The Federal Trade Commission (“FTC”) and U.S. Department of Justice (“DOJ”) have recently revisited several HSR exemption interpretations and sought penalties from investors relying on others. The Mergers & Acquisitions and Transportation & Energy Industries Committees presented a panel on March 31, 2017 at the ABA Antitrust Section Spring Meeting that addressed these recent developments and examined whether certain exemptions, such as those for acquisitions of investment rental property and warehouses, are especially vulnerable in the energy or any other industry. Karen Kazmerzak of Sidley Austin LLP chaired the panel, which was moderated by William R. Vigdor of Vinson & Elkins LLP. Speakers included Kay Lynn Brumbaugh of Andrews Kurth Kenyon LLP, Steve J. Kaiser of Cleary Gottlieb Steen & Hamilton LLP, Kara Kuritz, Attorney Advisor in the DOJ’s Legal Policy Section, and Kathryn E. Walsh, Deputy Assistant Director of the FTC’s Premerger Notification Office (“PNO”).
Mr. Vigdor opened the discussion by outlining the basic thresholds for determining whether a transaction is subject to the requirements of the HSR Act, noting in particular that the current size-of-transaction threshold is $80.8 million. Mses. Kuritz and Walsh then outlined the resources available to explain the HSR requirements and process. These resources include: the statute (15 U.S.C. § 18a), which sets forth the HSR thresholds, waiting period, and exemptions; the HSR Regulations (16 C.F.R. §§ 801-803); the Statement of Basis and Purpose, which explains the rationales behind the specific rules; and the PNO’s formal and informal interpretations. Ms. Walsh stated that the PNO Staff welcomes requests for informal interpretations and is happy to work with parties to determine whether a particular transaction is reportable. She also stated that when seeking an informal interpretation, HSR counsel should email all members of the PNO Staff to ensure that the request is not missed. Ms. Walsh went on to highlight the materials on the PNO website, including a searchable database of informal interpretations, blog posts, the Style Sheet for HSR Filings, and the instructions for completing the form. Ms. Walsh noted that late last year the agencies released revised instructions, which included changes to Items 3(a), 4(b), and 7(c).
Ms. Walsh then explained how HSR filings are processed. Each Wednesday the PNO circulates a package of all HSR filings received the prior week for a screening review by the FTC and DOJ. The package includes a summary sheet with recommendations on which transactions should be granted early termination. To ensure an HSR filing is included in the Wednesday package, parties should submit their filings by the previous Friday, although sometimes filings submitted on a Monday can also be included depending on Staff’s workload. The filing fee must also be received before the HSR notification will be included in the screening package. Finally, Ms. Walsh noted that email is now the preferred way of sending waiting period and early termination letters.
Oil & Gas Hypotheticals
The discussion was then turned over to Ms. Brumbaugh, who went through a number of hypotheticals designed to highlight common exemptions applicable to transactions in the oil and gas industry. The first two hypotheticals dealt with the formation by “Big Tex” of a wholly owned master limited partnership (called “Little Tex”) and the transfer of various assets from Big Tex to Little Tex. Ms. Brumbaugh explained that the formation of Little Tex was an exempt transaction under § 802.30(b), which applies to the formation of wholly-owned entities, and that the transfer of assets from Big Tex to Little Tex was therefore also exempt under § 802.30(a) for intraperson transactions.
The third and fourth hypotheticals were used to explain the exemption for acquisitions of carbon-based mineral reserves under § 802.3. In these hypotheticals, Big Tex took Little Tex public, resulting in its economic interest in Little Tex dropping from 100 to 49 percent. Big Tex then sold to Little Tex producing oil and gas wells along with field pipelines and treating and metering facilities that exclusively serve the wells. In the third hypothetical, the wells and associated assets had a fair market value of $400 million, and in the fourth hypothetical they had a fair market value of $550. Ms. Brumbaugh used the two hypotheticals to explain that the § 802.3 exemption applies to acquisitions of carbon-based mineral reserves and associated asset valued at $500 million or less. The transaction in the third hypothetical was therefore exempt while the transaction in the fourth hypothetical was not. 1 Ms. Brumbaugh also noted that $500 million limit is not adjusted annually for inflation, and once this amount is exceeded, the entire value of the transaction is used to determine the filing fee.
The fifth and sixth hypotheticals involved acquisitions by Little Tex of a natural gas processing plan and associated gathering pipeline and a storage facility, respectively. Ms. Brumbaugh explained that acquisitions of pipelines often used to be covered by the exemption for investment rental property under § 802.5 and storage facilities were often covered by the exemption for warehouses under § 802.2(h), but that the PNO changed its position in 2015, making both acquisitions reportable. Ms. Walsh added that the change in position was intended to bring the exemption back in line with its original intent. The key question in applying §§ 802.2(h) and 802.5 is whether the buyer intends to act like a traditional landlord, profiting only from the investment in the real estate, or intends to participate in the business conducted on the real estate.
