On August 24, 2015, the Federal Trade Commission (“FTC”) announced a proposed settlement to a civil complaint against three Third Point hedge fund entities (collectively, the “Third Point Funds”) and their management company, Third Point LLC, related to alleged violations of the Hart-Scott-Rodino Act (“HSR”)1 by Third Point.  The complaint, which the U.S. Department of Justice (“DOJ”) brought on behalf of the FTC, alleged that Third Point had inappropriately relied on the investment-only HSR exemption and failed to comply with HSR premerger notification requirements when it acquired shares of Yahoo! Inc. (“Yahoo”) in 2011.2  The FTC decided not to seek civil penalties, but the proposed judgment imposes a 5-year restriction on Third Point’s ability to rely on the investment-only exemption for acquisitions where Third Point takes specific actions to influence the issuer. Two FTC Commissioners dissented from the proposed judgment, stating that the HSR Act should not capture acquisitions of the type made by Third Point.3

This enforcement action highlights two important points for investors that are considering the investment-only exemption in connection with a minority acquisition. First, the enforcement action reaffirms the antitrust agencies’ consistent approach to interpreting “investment-only” intent narrowly.  Second, the dissenting statement by two FTC Commissioners, paired with certain public statements by the FTC’s Bureau of Competition, suggests that the FTC may be open to rethinking whether the current interpretation of the investment-only exemption is being applied effectively.

Background

The Third Point Funds are affiliated hedge funds founded by Daniel Loeb, a former board member of Yahoo.  Yahoo is a technology company engaged in providing Internet search, communications and digital content.

According to the complaint, the Third Point Funds made multiple open market acquisitions of Yahoo voting securities between August 8, 2011 and September 8, 2011.  The complaint also alleged that between August 10, 2011 and August 30, 2011, each Third Point Fund acquired Yahoo shares exceeding $66 million, which was the applicable HSR filing threshold at the time.  However, none of the three Third Point Funds submitted an HSR premerger notification form for their respective acquisitions of Yahoo shares prior to exceeding the HSR threshold.  The Third Point Funds relied on the “investment-only” exemption to the HSR filing requirement because each fund would hold less than ten percent of Yahoo’s outstanding shares and the shares would be held solely for investment.

On September 8, 2011, Third Point LLC filed a Form 13 D with the SEC publicly disclosing  Third Point’s holdings in Yahoo. Third Point also filed a letter it sent to the Yahoo board, criticizing its management decisions and stating Third Point’s intention to present a slate of directors at Yahoo’s next annual meeting. In addition to the Form 13 D filling, Third Point also, among other actions, made public statements about proposed changes to Yahoo’s board. On September 16, 2011, each of the Third Point Funds filed HSR forms for the acquisitions of Yahoo shares.  The waiting period for each filing subsequently expired on October 17, 2011.

Analysis

The HSR Act and HSR Rules provide certain filing exemptions to acquisitions of voting securities that otherwise meet the applicable thresholds.  This includes an exemption for stock acquisitions made “solely for the purposes of investment,” as long as the acquirer does not hold over ten percent of the issuer’s voting securities as a result of the acquisition.4  The HSR Rules limit the exemption by making it available only if the acquirer has “no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”5  Further, the FTC’s rationale for the exemption at the time the HSR Rules were implemented note that certain types of actions are inconsistent with holding securities solely for investment, including nominating a candidate for the board of directors, holding a board seat, proposing corporate action that requires shareholder approval, soliciting proxies, or being a competitor of the issuer.6

The FTC concluded that the Third Point acquisitions of Yahoo shares did not qualify for the investment-only exemption because of direct evidence that the Third Point Funds intended to become actively involved in the management and direction of Yahoo’s business.  Specifically, the complaint alleged that the Third Point Funds, Third Point LLC and/or their agents: (i) took steps to gauge certain individuals’ interest to become Yahoo’s CEO; (ii) took other steps to assemble an alternate slate of board of directors for Yahoo; (iii) drafted correspondence to Yahoo to announce that Third Point was prepared to join the Yahoo board; (iv) internally deliberated the possible launch of a proxy battle for directors of Yahoo; and (v) made public statements that they were prepared to propose a slate of directors at Yahoo’s next annual meeting.

