Investors that beneficially own more than 5% of a public company’s outstanding shares are required to report their ownership stake pursuant to Sections 13(d) and 13(g) of the Securities and Exchange Act of 1934. This disclosure obligation is designed to increase transparency about substantial ownership in public companies.

Depending on the specific characteristics of an investor, a Schedule 13D or Schedule 13G filing is made with the Securities and Exchange Commission (SEC) in order to satisfy this reporting requirement. A Schedule 13D filing provides more detailed disclosure about an investor, their ownership percentage, and the purposes behind their acquisition of a significant number of shares of the company.

Investors that qualify for “passive investor” status are able to file a Schedule 13G in lieu of a Schedule 13D. A Schedule 13G is a shorter form filing that requires less disclosure compared to a Schedule 13D. Many institutional investors are able to file Schedule 13Gs by relying on the passive investor exemption. Rule 13d-1(b) and Rule 13d-1(c) both provide an exemption from using the long-form Schedule 13D based on an investor being passive.

A “passive investor” is defined as a shareholder that beneficially owns more than 5% of a public company’s shares but that does not intend to influence or gain control of the company. “Control” is defined as having the power to direct or cause the direction of the management and policies of the company, whether through share ownership, contractual arrangements, or other methods.

Certain actions can cause an investor to lose their “passive investor” status. If an investor purchases shares of a public company with the “purpose or effect of changing or influencing control of the issuer”, the investor could lose their Schedule 13G eligibility. Additionally, an investor could lose their Schedule 13G eligibility if they engage in discussions with the company’s management team about selling all or substantially all of the company’s assets. The analysis in this type of situation would focus on the depth of the engagement. For example, exerting pressure on management to enact specific policies could lead to a finding that the shareholder is not a passive investor.

Investors should take a cautious approach to shareholder engagement in order to retain their Schedule 13G eligibility. Shareholders providing public companies with recommendations for improvement should make sure such feedback would not be perceived as pressuring the company to implement specific measures. Shareholder engagement that could be interpreted as having the purpose or effect of changing or influencing control of the company should be avoided. Investors accustomed to filing the short-form Schedule 13Gs will find filing the long-form Schedule 13D onerous.

Asset managers and other investors should also keep an eye on SEC actions taken against other investors to ensure that their recommendations for corporate action are not construed as exerting influence over the company. Depending on the substance and context of such discussions, shareholder recommendations to companies on topics such as staggered board structures, eliminating a poison pill, reforming executive compensation practices, modifying the dividend policy, and changing voting standards could risk jeopardizing an investor’s Schedule 13G eligibility.