The FTC's recent settlement with three related investment funds and their management company Third Point LLC (collectively, Third Point) provides important practical guidance for individual and institutional investors assessing whether the "investment-only" exemption applies to an acquisition otherwise reportable under the Hart-Scott-Rodino (HSR) Act.1 In addition to confirming the antitrust agencies' view that this exemption applies only in very limited circumstances and that they are serious about bringing enforcement actions for perceived misuse of it, the proposed Final Judgment2provides examples of specific conduct the antitrust agencies deem inconsistent with the passive intent element of the exemption, and suggests that a four-month "cooling-off" period or other corrective actions may restore an investor to passive status in some situations.
Reporting Obligations and the Investment-Only Exemption
Under the HSR Act, parties are required to file notification with the Federal Trade Commission (FTC or Commission) and Department of Justice (DOJ) and observe a waiting period prior to closing acquisitions of voting securities or assets that satisfy certain thresholds.3 This reporting requirement applies not only to mergers and acquisitions of controlling interests, but also to minority stock acquisitions if the thresholds are met. There are, however, a number of potential exemptions.
One exemption, known as the "investment-only" exemption, applies if "as a result of the acquisition, the acquiring person would hold ten percent or less of the outstanding voting securities of the issuer" and the acquisition is made "solely for the purpose of investment."4 While the ten percent threshold is straightforward, the issue of intent can be difficult to assess, depending on the investor's actions related to the issuer and its business.
For the investment-only exemption to be available, an acquiring person must have no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.5 In other words, the acquirer must be a truly passive investor.6 For large individual or institutional investors that can be engaged in activities to influence an issuer's management or business strategies from time to time, determining whether passive investment intent exists at the time of the acquisition may be difficult because the antitrust agencies will look at the nature of such activities and how close in time before or after the acquisition they have occurred.
FTC Found Third Point's Conduct Was Not Passive
On August 24, 2015, the FTC settled allegations that Third Point violated the HSR Act by failing to file for acquisitions of Yahoo! Inc. stock, and improperly relied on the investment-only exemption after taking steps to potentially replace Yahoo's directors and management.
According to the Complaint,7 from around August 8, 2011, until September 8, 2011, Third Point LLC acquired shares of Yahoo through several of Third Point's managed funds. During this period, three of those managed funds (not under common control for HSR purposes) came to hold shares valued in excess of the HSR threshold. However, those three funds did not file HSR notification until September 16, 2011, and the waiting periods did not expire until October 17, 2011.
The FTC alleged that Third Point was in violation of the HSR Act until the waiting periods expired and was not entitled to rely on the investment-only exemption. In particular, the FTC alleged that Third Point and/or its agents engaged in conduct that was inconsistent with having a passive investment intent, including:
- Contacting potential candidates about their willingness to serve as CEO or as a member of Yahoo's board of directors;
- Taking additional steps to assemble an alternate slate of directors for Yahoo;
- Drafting correspondence to Yahoo to announce Third Point LLC was prepared to have its representatives join Yahoo's board;
- Internally deliberating the launch of a proxy battle for directors of Yahoo; and
- Making public statements that Third Point was prepared to propose a slate of directors at Yahoo's next annual meeting.
Mere Activist Preparations Can Be Sufficient to Preclude Reliance on Exemption
The antitrust agencies viewed Third Point's conduct as falling short of actually nominating a director or executive of Yahoo. But based on the enforcement action, the FTC's position appears to be that any overt act aimed at changing an issuer's management, even if taken only internally or not directed at the issuer, can establish a non-passive investment intent and render the investment-only exemption unavailable.
Contrast this position with the original Statement of Basis and Purpose (SBP) published with the final rulemaking for the exemption in which the FTC stated the following could be evidence of intent inconsistent with the exemption:
- Nominating a candidate to the issuer's board of directors;
- Proposing corporate action requiring shareholder approval;
- Soliciting proxies;
- Having a controlling shareholder, director, officer, or employee simultaneously serving as an officer or director of the issuer;
- Being a competitor of the issuer; and
- Doing any of the foregoing with respect to any entity directly or indirectly controlling the issuer.8
While Third Point's alleged conduct does not appear to have been prohibited based on the examples in the SBP, the SBP is not an exhaustive list of prohibitions and the agencies have brought actions in the past alleging the investment-only exemption does not apply because of potential or contemplated activist conduct.9 Thus, Third Point makes clear that the FTC is continuing to consider the outer boundaries of what it means to be a passive investor for purposes of the HSR reporting requirements.
Settlement Articulates Benchmarks for Cooling-Off Period and Abandonment of Activist Intent
In addition to providing some guidance on conduct inconsistent with investment-only intent, the Third Point settlement provides guidance on how former activist investors can reestablish a passive intent. Specifically, the proposed Final Judgment suggests passive intent can be regained in certain circumstances through either the passage of time or affirmative abandonment of preliminary actions directed at changing an issuer's management.
