The Federal Trade Commission (FTC) filed a complaint in August 2015 against three affiliated activist hedge fund companies and Third Point LLC, their management company, for acquiring voting securities in Yahoo! Inc. without complying with the filing and waiting requirements of the Hart-Scott-Rodino Act (HSR Act).  The agency rejected Third Point’s claim that its purchases fell within the HSR Act’s exemption for acquisitions of up to 10% of a target’s voting securities “solely for the purpose of investment.”  The decision is important because it illustrates the narrowness of the FTC’s interpretation of the exemption and the agency’s continuing aggressiveness in pursuing HSR violations by both strategic and nonstrategic buyers.

This update summarizes the highlights from this decision and provides practical advice.

HSR Investment Purpose Exemption.  Since 1978, the FTC has interpreted strictly the “solely for the purpose of investment” exemption as available only to acquiring persons who do not intend to participate “in the formulation, determination, or direction of the basic business decisions of the [target].”  In the agency’s view, an intention to nominate directors of the target, constitutes an intention to “participate,” and categorically disqualifies the acquiring person from the benefits of the exemption.

Acquisition of Yahoo! Stock by Third Point Funds.  In 2011, the Third Point funds acquired on the open market Yahoo! voting securities in excess of the then-effective size of transaction threshold ($66 million).  Immediately after purchasing the stock, Third Point began communicating with third parties to ascertain their interest in becoming a candidate for Yahoo!’s board and taking other steps to assemble an alternative slate of directors. Third Point also made public statements about proposing its own slate of directors at Yahoo!’s next annual meeting.

FTC Enforcement Action.  In response to the FTC staff’s investigation of Third Point’s failure to comply with HSR, the company argued its purchases were exempt from reporting because they had been made solely for the purpose of investment.  The FTC staff disagreed. To settle the matter, Third Point entered into a consent decree barring Third Point from making acquisitions and relying on the investment-only exemption if it intends to engage in certain conduct such as nominating a candidate for the board of directors of the issuer, proposing corporate action requiring shareholder approval, soliciting proxies with respect to the issuer, having a representative serve as an officer or director of the issuer, and being a competitor of the issuer.  The agency did not require Third Point to pay any financial penalties because the violation had been inadvertent, was short lived and was Third Point’s first violation of the HSR Act.

FTC Decision.  Three of the five FTC commissioners voted to accept the consent decree. In their view, in light of the agency’s traditional strict approach to the “solely for the purpose of investment” exemption, this wasn’t a close case.  Two commissioners dissented, however, noting that in this case

• the buyer was not a competitor but an activist hedge fund, and
• pursuing enforcement against activist investors could chill advocacy that “often generates well-documented benefits to the market for corporate control.”

The problem for the dissenters, however, is that the HSR Act and its implementing rules do not draw a distinction between strategic and nonstrategic buyers, and the antitrust laws do not consider the “market for corporate control” a factor relevant to Clayton Act merger analysis, which focuses on a merger’s likely effect on the discrete product markets served by the merging firms.  For this reason, the dissenters concluded by recommending that the U.S. Congress or the FTC amend the HSR Act or implementing rules to permit acquisitions of up to 10% of a target’s stock without regard to the acquiring firm’s status or intent.

The agency considered and rejected such an amendment to the HSR rules in 1988, and there is little reason to believe an amendment to the HSR Act would pass muster today in Congress.

Practical Advice for Investment Firms

Investment Firms Should Evaluate HSR Compliance for Potential Investments.  In light of the FTC’s Third Point Funds decision, investment firms should be sure to include HSR compliance as an element of due diligence before making any investment decision.  A full text of the FTC’s decision is here.