The last oil and gas hypothetical involved an acquisition by Little Tex of 100 percent of the economic interest of Big D Partners LP, a limited partnership whose only assets were oil and gas reserves valued at $800 million that were not yet in production and had not generated any income. Ms. Brumbaugh explained that this transaction is not reportable because under § 802.4 you look through the entity’s legal structure to the underlying assets, which were all exempt under § 802.2(c) as unproductive real property. Ms. Brumbaugh also pointed out that in practice it can often be complicated to determine whether this exemption applies, making it important to talk to clients about which assets are producing and non-producing. Ms. Walsh added that the PNO is happy to work with counsel to determine whether the exemption applies.
Finally, Ms. Brumbaugh advised that if a deal involves any pipeline overlap, even a seemingly de minimis overlap, counsel should be ready to provide Staff with pipeline maps and explain why the overlaps are not a concern.
Passive Investment Exemption Hypotheticals
The second set of hypotheticals dealt with the acquisition of voting securities and the passive investment exemption. The first hypothetical, in which Big Tex acquires preferred shares worth $75 million in a company called Red River, was designed to illustrate how securities purchased on the open market are valued for HSR purposes. The panel explained that pursuant to § 801.10, securities purchased on the open market are valued at the greater of the acquisition price, which is the amount actually paid for the securities, or market price, which is defined as the lowest closing price within forty-five days prior to filing or closing. The hypothetical also points out that if the acquisition falls under the current $80.8 million threshold, then the acquirer’s intent with respect to control is irrelevant.
The second, third, and fourth hypotheticals illustrated how convertible voting securities are treated under the rules. The second hypothetical showed that acquisitions of preferred shares are exempt from the reporting requirements under § 802.31 to the extent that the shares do not convey present voting rights to the owner. However, when these securities are converted, they must be aggregated with other voting securities held by the acquirer to determine whether an HSR threshold is met. The third hypothetical asked how Big Tex calculates its holdings upon conversion of the preferred shares. The panel explained that Big Tex’s conversion of $75 million in voting securities are valued at market price pursuant to § 801.10(a)(1)(ii); the shares have no acquisition price because they are being converted. They must then be aggregated with Big Tex’s existing $75 million in securities, which would thus exceed the current $80.8 million threshold and render the conversion reportable. Ms. Brumbaugh noted that counsel should consider the timing and market value of conversions in light of the aggregation rule. The fourth hypothetical served as a reminder that an HSR filing is valid for one year after the waiting period expires pursuant to § 803.7, and the conversion must be made within that timeframe to avoid having to refile.
The fifth and sixth hypotheticals focused on the passive investment exemption under § 802.9. The fifth hypothetical asked whether Big Tex, holding less than 10% of Red River, could rely on the investment-only exemption. As a preliminary matter, Big Tex’s holdings need to be aggregated pursuant to § 801.13. If Big Tex still holds less than 10% of Red River, the parties must then look to Big Tex’s intent to see whether the passive investment exemption applies. In this hypothetical, Big Tex’s intent was to participate in the formulation, determination, or direction of the basic business decisions of Red River. Thus, the passive investment exemption does not apply. Ms. Kuritz explained that the facts of this hypothetical are similar to those in the DOJ’s 2004 enforcement action against Manulife Financial Corporation. She said that given the exemption’s fact-specific nature, parties who have doubts about the exemption’s applicability should seek guidance from the PNO, and also pointed out that parties seeking to apply the exemption bear the burden of showing its applicability. Ms. Kuritz also provided an overview of the DOJ’s most recent enforcement action regarding the passive investment exemption—the 2016 case against ValueAct. Ms. Walsh explained several indicia of conduct inconsistent with the passive investment exemption, as set forth in the rule’s Statement of Basis and Purpose: (1) nominating a candidate to the board of directors of the issuer; (2) proposing corporate action requiring shareholder approval; (3) soliciting proxies; (4) having a controlling shareholder, director, officer, or employee simultaneously serving as an officer or director of the issuer; (5) being a competitor of the issuer; or (6) doing any of the foregoing with respect to any entity directly or indirectly controlling the issuer.
The sixth hypothetical considered how the analysis changes if, at the time of filing, Big Tex really did have a passive investment intent but subsequently took actions inconsistent with passive investment. This question raised a difficult and fact-specific issue of whether Big Tex had the requisite intent at the time of filing; in theory, subsequent changes in intent are not considered. Mr. Kaiser explained that the question, therefore, is one of proof, and circumstances showing that Big Tex lacked intent inconsistent with the passive investment exemption support the argument that the company remains exempt from the filing requirements.
