On April 4, 2016, the Antitrust Division of the Department of Justice filed a lawsuit seeking a $19 million fine against activist investor ValueAct Capital for failure to comply with the notification requirements of the Hart-Scott-Rodino Act. The DOJ alleges that ValueAct did not qualify for the HSR Act’s exemption for passive investments in connection with its $2.5 billion investment in Halliburton Company and Baker Hughes Incorporated. The U.S. antitrust agencies have consistently interpreted the passive investor exemption – also known as the investment-only exemption – narrowly. If the litigation proceeds, the ValueAct case will be the first time the government’s position is tested in court.

The Passive Investor Exemption

The HSR rules limit investors’ ability to build significant ownership positions in companies quickly and without disclosure. Under the HSR Act, most acquisitions of voting securities valued in excess of $78.2 million (adjusted yearly) must be notified to the DOJ and the Federal Trade Commission and cannot be consummated until the expiration of a 30-day waiting period. An investor may seek early termination of the waiting period, but if granted, the names of the investor and target are publicly disclosed. The HSR rules also require the investor to provide written notice to the target company at the time of filing, which alerts the company that an investor intends to acquire a significant interest and may advocate change.

The HSR Act provides an exemption for acquisitions of up to 10 percent of the voting securities of a company that are made “solely for the purpose of investment.”1 To qualify for the exemption, the acquirer must have “no intention of participating in the formulation, determination, or direction of  the basic business decisions of the issuer.” While this exemption is frequently used by investors to take large ownership positions without the delay of an antitrust review, the antitrust agencies have construed this exemption narrowly and have brought two other actions challenging reliance on the exemption in the past year.2

ValueAct’s Conduct

Funds affiliated with ValueAct began acquiring shares in Halliburton and Baker Hughes shortly after the companies announced their agreement to merge. The DOJ alleges that ValueAct could not rely on the investment-only exemption because it anticipated influencing the business decisions of the companies at the time of the initial investments. The DOJ’s complaint cites the following actions and statements as being inconsistent with passive investment intent:

  • Sending memoranda to investors explaining that purchasing stakes in the firms would allow ValueAct to “be a strong advocate for the [Halliburton/Baker Hughes] deal to close” and, if the deal encountered regulatory issues, ValueAct “would be well positioned as an owner of both companies to help develop new terms.”
  • Proposing alternative options to Baker Hughes and Halliburton in case the transaction is not consummated, including proposing to Baker Hughes to sell certain businesses to Halliburton at a premium in lieu of receiving the reverse termination fee and advocating to Halliburton to pursue selective acquisitions of discrete Baker Hughes businesses.
  • Offering to Halliburton to use ValueAct’s position as a shareholder of Baker Hughes to pressure management to change its business strategy if the merger does not close and making a presentation to Baker Hughes’s CEO regarding operational and strategic changes to the company.
  • Participating in more than fifteen meetings and teleconferences with senior management of Halliburton or Baker Hughes, and discussing ways to achieve merger synergies and structure executive compensation plans.
  • Filing a  Schedule 13D with  the SEC stating that ValueAct  might discuss “competitive and strategic matters” with Baker Hughes and might “propos[e] changes in [Baker Hughes’s] operations.”

The DOJ has taken the position that this conduct runs counter to the antitrust agencies’ narrow interpretation of the exemption in past policy statements and enforcement actions. ValueAct, however, has responded that it has acted properly and in compliance with the HSR Act. Published reports indicate that ValueAct believes its investments were entirely passive when they were first made and that it later became active, at which point it amended its Schedule 13D filing for its holdings in Baker Hughes, reduced its stake in Halliburton, and filed for HSR clearance before acquiring additional shares in Baker Hughes.3

Key Takeaways

Skepticism of Change of Intent: Under the HSR rules, an investor is not required to submit an HSR filing for shares already held if the investor’s intent changes from passive to active.  However, an HSR filing would be required prior to any further acquisitions (even a single share). The ValueAct challenge is a reminder that a “change of intent” argument will be met with skepticism, particularly for investors with a history of activism. While the applicability of the exemption is investment-specific, in support of its allegation that ValueAct did not have passive intent from the beginning, the DOJ highlighted ValueAct’s investment history and cited general statements from ValueAct’s website and a presentation to potential investors describing ValueAct’s “ability to influence.”

Court Could Provide Critical Guidance: While the scope of the “solely for investment” exemption has been subject to much debate, it has never been interpreted by the courts, forcing parties to rely on guidance from agency speeches and prior settlements. In response to the DOJ’s lawsuit, ValueAct stated that the “most basic principles of shareholder rights” include “having a relationship with company management, conducting due diligence on investments, and engaging in ordinary course communications with other shareholders.”4 This statement foreshadows that ValueAct may seek to convince the court that the antitrust agencies’ narrow interpretation of the exemption is unworkable in practice and goes beyond what is required under the HSR Act. If the antitrust agencies’ position is upheld, activists may seek to develop alternative strategies for investing without triggering HSR notification requirements.

Scrutiny of Investments in Multiple Competitors: The DOJ recently stated that it is investigating whether investors’ minority interests in multiple competitors in consolidated industries may harm competition. The DOJ’s complaint in this case includes references to ValueAct using  its ownership positions in the companies to advocate for the merger, share information learned from Baker Hughes with Halliburton, and offer to pressure Baker Hughes’s management to change its business strategy in ways that could affect competition. On April 6, 2016, the DOJ separately filed a lawsuit to block Halliburton’s merger with Baker Hughes. While the antitrust agencies will continue to pursue HSR violations that present no threat of competitive harm, active investments in multiple competitors may be subject to heightened scrutiny.