United States: Independent Business Units Within A Financial Services Firm: Sections 13 And 16 Reporting Obligations

Sections 13 and 16 of the Exchange Act require the beneficial owners of a threshold amount of equity securities of an Exchange Act reporting company to file certain information with the SEC on a periodic basis. In a 1998 Release, the SEC addressed the issue of whether different business units operating independently within a single corporate organization are required to aggregate beneficial ownership of securities for Section 13 reporting purposes. Such aggregation would have the undesirable effect of requiring distinct business units to share sensitive information. The 1998 Release explained that an entity could "disaggregate" beneficial ownership by business unit for Section 13 reporting purposes if certain steps were taken to ensure that voting and investment decisions were made independently by each business unit. According to the 1998 Release, the maintenance and enforcement of written policies and procedures designed to prevent the flow of information between affiliated business units may prevent the attribution of beneficial ownership to the business unit’s parent and affiliated business units. By creating these information barriers, the beneficial ownership of securities among business units within a corporate entity would not be attributed to one another or to the parent and therefore would not be aggregated for purposes of the reporting requirements. The SEC indicated in a footnote to the 1998 Release that the disaggregation analysis would also apply to the definition of beneficial ownership contained in Rule 16a-1(a)(1).

In its Request for Advice, The Goldman Sachs Group, Inc. sought clarification that the existence of information barriers would prevent a business unit from being deemed to have a "pecuniary interest" in the securities holdings of other affiliated business units for purposes of Rule 16a-1(a)(2). Under Rule 16-a-1(a)(2), only securities in which the beneficial owner has a "pecuniary interest" are included in reports under Section 16, and it is only with respect to such securities that Section 16’s short-swing profit provisions apply.

The Staff responded favorably to the Request for Advice, stating that the disaggregation analysis described in the 1998 Release should apply to the determination of pecuniary interest, regardless of whether the business unit is subject to Section 16 based on its greater than 10% beneficial ownership of the issuer’s securities or based on the deputization by the business unit of a director of the issuer (thereby giving the unit the status of a director for reporting and short-swing profits purposes). The Staff cautioned, however, that aggregration would occur where the deputized director is also a director of the parent of the business unit. The Staff reasoned that a deputized director who is also a director of the parent would "represent the interests of all the Goldman Sachs business units" and therefore justify their aggregation.

The Request for Advice asked the Staff for further clarification as to whether "each business unit that contains personnel from the parent holding company may be treated as having a separate parent holding company" for purposes of Rule 13d-1(b)(1)(ii)(G) and Rule 16a-1(a)(1)(vii). Under Rule 16a-1(a)(1)(vii), a parent holding company of a qualifying institutional investor is treated like the institution itself and is not deemed to be the beneficial owner of securities held for the benefit of third parties under Section 16 if the subject securities held by the parent holding company (directly or indirectly through subsidiaries or affiliates that are not qualifying institutions) do not exceed one percent of the issuer’s securities. Under Rule 13d-1(b)(1)(ii)(G), such a parent holding company may use a short form reporting statement. The Staff responded that where "a parent holding company properly may be disaggregated into two or more separate business units, each of these business units may be considered separately for purposes of Rule 13d-1(b)(1)(ii)(G) and Rule 16a-1(a)(1)(vii)."