The U.S. Federal Trade Commission (FTC) on September 21 issued a Notice of Proposed Rulemaking (Notice)1 that would materially change the premerger notification rules (Rules)2 under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act)3 applicable to investment funds and master limited partnerships (MLPs) and pertaining to partial acquisitions.
The amended Rules would increase the number of reportable acquisitions made by investment funds and MLPs by amending the definition of “person” to include “associates” (such as affiliated investment funds and their portfolio companies). This proposed expanded definition would affect the “size of person” reporting threshold and would require the aggregation of all investments in an issuer across associates. The new definition would also require more extensive reporting of information related to an acquiring person’s associates.
Additionally, the FTC proposed a new rule that would provide a de minimis exemption for the acquisition of 10% or less of an issuer’s voting securities, even if not solely for the purpose of investment, subject to certain competition-related limitations.
The FTC separately issued an Advance Notice of Proposed Rulemaking (Advance Notice)4 seeking input on a wide range of topics to inform anticipated additional amendments to the Rules.
The HSR Act requires that parties to certain acquisitions of voting securities, non-corporate interests (such as interests in partnerships or limited liability companies), and/or assets submit notifications to the FTC and the Antitrust Division of the U.S. Department of Justice (together, the Agencies) and wait a specified period of time, generally 30 days, before consummating the acquisition. The purpose of the HSR Act is to permit the government to investigate and, where necessary, challenge anticompetitive transactions before they are consummated, as it can be difficult to restore competition fully once an anticompetitive transaction has taken place. Currently, acquisitions resulting in holdings greater than $94 million are potentially reportable where the parties to the transaction meet certain “size of person” thresholds. Acquisitions resulting in holdings greater than $376 million are potentially reportable regardless of the size of the parties to the transaction. A variety of exemptions from the requirement to file and wait are available under the HSR Act and Rules, including exemptions that apply to investors who intend to hold a small percentage of an issuer’s voting securities “solely for the purpose of investment.”
The HSR notification and report form (Form) that an “acquiring person” must file to start the waiting period asks for detailed information about the acquiring person, including financial statements, revenues, deal-related documents, subsidiaries, equity holders, and minority holdings. Under the current Rules, a “person” is defined as “an ultimate parent entity and all entities which it controls directly or indirectly.” “Control” is also a defined term under the Rules and generally refers to holding 50% or more of the outstanding voting securities, or having the contractual power to designate 50% or more of the directors, of a corporation; or having the right to 50% or more of the profits, or of the assets upon dissolution, of an unincorporated entity (such as a partnership or limited liability company). The Rules define “associates” generally as those entities not under the “control” of the acquiring person but who manage, or are under common management with, the acquiring person. The term is intended to encompass the portfolio companies of investment funds, master limited partnerships, and similarly structured funds. At present, the only information required to be provided in relation to associates concerns their majority and minority holdings in entities that have a competitive overlap with the issuer whose interests are to be acquired. Further, the presence of associates currently does not affect whether a transaction is reportable; it bears only on what information the acquiring person must submit in a reportable transaction.
Acquisitions in an issuer that are made “solely for the purpose of investment” and that do not result in holdings of greater than 10% of the issuer’s voting securities are exempt under the HSR Act and HSR Rule 802.9.5 The Rules provide that an investment is made “solely for the purpose of investment” if the acquiring person “has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”6 The Statement of Basis and Purpose (SBP) for the original HSR Rules from 1978 sets out specific types of conduct that are considered incompatible with an investment purpose, such as proposing corporate action requiring shareholder approval, or nominating a candidate to the board of directors.
In the years since the issuance of the SBP, the Agencies have narrowly interpreted “solely for the purpose of investment” through enforcement against acquiring persons who took actions short of those specified in the SBP as being incompatible with an investment purpose. Statements issued by the FTC and its officials have caused further uncertainty regarding the scope of the investment-only exemption of Rule 802.9.
Proposed Rule Changes
Expansion of Definition of “Person” to Include Associates
In the Notice, the FTC notes that, since the promulgation of the Rules in 1978, the investment landscape has changed dramatically, primarily through the expansion of investment funds and MLPs. These changes have resulted in notifications by certain types of investment entities that in the Agencies’ view do not present the full picture of the competitive impact of a transaction. Information related to associates that must be reported on the current Form details only interests in entities reporting in the same NAICS codes as the target, which may not reveal competitive overlaps (as companies may choose to use different NAICS codes for similar businesses). Further, the full economic stake being acquired in the target by a family of funds is not always reflected. Purportedly to address these concerns, the Rules would expand the definition of a “person” to include associates, which are already defined in the Rules.
This change would have implications for the reportability of acquisitions by investment funds and MLPs. First, investment funds and MLPs would be much less likely to fail to meet the “size of person” test where applicable, as all portfolio companies would be included in the size of “person.” Second, acquisitions of the same issuer would need to be aggregated across all associates when making a filing (both shares already held in the issuer and newly acquired shares). This aggregation requirement could result in previously nonreportable acquisitions in the same issuer becoming reportable when made by entities that are not under common “control” but that are part of the same family of funds. On the other hand, where more than one entity in the same family of funds is making a reportable acquisition of shares in the same issuer, funds and MLPs will be able to submit one filing rather than a separate filing for each entity’s acquisition.
