Hedge Funds

For Activist Investors, a Wide Reporting Window

William A. Ackman seemingly appeared out of nowhere.

It was only a month ago that David E. I. Pyott, chief executive of Allergan, learned that Mr. Ackman's firm, Pershing Square Capital Management, had amassed a 9.7 percent stake in his company and become its largest shareholder as part of a takeover effort with a rival, Valeant Pharmaceuticals.

Back in February, Valeant had approached Mr. Pyott about buying his company, the maker of Botox, but he rejected the overture.

Bill Ackman
Adam Jeffery | CNBC

Little did Mr. Pyott know that Mr. Ackman had started racing to buy up Allergan's stock that very month. While Mr. Ackman had bought enough shares by early April to breach the 5 percent threshold that requires a filing with the Securities and Exchange Commission, investors have 10 calendar days to make such a filing — and Mr. Ackman used the window to accumulate even more shares as quickly as he could.

Mr. Pyott wasn't the only one blindsided. Investors were stunned, too. How was it possible that Mr. Ackman had become Allergan's largest shareholder without anyone knowing?

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That question, and a spate of other similar secret buying sprees, is prompting renewed questions about whether a disclosure rule developed back in 1968, when investors would run across the floor of the New York Stock Exchange with tickets in hand, is outdated and whether the current rule is becoming just another example of the way the markets appear rigged against the ordinary investor. (I am leaving aside the discussion about the potential for abuse when a company teams up with a hedge fund.)

"These issues are part of a growing debate as to whether there are cases of 'illegitimate' imbalances of information beyond classic 'insider trading' that regulators should address," Victor I. Lewkow, a partner at Cleary Gottlieb Steen & Hamilton, wrote in a note to his clients.

In an age of activism, corporations are acutely focused on the rule, arguing that the 10-day period gives large investors an unfair advantage to accumulate shares without the requisite disclosure — and, of course, that it puts companies at a disadvantage to ward off unwanted suitors.

Read More Activist Ackman says Allergan CEO has conflict over letting go

But there is a larger issue for everyday investors.

When activists finally disclose the investment, it often moves the market, according to Wachtell, Lipton, Rosen & Katz, which has campaigned for years to change the rule on behalf of its corporate clients. "This delivers outsized returns to the activist and those they tip, while injuring investors who are deprived of the same knowledge," the firm said in a memo to clients in March. (I first wrote about this issue four years ago.) "In an era of high-frequency trading, the 10-day reporting window," it added, "simply makes no sense."

Indeed, the rule, which was established by the Williams Act in 1968, seems out of step for our modern times when transparency and disclosure have become a key tenet of our markets. In Britain, investors must disclose stakes of more than 5 percent within two days; in Hong Kong, it is three; in Germany, it is "immediately," but no later than four days.

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Activist investors counter that the 10-day period allows them to take big stakes without tipping off other investors who would invariably drive the price higher, giving them a financial incentive to pursue investments, which they argue is in the public good.

The question of whether activists promote the public good remains open. Some research has suggested that activists have created long-term value, while investors like Charlie Munger, the vice chairman of Berkshire Hathaway, recently declared, "I don't think it's good for America."

Allergan fires back at Ackman
Allergan fires back at Ackman

Mr. Ackman thinks the law should change — but in the other direction. In an interview, he proposed that investors should be allowed to buy up to 15 percent of a company before having to disclose it. "Control doesn't change at 5 percent or 10 percent or 15 percent; 15 percent is a meaningful stake. But if the rest of the shareholders don't agree with you, you're toast."

He said that activists must be able to acquire big stakes secretly or it becomes too costly to mount campaigns against management. "Shareholder activism is extremely time-consuming, expensive and a drain on an investment firm's resources," he said. More important, he argued, "it is a good thing for a large shareholder to be looking out for the other shareholders. A world in which every shareholder is forced to be passive is Japan."

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Whatever the case, activists — and other investors — have long sought to keep their investments secret until just the right moment, worried that a leak would cause the target stock to jump, making their investment too expensive.

Not only have some investors used the 10-day rule to buy up shares on the sly, but they also have also sought special dispensation from the S.E.C. to make investments confidentially, without any disclosure for long periods.

For example, David Einhorn argued for confidential treatment of his investment in Micron Technology. "Mirror trading by 'copycats' could lead to unwarranted volatility and inflated prices in the security," a representative for Mr. Einhorn's firm, Greenlight Capital, argued in a Nov. 14, 2013, letter, which my colleague, Matthew Goldstein, wrote about this month.

Read More Ackman and Valeant plot 'not fair': Gabelli

Warren E. Buffett, Carl C. Icahn, Mr. Ackman have all taken advantage of the confidentiality rule.

But in a world of activist investing and high-speed trading, everyday investors need more timely information, not less.

No less an expert than Leo E. Strine Jr., the former chief judge of the Delaware Court of Chancery, the nation's top business court, agrees that some reform is needed. He made a compelling argument in a paper that, at minimum, "filers have to disclose completely their ownership interests in instruments of any kind tied to the value of the company's stock."

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He said, "the voting electorate should have up-to-date, complete information about the economic interests of a hedge fund holding a large block of a corporation's shares and proposing that the corporation make business strategy changes it is suggesting."

Specifically, Judge Strine added: "Precisely how 'long' the fund's investment in the company is and in what manner the hedge fund is long is relevant information for the electorate to consider in evaluating the hedge fund's interest. So is how 'long' the activist is committed to owning its shares."

Activists often fight management, seeking more transparency and disclosure. You'd think they'd take their own advice.

—By Andrew Ross Sorkin, The New York Times. Andrew Ross Sorkin is also co-anchor of CNBC's "Squawk Box."