FTC Reminds Investment Funds that Reliance on "Investment Only" Exemption from HSR is Risky Business

09/17/2015

In late August 2015, the Federal Trade Commission (“FTC”) announced a settlement with three investment funds managed by Third Point LLC (“Third Point”) for alleged violations of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”) involving improper reliance on the “investment only exemption.” Although the FTC did not impose a civil penalty on Third Point (this was its first violation), the settlement imposes a five year moratorium on actions described below and requires that Third Point implement a detailed compliance program to prevent future violations.

Generally, the investment only exemption provided by Section 7A(c)(9) of the HSR Act and Section 802.9 of the rules is only available if (1) an acquisition of voting securities is made “solely for the purpose of investment,” and (2) if the acquiring person would hold 10% or less of the outstanding voting securities of the issuer, regardless of  the dollar value of the voting securities so acquired or held.

In the press release announcing the settlement, the FTC reiterated that "'The investment-only exemption is a narrow exemption limited to those situations in which the investor has no intention to influence the management of the target firm.'"  For years, investors have struggled with the specific limitations of the investment only exemption due to a lack of guidance on exactly what is meant by the requirement to “not intend to participate in the formulation of the basic business decisions of an issuer.” While the final judgment in this enforcement action is helpful by listing specific activities that the FTC considers inconsistent with the investment exemption, it does not resolve all of the uncertainty surrounding this exemption since it involves a determination of the intention of the acquiring person. As a result, reliance on the investment only exemption continues to be risky if the investor is engaged in shareholder advocacy activities.

Facts

Third Point began purchasing shares of Yahoo! Inc. (“Yahoo”) in the open market in 2011 and allocating the shares among various Third Point funds. At some point in August 2011, the value of shares in three of the funds, as calculated under the HSR Act and the rules promulgated thereunder, exceeded the size of the transaction threshold then in effect. The complaint alleges that Third Point engaged in the following on or about the same time as the acquisitions of shares:

  • Held discussions with third parties to gauge their interest in becoming the CEO or a potential board candidate of Yahoo;
  • Took “other steps” to assemble an alternate slate of board candidates;
  • Internally discussed whether to launch a proxy contest to obtain control of the Yahoo board;
  • Drafted correspondence to Yahoo announcing that Third Point was prepared to join the board of directors; and
  • Made public statements regarding the intent to propose a slate of board candidates at the next annual meeting.

On September 8, 2011, Third Point filed a Schedule 13D with the Securities and Exchange Commission which disclosed that Third Point began acquiring shares on August 8, 2011 and that the shares were originally acquired for “investment purposes.” The Schedule 13D also disclosed that on September 8, 2011, Third Point sent a letter to Yahoo’s board of directors which identified its future plans and changed intent.

On or about September 16, 2011, Third Point filed a notification form under the HSR Act with the FTC and the Department of Justice, and the waiting period expired on or about October 17, 2011.

The FTC determined that Third Point’s activities were inconsistent with, and precluded reliance on, the investment only exemption during the period from mid-August to October 17, 2011.

Five Year Injunction

Pursuant to the final judgment, Third Point is enjoined for five years from relying on the investment only exemption in connection with acquisitions subject to the requirements of the HSR Act if Third Point is involved in any of the following at the time of an acquisition or during the four months prior to that time:

  • nominating a board candidate;
  • proposing corporate action that requires shareholder approval;
  • soliciting proxies;
  • having a controlling shareholder, director, officer or employee who is serving as an officer or director of the issuer;
  • being a competitor of the issuer;
  • engaging in any of the first four items with respect to, or are a competitor of, any entity directly or indirectly controlling the issuer;
  • making inquiries of a person’s interest in serving as a board member or chief executive officer of the issuer and did not “abandon” and tell the person about the abandonment unless this occurred without the person’s knowledge;
  • sending a written communication or initiated an oral communication with the issuer regarding candidates for the board of directors or chief executive officer of the issuer unless the person communicates abandonment to the issuer or the person can show the activity occurred without the knowledge of the person’s chief executive officer or other person with authority to act for the person with respect to board of director or CEO matters; or
  • setting forth in writing a slate of persons for board membership or the position of chief executive officer and without later abandoning such activity.

In addition to the injunctive relief, the final judgment sets forth detailed requirements for a compliance program to be implemented by Third Point and gives the FTC certain inspection rights to confirm compliance with the judgment.

How will this Affect Future Reliance on the “Investment Only” Exemption?

One of the more troubling aspects of the final judgment is the requirement that Third Point observe a four month “cooling off” period following any of the enumerated activities considered inconsistent with the exemption. Technically, the acquiror’s intent at the time of the acquisition is dispositive under the rule. However, the cooling off requirement would preclude reliance on the exemption in situations where it is possible that Third Point’s intent had changed before the end of the cooling off period. Should investors then follow this as guidance in their investments? Four months is a long period of time in the context of many investments and will certainly impact investment strategy.

Third Point’s conduct was generally consistent with prior enforcement actions that have focused on an investor’s proposed changes to the board or the investor having representation on the board. However, the complaint alleged that the violations occurred in mid-August, a few weeks prior to the date of the letter. The specific content and timing of conversations that occurred prior to September 8 is not spelled out in the complaint or final judgment. Investors must be mindful of the fact that all activities will be scrutinized in hindsight, and this may impact the determination of the perceived intent in a way that was not expected at the time of the acquisition. In effect, investors may want to observe another “cooling off” period and not take certain actions until some period of time has passed since the date of the last acquisition to help avoid the allegation that the intent was not passive at the time of the acquisition.

In a dissenting statement, Commissioners Maureen K. Ohlhausen and Joshua D. Wright argued that the narrow interpretation was not in the public interest because there was no threat of competitive harm and the type of shareholder advocacy often “generates well-documented benefits to the market for corporate control.“ They also called for amending the rule to give parties more certainty. Until then, they note that the narrow interpretations will likely chill shareholders engaged in shareholder advocacy. In contrast, the Commission statement provides, “Nor should the public interest rest on the purported benefits of shareholder advocacy to capital and corporate governance markets…. Neither the legislative nor the rulemaking record supports an added conclusion that shareholder advocacy, even if beneficial, will almost never produce anticompetitive consequences.”

Shareholder activism has increased dramatically over the last few years, with billions of dollars flowing into activist hedge funds. With the recent Third Point enforcement action, it appears that the agencies are intent on policing the investment only exemption, but it is still unclear how far they will go in terms of identifying activities that constitute “participating in the business or management of the issuer.” Until further clarified in the rules, reliance on the investment only exemption by investment funds and others engaged in shareholder advocacy activities remains risky business.

For more information, please contact:

Jennifer Wisinski
214.651.5330
jennifer.wisinski@haynesboone.com

Debra Hatter
713.547.2615
debra.hatter@haynesboone.com

Thomas Lang
202.654.4521
thomas.lang@haynesboone.com

Brandon McCoy
214.651.5124
brandon.mccoy@haynesboone.com

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