In this role, he supervised all aspects of criminal investigation and prosecution, first as a member of the Major Frauds Section in the Central...

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Josh Mahoney is a trial lawyer and vigorous advocate for his clients. He has significant experience representing companies and their executives facing complex litigation and white collar investigations, with a particular focus on antitrust, commercial disputes, and construction litigation. Josh also maintains an active pro bono practice involving veterans’ benefits appeals and related issues through the firm’s Justice for Veterans Initiative.

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