Private equity firms and similar “financial buyers” might think they can sidestep many compliance and reporting requirements because they are, well, private. Yet obligations do exist—and one of the lesser-known pitfalls is the Hart-Scott-Rodino Antitrust Improvements Act.
The Federal Trade Commission, which enforces HSR, made headlines earlier this fall when it nicked a Connecticut hedge-fund manager at Darus Capital Management for $350,000 for failing to report acquisition of voting securities in two U.S. companies. Such enforcement actions are rare, but it did fire a shot across the bow of financial advisers to pay heed to HSR.
The Hart-Scott-Rodino Act essentially requires investors to report when they have acquired large stakes in companies, either in absolute terms or as a certain percentage of total sales. Most violations—there were 73 corrective filings in 2005—appear to be inadvertent, although such neglect can be costly. The penalty is an $11,000 per-day fine.
Alexis
“It adds up pretty quickly,” says Geraldine Alexis of the law firm Bingham McCutchen in San Francisco.
Marian Bruno, assistant director of the FTC’s Pre-merger and Notification Operations Division, tells Compliance Week that most HSR actions involving investors arise from situations where investors realize after the fact that they did not comply with filing requirements and then voluntarily self-report.
“I don’t think we’re hunting anybody down or trying to focus on a particular group,” Bruno says, noting that the rules should be pretty clear for sophisticated investors.
Barry Pupkin, an antitrust lawyer with the law firm Squire Sanders & Dempsey in Washington, says private investors should not be taken by surprise.
FTC activity in the area is “probably a continuation of what has happened and occurred before,” he says. “It indicates that the premerger office [of the FTC] takes compliance with the HSR act very seriously. If the regulations are violated, the Commission and its staff will proceed aggressively against those who violated the regulations.”
HSR At A Glance
Under HSR, which was enacted in 1976, all parties—including private equity firms and other financial investors—must notify the FTC and the Department of Justice’s Antitrust Division of certain transactions and wait 15 to 30 days before consummating the transaction.
The statute has a “size of transaction” threshold that is generally met if the acquiring party will hold securities or assets with a value of at least $56.7 million. In addition, a “size of person” threshold is generally satisfied if one party has assets or annual sales of at least $113.4 million and the other party has assets or sales of $11.3 million or more. Transactions where the value of the voting securities or assets to be acquired is greater than $226.8 million are reportable regardless of the size of the parties involved in the transaction.
Exceptions to the reporting requirement do exist, including the so-called “investment only” exemption. Under this exemption, acquisitions of 10 percent or less of the voting securities of an issuer made solely for investment purposes may be exempt. But the FTC has never come out and defined exactly what “solely for investment purposes means,” says Brian McCalmon of the law firm Preston Gates Ellis & Rouvelas Meeds.
The Commission “has given some guidelines about what it does not mean,” McCalmon says. He notes that maneuvers such as acquiring the right to exert day-to-day control of the business operations would lead the FTC to conclude that the investor was not a “passive” one, and therefore subject to HSR reporting requirements.
The usual penalty for HSR violations is a fine, but in extreme circumstances it can be more onerous. If the government ultimately concludes that the acquisition was anti-competitive, “it might come after you and ask you to do a divestiture,” says Alexis, a former Justice Department lawyer who now represents clients before the FTC, which is the primary regulator of HSR.
Notification Requirements:‘An Ongoing Concern’
Baer
William Baer, former director of the FTC’s Bureau of Competition, tells Compliance Week that “there continues to be vigilance at [the Commission] regarding notification and compliance requirements under Hart-Scott-Rodino. This is an ongoing concern.”
Baer, who is now a partner with the law firm Arnold & Porter, says recent activity involving private investors does not signal “a heightened interest or a new interest” but rather is an indication of the FTC’s historic treatment of HSR issues.
“The agency’s approach is generally, ‘If you failed to file but tell us about it as soon as you find out, we’ll generally let you go unless there’s a suggestion that it was something more than a good faith mistake,’” Baer says. “Deliberate evasions of the rules and repeated failures to file tend to be the situations that are investigated and in which civil penalties are sought.”
Alexis says that the FTC “isn’t any more aggressive vis-à-vis private equity funds” than it is with other parties. “They’ve gone after targets where you’re talking about huge amounts of money. That always gets the attention of the government.”
Talley
Thomas Talley, a partner with the Thacher Proffitt law firm, says some financial investors seem surprised to find out that they fall under HSR. “Some have not done much thinking about this,” he says. “They think if they acquire a business that is a limited liability corporation or a partnership they’re exempt.”
Talley also warns that groups of investors may be subject to HSR if they act in tandem. “You’re skirting the exemption by behaving in a collective way,” he says.
Passive Investors May Not Be Exempt
McCalmon notes that financial investors “typically don’t have an interest in controlling the company that they’re investing in—they’re using it as a wealth-generating item.” Therefore HSR issues “typically are not at the front of their minds.”
But investors who acquire 10 percent or more (15 percent for institutional investors) are not exempt from HSR reporting requirements. Neither are “activist investors”—those that are not purely passive.
McCalmon
“Sometimes institutional investors and other types of investors have become more active in the companies in which they are investing,” McCalmon says, noting that such investors can run into problems when they rely on the passive exemption.
Another area that has triggered problems, McCalmon says, is the reportability of so-called put-call agreements with respect to hedge funds. HSR reporting requirements are triggered based on the acquisition of “beneficial ownership” but such ownership is in question when it comes to put-call agreements—“which have been used aggressively by hedge fund investors to get the benefits of the gain in value of securities without actually owning them,” says McCalmon.
There has been some speculation that put-call arrangements do not implicate reporting requirements. But when two lawyers authored an article in The Daily Deal earlier this year suggesting just that, the FTC countered with a rare letter to the editor challenging that assertion, saying that put-call arrangements have to be analyzed on a case-by-case basis.
“There’s a significant degree of uncertainty over the status of put-call arrangements,” says McCalmon.
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