A recent interpretation by the staff of the U.S. Securities and Exchange Commission (“SEC”) of the beneficial ownership reporting rules under the Securities Exchange Act and the recent settlement of a lawsuit by the U.S. Department of Justice/ Antitrust Division alleging a failure to make disclosure filings under the Hart-Scott-Rodino Antitrust Improvements (“HSR”) by activist investor ValueAct have created a double edged sword available to publicly traded companies that have become the target of activist investors. The SEC disclosure rules require public disclosure by the activist of voting stock acquisitions resulting in holdings in excess of 5% of any class of the Company’s outstanding shares while the HSR rules either require the activist to make a pre-acquisition notification filing, pay a substantial filing fee and wait a designated period before significant stock acquisitions may be consummated or face the imposition of a significant fine for failing to do so.
The SEC staff interpretation concerned the availability of the “passive investor” exception to the Schedule 13D filing requirements. The occasion for the interpretation was whether the “passive investor” exception was automatically lost if the investor could not qualify for the “solely for the purpose of investment” exemption to the HSR filing obligation. The SEC staff responded that there would be no automatic disqualification. See U.S. Securities Exchange Commission, Compliance and Disclosure Interpretations: Exchange Act Sections 13(d) and 13(g)
. In particular, the investor could engage in the following conduct and still retain its Schedule 13G eligibility (and not require the filing of a Schedule 13D):
- Discussions with an issuer’s management on executive compensation or public interest issues, without more.
- Discussions with an issuer’s management on removal of staggered boards, majority voting standards in director elections, and elimination of poison pill plans, without more.
But the Schedule 13G exception would not be available (and the filing of a Schedule 13D will be required) if the acquiring shareholder engaged the issuer’s management specifically on the following issues:
- The sale of the issuer to another company,
- The sale of a significant amount of the issuer’s assets,
- The restructuring of the issuer, or
- A contested election of directors.
The HSR “solely for purposes of investment” rule looks to conduct that is somewhat parallel to determine exemption eligibility. First and foremost however, the exemption only applies when the acquiring person would hold not more than 10% of the of the outstanding voting shares of the issuer, regardless of the dollar value of the shares. Once this threshold is met, the exemption is unavailable. The type of conduct that can preclude the exemption is noted below:
- Nominating a candidate for the board of directors
- Proposing corporate action which would require shareholder approval
- Soliciting proxies with respect to the issuer
- Having a representative serve as an officer or director of the issuer
- Being a competitor of the issuer
- Seeking third party interest in being a candidate for the board or CEO of the issuer
The conduct of acquirers described in two recent failure-to-file HSR cases is helpful in fleshing out prohibited conduct that voids the exemption. In United States v. Third Point Offshore Fund, Ltd, et al., Civil Action No. 1:15-cv-01366 (D.D.C. filed August 24, 2015), the acquirer while claiming the exemption, was engaged in communications with third parties about their interest in becoming the CEO of Yahoo or joining its board. In addition, the acquirer put together an alternate slate of board of directors and internally discussed a possible proxy bid for the Yahoo board. The Department of Justice (“DOJ”) complaint focused on the intent of the acquirer in making its voting stock purchases as manifested by this and other conduct. In connection with the settlement of the case, Federal Trade Commission Bureau of Competition staff posted a blog entitled “Investment-only” means just that (August 24, 2015) which emphasized that the exemption is intended to be narrow and that if an entity acquires voting shares with the intention of “influencing the basic business decisions of the issuer, or with the intention of participating in the management of the issuer, the exemption is not available.”
In United States v. VA Partners I, LLC, et al.
, Civil Action No. 3:16-cv-01672 (N.D. Cal. Filed April 4, 2016), the acquirer, a self-proclaimed activist investor, purchased in excess of $2.5 billion of the outstanding voting shares of Hallilburton and Baker Hughes, two companies engaged in a previously announced merger transaction that was then being examined by the DOJ for competitive concerns. ValueAct openly advertised itself as having an “active, constructive involvement” investment strategy in the management of the companies in which it invests. It sent memoranda to its investors outlining its intent to work cooperatively with Hallilburton and Baker Hughes management to close the deal or “help develop new terms.” Through its significant stockholdings (DOJ alleged that it was the largest shareholder in both companies) ValueAct had access to companies’ senior management, frequently meeting with them to discuss ongoing operations of the companies and the status of the merger.
So how do these two developments benefit management of an issuer that has become the target of activist investors? First, the Schedule 13D filing will act as public notice to management as well as to the federal antitrust regulators that an activist is acquiring voting shares. Second, although an HSR report filing need not be publicly disclosed, it must be disclosed by the activist to the issuer. In addition, the HSR filing will require the activist to cease further stock acquisitions until the antitrust agencies have completed their review and either the waiting period has terminated or early termination has been granted. In either event, management of the target has time to react to the activist and to formulate its strategy accordingly. If, on the other hand, the activist files its 13D but fails to make an HSR filing, then new opportunities arise for the target. Given the interest that the federal antitrust regulators have taken recently in failure-to-file cases, management of the target will likely find a receptive audience if it has its counsel confidentially approach the regulators with evidence of improper, non-investment intent and conduct on the part of the activist. If an investigation results and corroborates the target’s claims, then not only are the activist’s stock acquisitions put on the shelf but it also faces the potential for substantial fines (the daily fine for HSR violations increased on August 1, 2016 from $16,000 to $40,000) and a broadly worded injunction substantially confining future activist investing.
With heartfelt thanks to my colleagues Stan Keller and Van Jolas