“Investment-only” means just that

Today, the Commission (with the help of our friends at the Justice Department) filed a proposed settlement in federal court to settle charges that three funds managed by Third Point violated the Hart-Scott-Rodino Act by failing to make the necessary premerger notification filings when they acquired shares of Yahoo! Inc. The complaint alleges that Third Point improperly relied on the investment-only exemption to the HSR requirements, and contains some lessons that should be of interest to investors and corporate managers alike.

The HSR Act exempts certain acquisitions of voting securities if made “solely for the purpose of investment.” (15 U.S.C. §18a(c)(9)) The HSR Rules state that acquisitions of less than 10 percent are exempt from filing if the investor has “no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.” (Rule 801.1(i)(1)). The Statement of Basis and Purpose issued at the time the Commission promulgated the HSR Rules further explains that certain conduct is inconsistent with a claim of investment purpose, and contains the following examples: nominating a candidate for the board of directors, holding a board seat or being an officer, proposing corporate action that requires shareholding approval, soliciting proxies, or being a competitor of the issuer. The exemption does not apply if the acquirer will hold stock over ten percent of the issuer’s voting securities, regardless of any intention to participate in management.

We have long made clear that the investment only exemption is a narrow exemption. As early as 1982, in a letter published as part of the Sixth Annual HSR Report, former Competition Director Thomas J. Campbell wrote “[t]he Bureau construes the term ‘solely for the purpose of investment,’ as used in the Act and in the premerger rules, to apply only to purchasers who intend to hold the voting securities as passive investors. If an acquiring person purchases voting securities 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.” A few years later, in 1988, James Mullenix, then Associate Director of BC, gave a speech before the ABA Spring Meeting and stated, among other things, “If any company is seriously considering a takeover attempt, but has not yet made a final decision, it is not buying stock solely for the purpose of investment. If it expects to nominate someone for a seat on the board of directors, it is not buying stock solely for the purpose of investment.” (57 Antitrust Law Journal 125, 128 (1988)).

More recently, in 2002, Marian Bruno, then-Assistant Director of the Premerger Office, gave a speech before the ABA warning institutional investors that the investment-only exemption is unavailable if the acquirer attempts to influence the management decisions of the issuer. Additionally, several of the complaints brought by the Department of Justice for HSR violations are based on the defendant “considering” certain actions that were deemed to be inconsistent with the investment only exemption. (U.S. v. Manulife Financial Corp. and U.S. v. Pennzoil).

Yahoo is a well-known multinational internet corporation, best known for its web portal and search engine. Third Point LLC is a New York-based financial investment firm that manages approximately $16 billion through a variety of funds. In the transactions at issue, three Third Point Funds (Third Point Offshore Fund, Ltd., Third Point Ultra, Ltd., and Third Point Partners Qualified L.P., each its own “ultimate parent entity” and each meeting the size of person test under the HSR Act) made multiple open market acquisitions of Yahoo voting securities between August 8, 2011 and September 8, 2011. The acquisition resulted in each of the funds holding in excess of $66 million, which was the applicable HSR filing threshold at the time. The Third Point Funds did not submit HSR premerger notification forms or observe the waiting periods prior to making the threshold-crossing acquisitions.

The Third Point Funds did not make the required HSR filings in reliance on the “investment-only” exemption to the HSR filing requirement (and because they each held less than ten percent of Yahoo’s outstanding securities). The complaint alleges, however, that while the Funds were acquiring Yahoo shares, Third Point was engaging in conduct that was inconsistent with a claim of investment purpose in Yahoo. For instance, between August 10 and September 16, when the Funds finally made HSR filings, Third Point took the following steps:

• contacted certain individuals to gauge their interest and willingness to become the CEO of Yahoo or a potential board candidate of Yahoo;
• assembled an alternate slate for the Yahoo Board;
• drafted correspondence to Yahoo announcing that Third Point was prepared to join the Yahoo Board;
• internally discussed the possible launch of a proxy battle for directors of Yahoo; and
• stated publicly that it was prepared to propose a slate of directors at Yahoo’s next annual meeting.

Although the HSR Act provided for civil penalties of up to $16,000 for each day an acquirer is in violation of the Act, the Commission, in consultation with our colleagues at the Antitrust Division, decided to seek only injunctive relief in this case. Here, Third Point soon filed the required Forms, so it was out of compliance with the HSR Act for only a short period, and it observed the required waiting periods for subsequent purchases of Yahoo shares during the waiting periods. This was also Third Point’s first violation of the HSR Act, which can be a factor in determining the appropriate consequences when parties mistakenly rely on an HSR exemption. The Commission’s decision not to seek civil penalties is made on a case-by-case basis and the Commission may seek civil penalties in a similar case in the future. (See our previous blog post: Have a good plan for HSR compliance.)

The Stipulated Order, which requires approval and entry by a federal judge, prohibits Third Point from making acquisitions in reliance on the investment-only exemption if Third Point has engaged in certain enumerated conduct:

• nominating a candidate for the board of directors of the issuer;
• proposing corporate action requiring shareholder approval;
• soliciting proxies with respect to such issuer;
• having a representative serve as an officer or director of the issuer;
• being a competitor of the issuer;
• doing any of the above activities with regard to an entity controlled by the issuer;
• asking third parties about interest in being a candidate for the board or CEO of the issuer, and not abandoning such efforts;
• communicating with the issuer 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 issuer, if done with the knowledge of the CEO.

This settlement thus contains valuable information for investors as well as CEOs or board members about conduct that is inconsistent with an intent to be a passive investor. Investors should note, however, that the test for the investment-only exemption is the acquirer’s intention, and that determination may not turn on any particular conduct. While the conduct specified in the injunction is evidence that an investor is not passive, other evidence, and other conduct, also may reveal non-passive intent. Clear evidence of a non-passive intent, even if not accompanied by conduct, can make the investment unavailable. Similarly, no particular conduct is likely dispositive, and we will assess a variety of factors to determine if an investor has properly invoked the investment-only exemption.

We have heard on occasion that our investment-only rules, promulgated many years ago, are too stringent, particularly for activist investors. We note that the investment-only exemption is set forth in the statute enacted by Congress. We understand that activist investor conduct can be – but is not inevitably – beneficial for shareholders, competition and consumers. To date, we are not aware of specific conduct our rules are inhibiting. Nevertheless, we remain open on this issue – as with other HSR rules – to consider the views of those subject to our rules on ways we can make our rules better or more clear.

Finally, we reiterate that the activities enumerated in this settlement as rendering the exemption unavailable to an investor are not exhaustive. The injunctive provisions of the order are drafted to focus on the specific conduct that occurred here (e.g., the investor actively reached out to third parties and solicited interest in participating in the management of the company). However, a statement of express intent (e.g., “I plan to seek a board seat”) would also demonstrate that an investor does not have the passive intent necessary to claim the exemption. Therefore, any investor who is considering engaging with management or any person considering taking a board seat should proceed with caution when relying on the investment-only exemption. Similarly, individuals who are managing members (e.g., CEO or board member) of a company as well as the company itself should be aware of the requirements of the HSR Act, should take steps to determine the applicability of the Act to their transactions, and should conduct routine compliance audits as necessary.

When in doubt about the application of the investment-only exemption (or any other aspect of the HSR law or rules), contact the FTC’s Premerger Notification Office. Our HSR experts are available to discuss your questions before you act.