Generally speaking, stock purchases which will cause an investor to hold more than $76.3 million of the target’s voting securities may require a pre-closing notification under the Hart-Scott-Rodino (“H-S-R”) Act. But there are two exemptions that minority investors often use to conclude an H-S-R Act notification is not required: the passive investment exemption and the pro rata shareholding exemption. We commented on these exemptions in our July 28, 2015 client alert, “Private IPOs and Unicorns May Trigger More H-S-R Filings.” And this week, the FTC provided additional clarity into what the passive investment exemption actually means when it charged three minority investors with violations of the H-S-R Act for failing to file notification by mistakenly relying on the passive investment exemption. The FTC’s action vividly illustrates that reliance on this exemption requires a nuanced analysis of an investor’s actual intent and should involve experienced H-S-R Act counsel.
The FTC brought its action against three Third Point LLC investment funds for acquiring Yahoo stock through open market purchases during a one-month period between August 8 and September 8, 2011. Third Point did not make a notification under the H-S-R Act before buying the shares even though each fund acquired enough Yahoo stock to put its total holdings over the minimum H-S-R Act filing threshold. (Note: The FTC adjusts the H-S-R Act monetary thresholds in mid-January of each year. The minimum value of voting securities or other interests that must be exceeded before an H-S-R Act filing may be required is $76.3 million for 2015. The minimum threshold in 2011 was $66 million.). Third Point did not file notification because it claimed each fund intended to acquire less than 10% of Yahoo’s outstanding stock solely for purposes of investment.
Under the H-S-R Act, an acquisition of voting securities that exceeds the $76.3 million filing threshold may be exempt from a notification requirement if the investor (i) will not hold greater than 10% of the target’s outstanding voting stock and (ii) intends to hold the stock solely for purposes of investment. The H-S-R Act rules define “solely for purposes of investment” to mean the investor has no intention of participating in the formulation, determination or direction of the basic business decisions of the target company. Since the H-S-R Act was promulgated almost 40 years ago, the FTC has said it will look to an investors’ specific investment intent to determine whether it is passive. The FTC has identified conduct it believes indicates an activist intent to influence management and the basic business decisions of the company, including:
- Holding a board seat or nominating a candidate for the board of directors;
- Proposing corporate action that requires shareholding approval;
- Soliciting proxies;
- Being an officer of the issuer; and
- Being a competitor of the issuer.
The FTC takes the view that even considering action that would influence management or the direction of the target’s business may mean an investor is active, not passive, and therefore not eligible to use the passive investment exemption.
In the Third Point matter, the three investment funds took the following actions during the period they acquired voting common stock of Yahoo but before making a remedial H-S-R Act filing:
- Reached out to potential candidates to be Yahoo’s CEO or for the board;
- Assembled an alternate slate of board directors that it publicly announced Third Point would propose at the next annual meeting;
- Informed Yahoo that Third Point was prepared to join the Yahoo Board; and
- Internally discussed the possible launch of a proxy battle for directors.
After making the open market purchases and taking the steps outlined above, each of the Third Point funds made a remedial filing under the H-S-R Act on September 16, 2011 to report their prior acquisitions of Yahoo stock.
While the H-S-R Act authorizes civil fines of up to $16,000 per day between the date an investor violates the H-S-R Act by making a stock acquisition without filing notification and the date the investor files a remedial notification, the FTC chose not to impose a financial penalty because this was Third Point’s first violation of the H-S-R Act, and Third Point made a remedial filing within a few days of its violations. Third Point also subsequently observed the H-S-R Act filing and waiting requirements when it purchased additional shares of Yahoo stock.
However, the FTC did require Third Point to agree pursuant to a proposed order entered in Federal District Court that it will not rely on the passive investment exemption in the future to avoid an H-S-R Act filing if Third Point takes any of the following actions with respect to its proposed investment:
- Nominating a candidate for the board of directors;
- Proposing corporate action requiring shareholder approval;
- Soliciting proxies;
- Having a representative serve as an officer or director;
- Being a competitor of the issuer;
- Doing any of the above activities with regard to a subsidiary of the target;
- Asking third parties about interest in being a candidate for the board or CEO of the target, and not abandoning such efforts;
- Communicating with the target about potential candidates for the board or CEO of the issuer, and not abandoning such efforts; or
- Assembling a list of possible candidates for the board or CEO of the target, if done with the knowledge of the CEO.
The list of conduct that the FTC enumerates in the Third Point settlement should guide any investor who is considering relying on the passive investment exemption. However, as the FTC cautioned in its public announcement of the action against Third Point, this list of conduct that the FTC may view to be indicative of an activist shareholder intent is not exhaustive. The key is an investor’s actual intent when it makes a minority investment. The FTC will look closely at an investor’s intent, and may conclude an investor is not passive even if the investor has not taken any overt action that could be viewed as activist. For instance, an investor who acquires 9% of a target’s voting securities while it considers taking a majority stake or nominating a candidate for the board may not be considered passive even if the investor takes no other action.
As interesting and informative as the FTC’s action against Third Point is to investors, the dissent by Commissioner Maureen K. Ohlhausen (a Republican appointed by President Obama in 2012) and former Commissioner Joshua D. Wright (a Republican appointed by President Obama in 2013 and who stepped down this month) is a salvo in the direction of modernizing the H-S-R Act and rules “to eliminate filing requirements for a category of stock acquisitions that have proven unlikely after 40 years of experience to raise competitive concerns.” The dissenting Commissioners believe the FTC’s interpretation of the passive investment exemption “is likely to chill valuable shareholder advocacy while subjecting transactions that are highly unlikely to raise substantive antitrust concerns to the notice and waiting requirements of the HSR Act.”
As Ohlhausen and Wright point out, the fact of the matter is the H-S-R Act imposes significant costs and administrative burden on investors whose minority acquisitions pose no threat of competitive harm. The antitrust agencies issued second requests (a formal process used by the FTC and DOJ to investigate and challenge transactions that may substantially lessen competition) in only 3.31% of all transactions that were notified under the H-S-R Act between 1976 and 2011 – and it appears none of these challenges involved the acquisition of a minority stake of 10% or less. Ohlhausen and Wright posit the agencies’ experience since the H-S-R Act was promulgated in 1976 shows minority acquisitions of 10% or less of the outstanding stock of a target are “highly unlikely” to result in a substantive antitrust review. The few instances where a minority acquisition of 10% or less of the stock of an issuer is anticompetitive can readily be remedied post-closing – by requiring the investor to sell its holdings or agree to limitations on its shareholder activism. The dissenting Commissioners argue that corporate governance and the capital markets would benefit if minority investors were permitted to engage in shareholder advocacy without having to file notification under the H-S-R Act.
The dissents remain just that – a minority view among the Commissioners. It remains to be seen whether a renewed movement is afoot to replace the existing passive investment exemption with a blanket exemption for stock acquisitions of 10% or less – or at least to limit the applicability of the exemption to specific types of affirmative conduct, such as holding a board seat, serving as an officer or being a competitor. In the meantime, the wisest course for a minority investor to take is to consult with experienced H-S-R Act counsel before relying on the passive investment exemption.