In light of these actions, the FTC alleged that each of the Third Point Funds violated the HSR Act by failing to submit a timely HSR form and observe the HSR waiting period, before acquiring Yahoo shares in excess of the $66 million threshold.  The penalties for HSR violations are civil penalties of up to $16,000 for each day that an acquirer is in violation of the HSR Act.  Therefore, in the aggregate, Third Point’s fine could have been over $2.8 million ($16,000 per day for the periods between August 10 and October 17, August 17 and October 17 and August 30 and October 17, the HSR waiting period expiration for each fund).

However, per the stipulated settlement, the government did not seek civil penalties. Instead, the settlement prohibits the Third Point Funds from making an acquisition of an issuer without filing and observing the HSR waiting period, if during the preceding four months, the Third Point Funds engage in certain conduct, including the following:

  1. nominate a candidate to the board of directors of the issuer;
  2. propose corporate action requiring shareholder approval;
  3. solicit proxies with respect to the issuer;
  4. are a competitor of the issuer;
  5. inquire a third party as to his or her interest in the board or management of the issuer;
  6. communicate with the issuer regarding board or management representation; and
  7. assemble in writing a board or management slate of the issuer.

The final judgment has to be approved by a district court judge; however, the court’s entry of judgment should be straightforward.

Commentary

  • This HSR enforcement action marks the second time in three years the agencies have alleged that certain acquirers failed to file an HSR notification and could not avail themselves of the investment-only exemption.7
  • As part of the proposed settlement, the FTC’s Bureau of Competition issued a release on its Blog supporting the rationale for the alleged HSR violation.8 The Bureau noted that the FTC has “long made clear that the investment-only exemption is a narrow exemption.” The limitations on the exemption have been communicated consistently through speeches and previous enforcement actions relating to conduct that was inconsistent with investment-only intent.  Interestingly, the Bureau noted it was willing to consider changes to the HSR Rules to make the “rules better or more clear.”
  • Commissioners Maureen Ohlhausen and Joshua Wright (whose last day as a Commissioner coincided with the release of the proposed settlement) dissented and noted in their dissenting statement that while an HSR violation occurred, an enforcement action was not in the public interest.9 Rather, they contended that acquisitions by activist investors such as Third Point raise a very low risk of potential competitive harm and often generate well-documented benefits to the market. Importantly, minority acquisitions by activist investors could easily be remedied by a post-consummation divestiture and did not involve concerns of “unscrambling of assets” that led to enactment of the HSR Act.
  • In their dissenting statement, Commissioners Ohlhausen and Wright proposed two options for modifying how the HSR Rules are applied to share acquisitions that do not exceed 10% of the issuer’s outstanding voting securities. Their first suggestion was to consider a new exemption for any share acquisitions that do not result in the acquirer holding greater than 10 percent of an issuer’s outstanding voting shares.  The second suggestion was to link investment-only intent to specific conduct outlined in the Statement of Basis and Purpose that was written when the HSR Rules were first issued.10  E.g., nominating a candidate for the board, soliciting proxies, being a competitor of the issuers, etc.  Such rules, the Commissioners contend, would provide clear guidance for what conduct would disqualify an acquirer from relying on the investment-only exemption.
  • The government’s action reaffirms the FTC’s consistent guidance that stock purchasers, including private equity firms and activist shareholders, intending to influence the direction of a business should keep in mind the HSR premerger notification thresholds and filing requirements.
  • The action highlights the relatively high bar to claiming the investment-only exemption. Additionally, the prohibited actions enumerated in the proposed settlement provides further clarification of, and potentially expands, the existing enforcement precedent and informal interpretations on the investment-only exemption.
  • Finally, investors should understand that the agencies’ decision of whether to seek civil penalties is based on a highly fact-specific analysis. The lack of a fine in this enforcement action should be viewed in conjunction with the $850,000 fine that Biglari Holdings, Inc. paid in 2011 to settle similar allegations of failing to file an HSR notification without being able to rely on the investment-only exemption. In both instances, defendants were first time violators involved in transactions that did not raise serious anticompetitive concerns. Taken together, these enforcement actions demonstrate that the agencies have enforcement discretion, but being a first time violator does not guarantee a settlement without significant fines.