Finally, acquiring persons with associates would need to provide extensive additional information related to those associates, including Securities and Exchange Commission filings, financial statements, deal-related documents, revenues, subsidiaries, and prior acquisitions of companies in the same industry as the target.
Creation of a New Exemption for Certain De Minimis Investments
The second major change proposed is the creation of a new Rule that would exempt the acquisition of 10% or less of an issuer’s voting securities unless the acquiring person already has what the Rule would treat as a competitively significant relationship with the issuer. In the Notice, the FTC states that filings are regularly received for acquisitions of 10% or less of an issuer that are not solely for the purpose of investment but that divert agency resources even though they “almost never” present competition concerns.
Proposed Rule 802.15 is intended to address changes in investor behavior since passage of the HSR Act. The FTC recognizes that a broad range of potential shareholder engagement involves more than passive holding but less than those actions specified as incompatible with the “investment-only” exemption in the 1978 SBP. In particular, the narrow interpretation of Rule 802.9 has made it difficult for investors to know what types of communication with the issuer are considered incompatible with the investment-only requirement of Rule 802.9. The FTC acknowledged the argument that the existing exemption, as interpreted, could have the effect of chilling communications between investors and management that can have benefits such as encouraging corporate accountability.
Proposed Rule 802.15 would allow for an exemption from HSR filing requirements where:
- the acquiring person will not hold in excess of 10% of the issuer;
- the acquiring person is not a competitor of either the issuer or any entity within the issuer;
- the acquiring person does not hold voting securities in excess of 1% of the outstanding voting securities or non-corporate interests of any entity that is a competitor of either the issuer or any entity within the issuer;
- no employee/principal/agent of the acquiring person is an officer or director of either the issuer or any entity within the issuer;
- no employee/principal/agent of the acquiring person is an officer or director of a competitor of either the issuer or any entity within the issuer; and
- there is no vendor-vendee relationship between the acquiring person and either the issuer or any entity within the issuer where the value of the sales between the acquiring person and the issuer in the most recently completed fiscal year is greater than $10 million in the aggregate.
Rule 802.9 would remain unchanged and available to investors whose holdings do not exceed 10% and who have no intention to be involved in the basic business decisions of an issuer.
The FTC vote to publish the Notice was 3-2, with Commissioners Rohit Chopra (D) and Rebecca Kelly Slaughter (D) voting no. Each issued a separate statement opposing the adoption of a 10% de minimis exemption. This split among the FTC commissioners implies that the final rule may have some sensitivity to upcoming election outcomes.
Certain explanatory and ministerial changes to the Rules and Form were also proposed.
Information Gathering for Future Amendments to the HSR Rules
The FTC is seeking input via the Advance Notice on seven topics to inform future amendments to the Rules to address the ways markets and business practices have evolved:
- Size of Transaction: How have concepts and methodologies related to “acquisition price” and “fair market value” changed since the 1970s/early 1980s? Should debt that is paid off by the buyer continue to be subtracted from acquisition price?
- REITs: How have real estate investment trusts (REITs) evolved since the 1970s/early 1980s? Given that REITs now actively operate businesses, is a blanket exemption still suitable?
- NCEs: How have non-corporate entities (NCEs), such as partnerships and limited liability companies, evolved since 2005? Should NCEs be treated as equivalent to voting securities?
- Acquisitions of Small Amounts of Voting Securities: Holdings by investment funds and institutional investors have greatly evolved and increased since 1978, including increased participation in corporate governance. In this new environment, what new rules are needed?
- Influence Outside the Scope of Voting Securities: What impact do investors have on a company’s business decisions if they hold convertible voting securities with a present right to designate or appoint members of the board, or if they are granted a board observer?
- Transactions or Devices for Avoidance: What mechanisms do targets use to pay extraordinary dividends, and what are the reasons for such dividends? Do targets use other mechanisms to reduce cash on hand? What other actions should the FTC review closely as potential devices for avoidance?
- Filing Issues: Is the five-year timeframe for acquisitions of voting securities that do not cross the next HSR threshold too long? If the FTC required an acquiring person to include all acquisitions made within the past five years above HSR thresholds, regardless of overlap with the target company, what would be the burden or benefit?
Comments on any other HSR Rule are also welcome.
The FTC has invited public comments on the proposed rule changes. Interested parties must submit comments within 60 days after the date the Notice and Advance Notice are published in the Federal Register (publication anticipated on or around September 24, 2020). Our lawyers are available to assist clients with the preparation and submission of such comments. For those wishing to view the full set of materials issued by the FTC, they may be found here.
1 FTC and DOJ Seek Comments on Proposed Amendments to HSR Rules and Advance Notice of Proposed HSR Rulemaking, FTC Press Release (Sept. 21, 2020).
2 16 C.F.R. Parts 801, 802, and 803.
3 15 U.S.C. §18a.
4 FTC and DOJ Seek Comments on Proposed Amendments to HSR Rules and Advance Notice of Proposed HSR Rulemaking, FTC Press Release (Sept. 21, 2020).
5 16 C.F.R. 802.9.
6 16 C.F.R. 801.1(i)(1).
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