The Hart-Scott-Rodino Act’s First Amendment Problem

Scott Gant is a Partner at Boies, Schiller, and Flexner LLP. This post is based on a recent article, forthcoming in the Cornell Law Review Online, by Mr. Gant, Andrew Z. Michaelson, and Edward J. Normand.

The Hart-Scott-Rodino Antitrust Improvements Act (“HSR Act”) is a centerpiece of federal antitrust law. Designed to aid enforcement of Clayton Act Section 7, which prohibits mergers and acquisitions that “may … substantially … lessen competition” or “tend to create a monopoly,” the statute requires the prospective acquirer of an issuer’s voting securities exceeding a certain amount to notify the Federal Trade Commission (“FTC”) and the Antitrust Division of the Department of Justice (“DOJ”) of the potential acquisition, pay a filing fee, and observe a thirty-day waiting period before proceeding.

The FTC or DOJ may thereafter issue to the proposed acquirer a “second request” for additional information about the acquisition, and conduct an investigation, take testimony, and seek to prevent the acquisition. Investors that have acquired shares without complying with these requirements are subject to civil penalties of up to $40,000 per day.

Because the HSR Act is supposed to concern itself only with transactions that may lessen competition, when Congress enacted the statute in 1976 it exempted eleven types of transactions from its filing requirement, and also authorized the FTC to exempt other acquisitions “not likely to violate the antitrust laws.” The most prevalent and important exemption is the “Investment-Only” carve-out (the “I-O Exemption”), which applies to “acquisitions, solely for the purpose of investment, of voting securities, if, as a result of such acquisition, the securities acquired or held do not exceed 10 per centum of the outstanding voting securities of the issuer.”

Congress created these exemptions intending that the filing requirement would apply only to “the very largest corporate mergers—about the 150 largest out of the thousands that take place every year.” But things have turned out quite differently. In recent years, even with its numerous exemptions, the HSR Act’s filing requirement has applied to more than ten times the number of transactions originally envisioned. This is in part because the FTC has consistently advanced and enforced an unduly restrictive view of the I-O Exemption. The FTC’s interpretation has deprived all types of investors, including large institutions and hedge funds, of the ability to avoid the HSR Act’s thirty-day waiting period and substantial filing fees.

Two years after the HSR Act became law the FTC adopted Rule 801.1(i)(1), which provides

“Voting securities are held or acquired ‘solely for the purpose of investment’ if the person holding or acquiring such voting securities has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”

Concurrent with enactment of the Rule, the FTC released a “Statement of Basis and Purpose” (“SBP”), further explaining:

[M]erely voting the stock will not be considered evidence of an intent inconsistent with investment purpose. However, certain types of conduct could be so viewed. These include but are not limited to: (1) Nominating a candidate for 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.

While the adoption of Rule 801.1(i)(1) and issuance of the SBP left uncertainty regarding the I-O Exemption, with them the FTC made clear that unless the acquirer has “no intention” of speaking about any issue arguably bearing on the “formulation, determination, or direction” of a “basic” business decision of the issuer, the acquirer risks losing its eligibility for the Exemption.

The FTC’s restrictive interpretation of the I-O Exemption has been reinforced in the intervening years-by both “informal” statements regarding the scope of the Exemption and more than fifteen enforcement actions by the FTC and DOJ for alleged improper reliance on the Exemption. With these statements and enforcement actions, it has become evident that, from the standpoint of the agencies, an acquisition made only for “investment” requires complete passivity at the time of investment and the foreseeable future. Investment funds and advisers that merely keep open the possibility of weighing in on corporate governance matters appear, under the agencies’ view, to fall outside the I-O Exemption.

Rule 801.1(i)(1), the SBP, and the agencies’ enforcement actions therefore have collectively created powerful incentives for acquirers to forego speech even arguably relating to the business decisions of the issuer. By doing so, acquirers avoid the non-trivial filing fee and otherwise applicable mandatory thirty-day waiting period before proceeding with the transaction. Many acquirers under the 10% threshold unsurprisingly opt for silence, refraining from speaking out about issues potentially bearing on “the basic business decisions of the issuer.”

They should not have to do so. While the antitrust laws are unquestionably important for well-functioning markets and a vibrant economy, the government’s enforcement of them is subject to constitutional constraints. The enforcement agencies have veered off course by effectively coercing large numbers of speakers that should qualify for the I-O Exemption to abstain from engaging in otherwise permissible speech in order to avoid the HSR filing fee and waiting-period (and by coercing others to pay the filing fee and observe the thirty-day waiting period so that they can engage in permissible speech), thereby effecting a widespread infringement of the First Amendment which cannot be justified by legitimate antitrust enforcement objectives.

What, then, is to be done about the HSR Act’s First Amendment problem? One option is for the FTC and DOJ to abandon their narrow interpretation of the I-O Exemption-starting with amendment of Rule 801.1(i)(1) and the SBP. A second option is for Congress to amend the HSR Act. A third path is for an acquirer to challenge the I-O Exemption and Rule 801.1(i)(1) in court. Regardless of which precise path is taken, steps to remedy the HSR Act’s First Amendment problem are long overdue.

The complete article is available here.

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