The HSR Act’s Investment-Only Exemption for Targets and Activist Investors

Activist shareholder campaigns continue to grow in number and prominence. One of the largest private equity deals of 2014—the $8.7 billion buy-out of PetSmart Inc.—came about following comments by a significant shareholder. A merger of the two leading office superstores, Staples and Office Depot, and the breakup of DuPont Co., each are being promoted by activist investors. These are but three examples of recent activist campaigns; with close to $200 billion in available funds, others are sure to follow. [1] The continued rise of shareholder activism serves as a useful reminder that targets and investors should be mindful of the scope of the investment-only exemption under the Hart-Scott-Rodino Act. Whether and when particular conduct may disqualify a shareholder from the passive investment exemption is a highly fact-specific inquiry and has been the subject of several enforcement actions in recent years.

The Passive Investment Exemption

In general, absent an applicable exemption, the HSR Act requires a pre-merger notification filing if, as a result of a transaction, the acquiring party will hold voting securities of an issuer valued in excess of $76.3 million. [2] Transactions subject to the HSR Act cannot be consummated until the expiration of an initial 30-day waiting period (15 days in the case of all-cash tender offers). [3] In nonconsensual transactions such as open market purchases, the waiting period commences after the buyer’s complete filing is submitted, and the issuer must submit its responsive filing within 15 days (10 days for an all-cash tender offer).

The HSR Act provides an exemption from reporting requirements for acquisitions that result in holding 10 percent or less of an issuer’s outstanding voting securities and that are made “solely for the purpose of investment.” [4] The HSR rules provide that voting securities are held or acquired “solely for the purpose of investment” if the investor has “no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.” [5] The Federal Trade Commission takes the position that stock is no longer held “solely for the purpose of investment” after an investor decides to participate in or influence management of the issuer.

Because the HSR rules require an investor to provide written notice to the issuer before acquiring shares, such notice may serve as the first warning to management that an investor intends to take a significant stake in the company and advocate changes, or that an existing shareholder has morphed from passive to active and intends to increase its stake.

Investment Intent

The investment-only exemption has been construed narrowly by the FTC. Although the FTC has clearly stated that merely voting the shares does not disqualify a shareholder from the exemption, common activist conduct may be inconsistent with investment-only intent. In particular, the FTC has delineated several actions as nearly always signaling a non-passive intent, including: (1) nominating a candidate for the board of directors of the issuer; (2) proposing corporate action requiring shareholder approval; (3) soliciting proxies; (4) 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. [6] A then-senior FTC premerger office staffer asserted that “any investor who anticipates seeking to influence management decisions is an ‘active’ investor and not entitled to rely on the ‘investment only’ exemption.” [7]

Investor Communications

Beyond the above, the FTC has provided little specific guidance on the parameters of the exemption, particularly with respect to communications by investors. Certain investor communications, whether with management, other shareholders, or the public, can be difficult to categorize as consistent with purely passive intent, though nonetheless may fall within the investment-only exemption. For example, while an ordinary request for information from management likely would not be deemed inconsistent with passive intent, a communication formally proposing a corporate action that would require shareholder approval or nominating a director candidate to run against the Board’s nominees will be subject to inquiry. Communications to management present the greatest risk, but communications to the public or other shareholders also could be viewed by the antitrust agencies as evidence of activist intent. The specific content of any public, management, or shareholder communication will be key in determining whether an investor will be considered passive for HSR purpose.

