Narrow reading of exemption by majority of split FTC may limit tactics available to potential shareholder activists
A recent enforcement action by the Federal Trade Commission (FTC) and U.S. Department of Justice (DOJ) demonstrates that an investor risks being denied use of the exemption under the Hart-Scott-Rodino Act (HSR Act) for acquisitions of voting securities made “solely for the purpose of investment” if it actively considers taking, or prepares to take, certain types of actions directed at an issuer, at least where the investor makes known to the issuer or to other third parties that such actions are contemplated, even if it has not formed an intention to take any such action.
The FTC on August 24, 2015 announced that the DOJ had filed in federal court on its behalf a proposed settlement resolving allegations that three investment funds with a common manager had not made necessary HSR filings before making certain acquisitions of Yahoo! Inc. (Yahoo) voting securities in 2011.1 The FTC asserted that the funds’ reliance on the exemption for acquisitions of voting securities “solely for the purpose of investment” had been improper in light of certain activities allegedly engaged in by the manager.
The HSR Act and the Investment-Purpose Exemption
The HSR Act requires that parties to acquisitions of voting securities, non-corporate interests, and/or assets formally notify the FTC and DOJ in advance and comply with a waiting period requirement before completing such acquisitions if certain dollar thresholds are exceeded and no exemption applies. Currently acquisitions that will result in aggregate holdings valued in excess of $76.3 million are potentially reportable. This threshold is adjusted each February based on changes in gross national product.
Section 7a(c)(9) of the HSR Act, 15 U.S.C. §18a(c)(9), and Section 802.9 of the FTC’s HSR Rules, 16 C.F.R. § 802.9, each exempt acquisitions of voting securities made “solely for the purpose of investment,” provided that the acquiring person will not hold more than 10 percent of the issuer’s outstanding voting securities as a result of the acquisition. According to Section 801.1(i)(1) of the Rules, 16 C.F.R. § 801.1(i)(1), “Voting securities are held or acquired ‘solely for the purpose of investment’ if the person holding or acquiring such voting securities has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”
The FTC has provided a non-exhaustive list of actions it considers inconsistent with having solely an investment purpose. These include holding a seat on or nominating a candidate for the issuer’s board, being an officer of the issuer, proposing corporate action requiring shareholder approval, soliciting proxies, and being a competitor of the issuer.
The Recent FTC/DOJ Enforcement Action
According to the government’s complaint in last week’s enforcement action, the three funds each made
HSR-reportable acquisitions of Yahoo voting securities in August 2011 but, based on an allegedly erroneous view that these acquisitions were exempt, did not file notifications in advance of the acquisitions.
The three funds did each file HSR Act notifications in September 2011, after the fund manager had filed a Schedule 13D with the U.S. Securities and Exchange Commission (SEC) publicly disclosing the funds’ holdings in Yahoo. The FTC and DOJ, however, alleged that the manager had taken actions before its HSR Act filings indicating an intention inconsistent with acquiring shares “solely for the purpose of investment.” The actions cited by the agencies included: (1) contacting third parties to gauge their interest in becoming CEO or a board member of Yahoo; (2) assembling an alternate slate of board of directors for Yahoo; (3) drafting correspondence to Yahoo announcing the fund manager’s interest in being represented on Yahoo’s board; (4) internally discussing the possible launch of a proxy battle; and (5) publicly stating that it was prepared to propose a slate of directors at Yahoo’s next annual meeting.
In light of these alleged activities, the FTC concluded that the exemption for acquisitions “solely for the purpose of investment” did not apply and that the funds had been required to make HSR filings sooner than they did. The DOJ, at the FTC’s request, filed a civil antitrust action alleging violations of the HSR Act. Although the statute allows imposition of substantial civil monetary penalties, the agencies did not seek them in this case, where the violation was inadvertent and short in duration and was each fund’s first violation of the HSR Act.
In an unusual step, two of the FTC’s five Commissioners voted against referring the complaint and proposed settlement to the DOJ for filing in federal court and issued a Dissenting Statement arguing that the enforcement action was not in the public interest and was “likely to chill valuable shareholder advocacy” that would not cause competitive harm. The dissenters took particular exception to certain provisions of the consent order enjoining the manager from relying on the investment-purpose exemption “when it engages in certain shareholder advocacy such as soliciting third parties for interest in becoming a board candidate, discussi[ng] with an issuer board its candidates, or assembling a board slate.” The dissenters also called for the FTC and DOJ to “reconsider the parameters” of the exemption, while acknowledging that past efforts to modify the exemption have stalled, partly because of Congressional opposition.
Significantly, though, neither the dissenters nor the Commissioners who voted to refer the complaint to the DOJ seriously questioned whether the fund manager, in the words of Section 801.1(i)(1), had formed an “intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer” when it allegedly violated the HSR Act. Even the dissenters stated that the majority’s interpretation of the HSR Rules was “neither unreasonable nor plainly contrary to the text of the statute and regulations at issue” and was “[not] necessarily inconsistent with previous consent orders involving the exemption.” Similarly, in a blog post issued the day the complaint was filed, the Director of the FTC Bureau of Competition commented that some past DOJ complaints had been “based on the defendant ‘considering’ certain actions that were deemed to be inconsistent with the investment only exemption.”
Given these views on the part of the FTC Commissioners and staff, and the DOJ’s apparent concurrence, it is evident that merely discussing the possibility of taking certain actions in relation to an issuer and preparing to take such actions can create a substantial risk that a fund manager or other investor will be deemed unable to rely upon the investment-purpose exemption, at least where the investor makes known to persons outside its organization that such actions are contemplated. Investors planning otherwise-reportable transactions who do not file HSR notifications in these circumstances risk being penalized, especially if the FTC and DOJ consider the recent enforcement action as having put others on notice that such conduct will be dealt with severely in the future. If nothing else, similarly-situated acquirers who elect not to file face the possibility of a protracted, costly, and intrusive government investigation.
The recent settlement may affect the timing with which issuers with a market cap greater than approximately $1.5 billion receive notice that they are targets of activist hedge funds. Where the “solely for the purpose of investment” exemption does not apply, an HSR filing is often the first legally-required notice of an investor’s accumulation of a significant position in the stock on an issuer of that size. Holdings below five percent do not necessitate a Schedule 13D or 13G filing with the SEC, but holdings valued in excess of $76.3 million are potentially reportable under the HSR Act regardless of the percentage, unless exempted. If neither the “solely for the purpose of investment” exemption nor any other exemption were available, an activist investor would very likely have to notify the issuer formally of its intention to make an HSR filing, file the HSR submission, and satisfy the waiting period requirement before crossing the $76.3 million threshold, even if it were not obligated to make an SEC filing. In some cases the need to file under HSR will further depend on whether holdings of multiple funds with the same manager must be aggregated based on the “control” tests set forth in the HSR Rules.
Issues relating to the “investment purpose” exemption are often complex and nuanced and require careful analysis. A fund manager or other investor considering taking actions that the FTC and DOJ have deemed inconsistent with the exemption should seek advice from HSR counsel where a contemplated stock acquisition is large enough to be potentially reportable.
The text of the FTC’s press release with links to other materials relating to the recent enforcement action can be found here.