An activist hedge fund has settled charges that it improperly relied on the so-called passive investor exemption under the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act) in making acquisitions of shares of the internet company Yahoo.1 The settlement, which resulted in no fine to the defendants, Third Point LLC and its affiliates, provides guidance on the types of conduct that preclude reliance on the exemption and highlights the narrow reading of the exemption by the Federal Trade Commission (FTC). The two Republican Commissioners dissented from the FTC’s vote to bring the enforcement action, questioning whether bringing such a case was in the public interest given the extremely low likelihood of an actual anti-competitive effect.
The HSR Act requires parties to mergers and acquisitions exceeding certain thresholds to file notification with the FTC and the Antitrust Division of the Department of Justice before consummating the proposed transaction. The Act and its implementing regulations include certain exemptions from the notification and waiting period requirements. One such exemption -- the so-called “passive investor exemption” -- applies to the acquisition of 10% or less of the outstanding voting securities of an issuer if made “solely for the purpose of investment,”2 which is defined as having “no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”3
The HSR Regulations themselves provide no further guidance on what qualifies as investment-only intent. The Statement of Basis and Purpose (SBP) to the HSR Regulations give the following examples as conduct that could be considered inconsistent with investment-only intent:
- nominating a candidate for the board of directors of the issuer;
- 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; or
- doing any of the foregoing with respect to any entity directly or indirectly controlling the issuer.4
Because the exemption is based on an acquiror’s subjective intent there has long been uncertainty as to its outer limits.
On August 11, 2011, three Third Point funds began acquiring shares of Yahoo, each eventually crossing the then-applicable notification threshold of $66 million. The FTC’s complaint alleges that the actions of the funds’ management company evidenced an intent inconsistent with the passive investor exemption. Specifically, the FTC alleged that Third Point:
- contacted certain individuals to gauge their interest and willingness to become the CEO of Yahoo or a candidate to the Yahoo board;
- took steps to assemble an alternate slate for the Yahoo Board;
- drafted correspondence to Yahoo announcing Third Point was prepared to join its board;
- internally discussed the possible launch of a proxy battle for Yahoo directors; and
- stated publicly that it was prepared to propose a slate of directors at Yahoo’s next annual meeting.
Under the terms of the settlement, Third Point is prohibited from relying on the passive investor exemption in acquisitions of an issuer’s stock if it engages in similar conduct with respect to that issuer. Additionally, Third Point must maintain an internal compliance program. The Commission vote in favor of bringing the action and settlement was 3-2, with the two Republican Commissioners dissenting. The FTC chose not to seek civil penalties from Third Point.5
This enforcement action is noteworthy for a few reasons:
- It serves an important reminder that the FTC interprets the passive investor exemption narrowly and provides additional clarity on the types of conduct considered inconsistent with investment-only intent. Notably, the actions Third Point took had not, at that time, interfered with the governance of Yahoo. Indeed, as the dissenting Commissioners observed, the conduct at issue had not previously been the subject of an enforcement action: prior enforcement actions have involved only conduct that was expressly identified as inconsistent in the SBP, an intent to acquire control of the issuer, or acquisitions of more than 10% of the shares of an issuer (beyond which the exemption is no longer available).
- It highlights how seriously the FTC takes compliance with the exemption. Indeed, many of the HSR enforcement actions the FTC has brought have been for improper reliance on the passive investor exemption. In addition to the usual press release and competitive impact statement accompanying the settlement, the FTC posted a blog entry by the Director of the Bureau of Competition regarding the settlement, noting that “any investor who is considering engaging with management or any person considering taking a board seat should proceed with caution” if relying on the exemption.
- Some terms of the judgment provide guidance as to best practices for compliance. For example, Third Point is prohibited from relying on the exemption if it has engaged in activist conduct in the prior 4 months, except in certain cases where it has made a statement that it is not pursuing candidates for the board or CEO of the relevant issuer. This suggests that where an investor has swung rapidly out of activist and into passive mode, waiting a period of time before making acquisitions in reliance on the exemption may be prudent. At a minimum, establishing a clear paper trail evidencing the change of intent is critical to avoid compliance issues.
- It is unusual for FTC Commissioners to dissent in an HSR enforcement action. The dissenting Commissioners argue that activist investors like Third Point engage in valuable activity and that acquisitions of under 10% of the shares of a company are unlikely to raise competitive concerns irrespective of the investors’ intent. It remains to be seen whether changes will be forthcoming to expand the exemption, although it is interesting to note that the settlement itself includes a provision that would relieve Third Point of compliance obligations in the event the passive investor exemption is revised to a straightforward exemption on holdings below a fixed percentage without regard to the investor’s intent. In the meantime, investors are reminded to consider the narrow application of the exemption when seeking to rely on it.