The seventh hypothetical was similar to the fourth hypothetical, and illustrated that so long as Big Tex completes the acquisition within one year of filing, the company may acquire additional shares of Red River up to the next filing threshold over the next five years. If, however, Big Tex’s subsequent acquisitions exceed the next transaction value threshold (keeping in mind that the value of voting securities are aggregated), another filing would be required.
Foreign Investment Exemption Hypotheticals
The final set of hypotheticals dealt with foreign exemptions. In the first and second hypotheticals, Big Tex acquired 100% of the voting securities of Big Royal, a British company with its principal offices in London, for $5 billion. Big Royal has $1 billion in assets located outside of the United States and $45 million in assets located in the United States, but no sales in or into the United States. Although this transaction certainly exceeds the minimum HSR thresholds, it is exempt from the reporting requirements under § 802.51 as an acquisition of voting securities of a foreign issuer. The second hypothetical asked whether the transaction would be reportable if Big Royal was a U.S. person. Here, the § 802.51 exemption does not apply because Big Royal is a U.S. person. The panelists emphasized the need tolook at U.S. assets separately from foreign assets—in this case the parties would apply the “look through” test under § 802.4, which exempts the acquisition of an issuer holding assets which would be exempt if acquired directly. Here, the $1 billion in foreign assets is exempt under § 802.50 and the $45 million U.S. asset acquisition does not meet the size of transaction test. Thus, this transaction is not reportable. Ms. Walsh highlighted the § 802.4 tip sheet on the PNO’s website, which helps parties analyze these types of transactions.
Even if the foreign assets contributed $45 million in U.S. sales in the most recent year, as posited by the third hypothetical, the transaction would not be reportable because the $45 million in revenue does not exceed the filing threshold.
However, if those foreign assets contributed $125 million in U.S. sales in the most recent year, as posited by the fourth hypothetical, the transaction would be reportable because it would exceed the current $80.8 million filing threshold. For the fifth hypothetical, the panelists pointed out that § 802.4 does not affect the size of the transaction or filing fee; it simply makes the transaction reportable or non-reportable.
Thus, to the extent that this transaction is reportable, the filing fee is based on the entire value of the transaction, $5 billion, and therefore would be $280,000. The sixth hypothetical explained that under § 802.4, sales attributable to U.S. assets are irrelevant; if the foreign asset part is not reportable, then whether the transaction is reportable depends on the value of the U.S. assets, not the sales attributable to those assets.
The seventh and eighth hypotheticals looked at the reporting requirements for acquisitions of foreign issuers with product sales into the U.S. The seventh hypothetical asked whether the transaction would be reportable if Big Royal had no U.S. assets but sells products to unaffiliated distributors who then sell the products to U.S. customers. The panelists explained that the transaction is not reportable because third party sales of Big Royal’s products do not count as sales “in or into the U.S.” by Big Royal unless the products are specifically designed for the U.S. market and would not be sold in any other market. Mr. Kaiser explained that certain pharmaceuticals may meet this U.S. market requirement. If the products were sold directly to U.S. customers, as proposed by the eighth hypothetical, the rules require the parties to look at where title and risk of loss pass to the buyer. If title and risk of loss pass outside of the U.S., the sale is not “in or into the U.S.” even if the buyer is a U.S. company.
The ninth hypothetical asked whether the analysis would be different if Big Royal provided services to U.S. customers instead of products. The answer depends on where the services are rendered. If the services are provided outside of the U.S., then they are not considered sales “in or into the U.S.” and would not contribute towards reporting thresholds. The panel emphasized that in this analysis, the nationality of the customer is irrelevant.
The tenth hypothetical dealt with moveable assets. It asked whether the transaction would be reportable if Big Royal was a shipping company owning $100 million in assets with no sales in or into the U.S. and $200 million of ships. Here, the registration of each ship determines whether it is a U.S. or foreign asset. If the fair market value of the ships registered in the U.S. exceeds the current $80.8 million threshold, the transaction is reportable. Regarding foreign ships, revenues derived from shipping to or from the U.S. would be considered sales “in or into the U.S.”
Ms. Walsh then discussed how the PNO treats other types of movable assets, such as satellites and undersea cables, and referred the audience to interpretations on the PNO website for further information.
Finally, hypotheticals eleven and twelve examined minority acquisition of foreign issuers. In the eleventh hypothetical, Fund A, formed and having its principal place of business in the Cayman Islands, acquired 40% of the outstanding securities of Big Royal, a foreign issuer with $100 million in assets in the U.S., for $5 billion. Mr. Kaiser characterized this transaction as a “foreign-on-foreign” transaction, which is exempt from reporting requirements under § 802.51(b)(1) so long as, as a result of the transaction, the foreign person will not hold 50% or more of the outstanding voting securities of the issuer. Hypothetical twelve illustrated that this exemption for acquisitions of less than 50% of the voting securities of a foreign issuer only applies where the acquiring person is a foreign person; if Fund A had its principal offices in New York, the transaction would be reportable.