Large Trader Rule May Snare Some Individual Investors

“SEC to UHNW: Get CIK on EDGAR, get LTID thru 13H, tell BD.”

This is not a text message your teenager sent discussing weekend plans. Unfortunately, it is a brief description of SEC’s new Large Trader Identification System that has thrust new regulatory requirements upon certain unsuspecting wealthy investors and family offices.

After the flash crash in May 2010, the SEC implemented a rule requiring “Large Traders” to self-identify themselves by filing new Form 13-H through the SEC’s EDGAR system. A Large Trader is defined, in part, as any person who, for his own account or for an account for which he exercises investment discretion, effects transactions in exchange-listed securities in an aggregate amount equal to or in excess of either:

• 2 million shares or $20 million in value on any day
• 20 million shares or $200 million in value in any calendar month

Thus, a wealthy individual who day trades or a family office making investment decisions for several family accounts may need to self-identify if the daily threshold is crossed just once. Many individuals and family offices entrust discretionary investment authority to outside advisors, relieving them from the requirements. However, those who manage their own investments are considered to exercise discretion over their own accounts. 

The SEC estimated that only 400 people or entities will be considered Large Traders, but we believe the net is in fact much broader. It is not implausible to imagine a family office selling a position across several family members’ accounts totaling $10 million, and reinvesting the $10 million into other securities, thereby crossing the $20 million threshold. Furthermore, even if several affiliated traders themselves do not cross the threshold, the controlling parent entity must aggregate their trades and may itself be a Large Trader required to self-identify. In this respect, the SEC has set the bar much lower than IRS requirements to be considered a “trader” for purposes of the passive-activity loss rules, which emphasize active and ongoing involvement in trading activity rather than the absolute magnitude of trading activity.

Certain transactions are exempt from the calculation of trading activity, including gifts or estate distributions, employee stock or option awards or sales, mutual fund trades, IRA rollovers and private placements. 

Information submitted on Form 13-H, such as types of business, people involved, form of organization, brokers used, affiliates and trading strategy will not be publicly disclosed. Large Traders are required, however to provide their large trader identification number to their brokers, and brokers may contact you to request your number. Even though the initial deadline for reporting has passed (December 1, 2011), the SEC has stated that it may request information from brokers about their customers who appear to be potential large traders. 

Because the SEC so broadly defined a Large Trader we suspect this may be a trap for the unwary. As with any significant transaction, an acute understanding should be gained with respect to both tax and regulatory reporting requirements.