In general, the FTC has been reluctant to adopt broad interpretations of the passive investment exemption, preferring instead to be consulted on the specific facts at hand (on a confidential, no-names basis) through its informal guidance process. However, we know from previous informal guidance that an intention to make “strong suggestions” to management or the board may be inconsistent with passive intent, particularly where such suggestions are accompanied by threats (either implicit or explicit) to control management or compel its decisions. FTC enforcement actions have focused on egregious conduct. A 2012 FTC enforcement action alleged that Biglari Holdings Inc. was not passive and thus violated the HSR Act in connection with its holdings in Cracker Barrel Old Country Store, Inc., based on the fact that Biglari’s CEO had met with his counterpart at Cracker Barrel days after crossing the HSR reporting threshold to request that he and a colleague immediately be appointed to Cracker Barrel’s board of directors. [8]

SEC Filings

The filing with the SEC of a Schedule 13D, as opposed to a 13G, while not dispositive, may provide evidence of a non-passive intent for purposes of the exemption. The FTC has made clear that an investor would not have passive investment intent where it filed Schedule 13Ds indicating that: (i) the acquirer might seek control of the target; (ii) although the acquirer had no present plans to merge with, liquidate, or reorganize the target, it might formulate such plans or proposals in the future; (iii) the acquirer had demanded that the target disclose its shareholder list for the purpose of communicating with the target’s shareholders about a proposed transaction between the target and another entity; and (iv) the acquirer had retained the services of a proxy solicitation concern.

Changes in Intent

If a person acquires voting securities in excess of $76.3 million solely for the purpose of investment, and thereby qualifies for the exemption, but thereafter decides to take an activist role, that person would not be required to submit an HSR filing with respect to the voting securities already held. However, any further acquisition of voting stock, even a single share, would require an HSR filing. In addition, the FTC has brought enforcement actions challenging “overnight” changes of intent. [9]

In Conclusion

The passive investment exemption to the HSR Act presents difficult questions for investors and targets, particularly in the area of investor communications. There are few concrete guide posts for the exemption, though the consequences of running afoul of the HSR Act can be significant. Failure to comply with the requirements of the Act can result in civil penalties of up to $16,000 per day for each day of non-compliance, pose significant reputational risk, and subject investors to costly and distracting investigations. Investors and targets should be cognizant of the exemption’s parameters and consider seeking advice of counsel regarding its applicability to a particular situation.

Endnotes:

[1] “Top Activist Hedge Funds Close in on $200 Billion Mark; ValueAct Capital, Elliott Management & JANA Partners Lead the Way,” hedgetracker.com, Jan. 19, 2015.
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[2] Pursuant to amendments to the HSR Act adopted in 2000, annual adjustments to the notification and filing fee thresholds are made based on an index tied to changes in U.S. gross national product. The size-of-transaction threshold referenced herein is applicable for transactions consummated on or after February 20, 2015.
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[3] For transactions that clearly do not present competitive issues and do not warrant investigation, the U.S. antitrust authorities may, upon request of the filing party, grant early termination of the waiting period. Early termination is not guaranteed, and there is no set period during which it must be granted. Where warranted, it typically is granted within 2-3 weeks after filing and is publicly disclosed.
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[4] 15 U.S.C. § 18a(c)(9) and 16 C.F.R. § 802.9. Qualified institutional investors may hold 15 percent or less of an issuer’s outstanding voting securities if the acquisition is made in the ordinary course of business and solely for the purpose of investment. 16 C.F.R. § 802.64.
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[5] 16 C.F.R. § 801.1(i)(1).
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[6] 43 Fed. Reg. 33,450, 33,465 (1978). In the FTC’s view, being a competitor of the issuer alone will give rise to a rebuttable presumption of activist intent. However, if any additional factors also are present, the FTC takes the position that a non-rebuttable presumption of activist intent is created.
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[7] Marian R. Bruno, Assistant Director, FTC Premerger Notification Office, “Hart-Scott-Rodino at 25” (June 13, 2002) (emphasis added).
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[8] Biglari settled the matter by agreeing to pay $850,000 in civil penalties.
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[9] See, e.g., Complaint, United States v. Manulife Financial Corp., No. 1:04CV00722, May 3, 2004 (alleging that the investment-only exemption was inapplicable where, inter alia, acquirer had discussed a possible combination with the issuer four months prior to crossing the HSR threshold and buyer’s CEO contacted his counterpart at the issuer to discuss a possible combination shortly after crossing the HSR threshold).
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