DOJ and SEC Guidance on HSR and “Passive” Investors

A settlement on July 12, 2016 by the DOJ with ValueAct for violations of the HSR Act’s notification requirements and an interpretation of the Exchange Act’s beneficial ownership reporting rules posted by the SEC staff on July 14, 2016 combine to provide new guidance that will have an immediate impact on shareholder activism and engagement.

These developments at the DOJ and SEC matter because, as explained in our earlier post, the effectiveness of hedge fund activism is directly related to the extent to which the funds may engage in “under the radar” accumulations of equity positions. At the heart of these new developments is a struggle by these two governmental agencies to determine where to draw the line between active vs. passive investing, albeit under rules using different language and against backdrops of different statutory regimes, for purposes of determining when a shareholder’s level of engagement is “active” enough that the investment ceases to qualify for a passivity exemption from the requirement to make an HSR Act notification or a filing of a Statement of Beneficial Ownership on Schedule 13D (especially in the case of those activist hedge funds that purport to qualify for the exemption under Rule 13d-1(b) that permits delayed filings on Schedule 13G, see the chart contained in the complete publication of our prior post). As explained in greater detail in our prior post where we analyze the nuances of the investment thresholds for HSR Act notifications and Schedule 13D filings, these requirements to make an HSR notification and file a Schedule 13D, especially when combined with each other, can impede meaningfully the ability of an activist shareholder to buy under the radar in many scenarios.

The DOJ’s complaint that ValueAct failed to qualify for the exemption from the HSR Act notification was based on allegations not only that ValueAct was communicating opinions on strategic matters to the issuers in question, but also that ValueAct coupled these communications with a self-promoted reputation as an activist that uses disruptive tactics, including proxy contests and other efforts to change board composition, to assure that issuers implement its opinions. We noted that the SEC staff may use a similar rationale to view activist hedge funds as ineligible to rely on a Schedule 13G passivity exemption from Schedule 13D filing requirements when these funds are conveying opinions to boards even though they are holding off on threatening proxy contests. Accordingly, we hypothesized that the ValueAct complaint and any adherence by the SEC staff to a similar approach in analyzing Section 13(d) matters should not stand for the proposition that HSR Act notifications or Schedule 13D filings are required when “non-activist” institutional investors communicate substantive opinions to issuers without any express or background threats to lead the charge on a change to board composition.

The ValueAct settlement, however, does not go so far as to require that ValueAct, so long as it holds itself out as an activist with a proud history of causing changes to the compositions of boards and senior managements, must file an HSR Act notification whenever it holds in excess of the applicable HSR Act threshold (currently $78.2 million worth of voting stock) in an issuer to which it intends to communicate any substantive views. Instead, the settlement focuses on the specific subject matter of proposals that trigger an HSR Act notification if ValueAct either “intends” to make any such proposal or has an investment strategy specific to the issuer in question that “identifies circumstances in which ValueAct may” make such proposals. The types of proposals covered would include formal shareholder proposals for inclusion in a proxy statement, as well as all types of oral or written communications to any director or officer, but would arguably not cover the publication of proposals in white papers addressed to broad audiences, such as a hedge fund conference, or commentary aimed at the general market via the press or social media. The subject matter includes:

• proposals that the company merge with a third party, acquire a third party, or sell itself to a third party, or similar proposals to the third party for such a transaction with the company if ValueAct owns any equity in the third party;
• proposals to modify or pursue an alternative to the company’s publicly announced merger or acquisition transaction;
• proposals to change the corporate structure that would require shareholder approval; and
• proposals to change the company’s strategies regarding the pricing of any products or services, production capacity, or production output.

Notably missing from this list are proposals relating exclusively to changes to executive compensation, even though the DOJ’s complaint against ValueAct highlighted alleged efforts by ValueAct to change an issuer’s compensation structures.

To what extent do shareholders need to be wary when venturing into communications with a company that touch upon these areas? The claims in the ValueAct complaint arise from a particularly bad set of alleged facts. According to the complaint, ValueAct allegedly took numerous steps, as a shareholder of both Halliburton and Baker Hughes in excess of the threshold for HSR Act notification, to pressure directors and officers of each company as to strategic options to take in connection with navigating and reacting to the difficult antitrust review process that the pending Halliburton-Baker Hughes merger was undergoing. Moreover, ValueAct apparently had a history of alleged failures to make required HSR Act notifications. While a perfect storm of alleged entanglement with the DOJ’s antitrust review of a merger is what caused ValueAct to grab the attention of the DOJ, all shareholders—even those with neither a self-promoted reputation as an activist nor any intent ever to get involved with leading a campaign to change the composition of the board or management—should consider the parameters of the ValueAct settlement in determining whether they have active or passive intent for HSR purposes.

By contrast, the SEC staff’s release was designed more pointedly to give comfort that those investors, which do not traditionally consider themselves to be activist or that merely consider themselves to be “good governance activists,” may continue with their issuer engagement strategies without triggering a Schedule 13D filing obligation. Additionally the SEC staff’s statement reinforces that the typical subject matter of hedge fund activist approaches definitely do merit a Schedule 13D filing when the applicable ownership threshold is met. On the SEC staff’s list of topics that, on their own, do not render an investor ineligible to rely on the passivity exemption from filing a Schedule 13D are:

• executive compensation, social or public interest issues (including environmental policies) and
• corporate governance topics (including staggered boards, majority voting standards, and elimination of poison pills) where the discussion is part of a “broad effort … for all its portfolio companies.”

While specifically calling for the sale or restructuring of the company, sale of significant assets, or a proxy contest would definitely put the shareholder into Schedule 13D territory.

The results of these “passive vs. active” line drawing efforts by the DOJ and the SEC—in pursuit of different policy objectives and without coordination, but with similar and inter-related impacts—will become increasingly tricky and significant as a handful of traditional money managers and institutional investors continue to show up among the top shareholders of almost all publicly traded companies while, in parallel, these money managers and institutional investors become more directly involved in influencing these companies and arguably position themselves to become the heirs to the campaigns run nowadays by hedge fund activists.