With respect to the passage of time, the proposed Final Judgment prohibits reliance on the investment-only exemption if any of the proscribed conduct-the actions specified in the SBP as well as the specific conduct of Third Point in this case-is undertaken within the four months before an otherwise reportable acquisition.10 In imposing this "cooling-off" requirement on Third Point, the FTC seems to suggest that it is skeptical of any sudden switch from overt activist conduct to a claim of passive intent. However, the proposed Final Judgment also indicates that certain activist conduct related to potential management changes11 can be "abandoned" through a direct communication to the issuer (and any third-party candidates, where applicable) stating that the acquirer is no longer pursuing board or management representation, and that doing so can return an investor immediately to passive intent (assuming there has been no other conduct inconsistent with a passive investment intent).12
While the terms of this settlement will be helpful when determining whether conduct leading up to an acquisition would be viewed by the antitrust agencies as precluding reliance on the investment-only exemption, investors also must consider the effect of actions that will be taken in the near termafter an acquisition. For example, in Biglari Holdings,13 Biglari considered itself exempt as a passive investor. However, according to the complaint, the day after concluding a series of reportable acquisitions of Cracker Barrel stock, Biglari's CEO reached out to Cracker Barrel executives to arrange for a meeting at which he ultimately presented ideas for improved operations and requested two seats on Cracker Barrel's board.14 The FTC's position was that there was no passive intent at the time of the acquisition based on this immediate post-acquisition activity.
Agencies Less Forgiving of First-Time Violations Involving Improper Application of Investment-Only Exemption
Typically, when a failure to make a required HSR Act filing occurs due to inadvertent oversight and the party is a first-time offender, the agencies will not bring an enforcement action, provided that the party agrees to implement compliance procedures going forward. This exercise of discretion is significant given that civil penalties currently can be assessed at a rate of US$16,000 per day.
The Third Point settlement demonstrates, however, that the agencies take a much stricter view on enforcement when it comes to violations involving alleged improper use of the investment-only exemption. While the FTC did not obtain civil penalties against Third Point, only injunctive relief, this outcome cannot always be expected-particularly in situations where the agencies may find a reporting violation more blatant. In Biglari Holdings, for example,the FTC brought an action for a first offense and obtained a significant civil fine of US$850,000.15
Potential Rule Change Afoot?
The Third Point settlement involved two peculiarities that suggest the antitrust agencies might be re-evaluating the investment-only exemption and considering a rule change to simplify its application. First, the decision to bring the action was a split vote by the Commission-rare in the HSR enforcement context. The dissenting Commissioners, Ohlhausen and Wright, agreed with the majority that there was reason to believe a technical HSR violation had occurred, but would have closed the case without action as a matter of prosecutorial discretion because the case presented "absolutely no threat of competitive harm."[[N:Dissenting Statement of Commissioners Maureen K. Ohlhausen and Joshua D. Wright, In re Third Point, File No. 121-0019 (Aug. 24, 2015) [hereinafter Dissenting Statement],https://www.ftc.gov/system/files/documents/public_statements/777351/150824thirdpointohlhausen-wrightstmt.pdf.]] To end enforcement in the future where the risk to competition is non-existent, the dissenting Commissioners explicitly called for modification of the investment-only exemption.
Second, the consent judgment-agreed to by the majority of the Commission-refers to the possibility of an exemption based on the percentage of stock held post-acquisition without regard to intent. Specifically, the proposed Final Judgment states it will be in effect for five years, except if the current investment-only exemption is replaced with a "flat exemption," defined as an exemption for an acquirer that "is not a competitor of the Issuer, on the sole basis that the acquisition results in the Acquiring Person's holding less than a specified percentage of the outstanding Voting Securities of the Issuer."16 While this would not be the first attempt to change the investment-only exemption,17these aspects of the Third Point settlement suggest the issue may be receiving a fresh look at the antitrust agencies.
Large individual and institutional investors frequently make stock acquisitions valued high enough to cross the HSR Act reporting threshold. Before deciding that an acquisition is exempt under the investment-only exemption, careful review of both external and internal conduct needs to be taken to determine if there has been, or shortly will be, any activity-even if preliminary in nature-that might be considered inconsistent with passive intent. While the ambiguity in assessing intent based on a non-exhaustive list of examples from the agencies can be difficult in certain situations, the Commission's recent settlement in the Third Point case provides helpful guidance, both on what types of preliminary activist activity render the investment-only exemption unavailable, and on what can be done to allow reliance on the exemption once an investor's intent has become passive again.