Locke Lord QuickStudy: The HSR Act’s “Investment” Exemption – Strategic Considerations in Light of Recent Enforcement

On April 4, 2016 the Department of Justice (DOJ) sued ValueAct Capital (ValueAct), an “activist” investment fund, for violation of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act), seeking civil penalties in excess of $19 million.  This QuickStudy identifies certain strategic considerations in light of the ValueAct enforcement. 

The HSR Act requires that parties to certain proposed transactions, including the acquisition of voting shares above a certain threshold amount, provide prior notification to the Federal Trade Commission (FTC) and DOJ.  The parties must observe a 30-day waiting period before closing while the agencies determine whether to challenge the notified transaction as anticompetitive under the Clayton Act § 7. Failure to comply with the HSR Act’s filing requirement can result in significant civil penalties – up to $16,000 per day – and, potentially, an injunction blocking the proposed transaction until compliance is made, regardless of whether the proposed transaction is found anticompetitive.

The “Investment” Exemption
An otherwise reportable acquisition of voting securities may nevertheless be exempted from the HSR Act filing requirement if the acquisition is "solely for the purpose of investment."  15 U.S.C. § 18a(c)(9).  This exemption applies narrowly, only where the acquiring person (1) "has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer" and (2) if, as a result of the acquisition, the acquiring person would hold 10% or less of the outstanding voting securities of the issuer, regardless of the dollar value of the acquisition.  Id.; 16 C.F.R. §§ 801.1(i)(1) & 802.9.  Due to the somewhat vague standard governing the acquiring person’s intentions, the “investment” exemption has been the subject of numerous HSR enforcement actions in recent years.  

Enforcement Against ValueAct
DOJ’s complaint charged ValueAct for failing to report sizeable investments (totaling $2.5 billion) in both Halliburton and Baker Hughes, two parties to a proposed $34 billion mega-merger.  ValueAct has claimed that the “investment” exemption applied and, therefore, it did not and does not have to file.  But DOJ has alleged that ValueAct’s statements in SEC filings and elsewhere indicate a clear intention by ValueAct to influence the management and shareholders of both Halliburton and Baker Hughes so as to facilitate the closing of the proposed merger. ValueAct met regularly with both companies’ executives to discuss and implement the deal plans. More particularly, ValueAct  was actively considering a back-up plan to sell off Baker assets if the deal fell apart. DOJ is seeking the maximum civil penalty possible against ValueAct of $16,000 per day, which had accrued to approximately $19 million at the time of the complaint and continues to accrue while ValueAct is not in compliance.  Some form of injunctive relief – possibly requiring ValueAct to sell its stake in one or both of the parties – may also be possible under 15 U.S.C. § 18a(f) & (g). In addition, DOJ is investigating the Halliburton/Baker transaction (both companies made their HSR Act filings) as it potentially threatens to lessen competition.

Strategic Considerations
Pre-Acquisition.  Both the acquiring and acquired persons in a reportable transaction are required to submit an HSR Form and otherwise comply with the HSR Act.  It is standard practice for HSR counsel to the respective parties to consult prior to determining whether an exemption may apply rendering a particular transaction non-reportable.  Because the obligation to file is on both companies, not just the acquiring person, the company whose stock is to be acquired should, to the extent possible, explore the acquiring person’s justification for using the “investment” exemption before agreeing that the acquisition will be non-reportable.  Otherwise, the issuer of the acquired shares is also at risk for failing to comply with the HSR Act.   

Post-Acquisition.  After an investor has closed an acquisition that it did not report under the “investment” exemption, it must remain strictly passive in its investment and cannot take actions inconsistent with the requirements of the exemption, in particular, attempts to influence the management of the issuer.  In a scenario where a passive investor becomes active and attempts to influence the issuer’s management (i.e., becomes an “activist”), the activist’s target now has a tool with which to combat the activism.  That is, the issuer can notify the FTC or DOJ of the activist’s failure to comply with the HSR Act.  Doing so would help to shield the issuer from liability for its own noncompliance with the HSR Act, as the issuer, just like the acquiring person (the activist here), has a duty to file in any reportable and non-exempt transaction.  Such action is likely to initiate an agency investigation and thus slow down the activist, at least until such time as the agencies can complete their review and complete any proceedings to impose penalties under the Act.  In other words, an issuer confronted with an activist investor who acquired shares without reporting under the HSR Act may be able to delay the activist’s ability to execute its agenda by using the HSR Act as a shield.

ValueAct’s conduct, if it was as DOJ alleges, is as clear a violation of the “investment” exemption as there could be.  It may also independently constitute a violation of Sherman Act § 1.  But the obligation of the acquired issuer to file provides ample justification for the issuer to notify the FTC or DOJ of an activist who is meddling in company management without first complying with the HSR Act.