The FTC has settled an enforcement action against Third Point Funds and their management company related to their acquisition of stock in Yahoo! Inc.

Based on the FTC’s press release, the funds had acquired shares in Yahoo! that exceeded the requirements for pre-acquisition filings under the Hart-Scott-Rodino Act.  (Filing is currently required prior to acquiring more than $76.3m worth of shares.  Notice of the planned acquisition must be given to the target company prior to filing, potentially providing a very early notification to the target of the acquisition of its shares by an activist.)  To avoid this filing requirement, the Third Point funds relied on the “investment only” exception, which permits investors to acquire up to 10% of an issuer’s stock without observing the HSR Act’s notice and waiting period requirements – so long as the investor’s intent is passive.

Over the years, the contours of what constitutes “passive” has been subject to some question and much discussion.  There is a sense that some investors read the term “passive” very liberally while others read it more strictly.  Without clear standards, investors who take the stricter approach sometimes wonder how their peers have made certain investments without an HSR filing.

In its press release, the FTC’s Bureau of Competition Director came down strongly on the side of a strict interpretation, stating 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.”  On the facts of the case, the FTC disagreed that Third Point’s intent was sufficiently passive.  In particular, the FTC cited as indicia of non-passive intent the fact “that Third Point was communicating with third parties to ascertain their interest in becoming a candidate for Yahoo!’s board of directors, taking other steps to assemble an alternate slate of board of directors, drafting correspondence to Yahoo! announcing Third Point’s interest in joining Yahoo!’s board, internally deliberating about the possible launch of a proxy battle for Yahoo! directors, and making public statements about proposing a slate of directors at Yahoo!’s next annual meeting.”

This case has a couple of interesting twists.  First, the FTC settled without a civil penalty.  The FTC said it did not insist on a penalty (which could have run up to $16,000 per day) because it was a first offense and because the violation was “short-lived.”  The FTC did require Third Point to stipulate to an injunction against acquisitions in similar circumstances in the future, and to implement a compliance program.  Typically in first-offender situations, however, the FTC does not initiate an enforcement action at all.  The fact that it did so here and then publicly resolved it, with ongoing obligations to the investor, suggests that the FTC wanted to send a message to the investing community that the investment-only exemption will be narrowly construed.

Second, the vote to accept the settlement was 3-2, with the two Republican commissioners, Joshua Wright and Maureen Ohlhausen voting no.  It is quite unusual (if not unprecedented) for the FTC to split on an HSR enforcement matter.  The dissenting statement of Commissioners Wright and Ohlhausen—in which they took pains to note their view that there may well have been a technical violation of the HSR Act here—suggests that their vote was motivated at least in large part by a concern that the investment only exemption needs to be revamped (or, put another way, that the HSR requirement for filings for acquisitions of a small percentage of an issuer’s voting securities should be rethought).   The dissenters suggested either jettisoning the investment-only intent requirement for the 10% exemption or at least tying the definition of non-investment only intent to the specific categories in the statement of basis and purpose that accompanied the regulation when it was promulgated in 1978, specifically “(1) [n]ominating a candidate for the board of directors of the issuer; (2) proposing corporate action requiring shareholder approval; (3) soliciting proxies; (4) having a controlling shareholder, director, officer or employee simultaneously serving as an officer or director of the issuer; (5) being a competitor of the issuer; or (6) doing any of the foregoing with respect to any entity directly or indirectly controlling the issuer.”

Over the years, many in the HSR bar have voiced similar concerns to FTC Commissioners and staff.  As the dissenting commissioners noted, the idea that a small (in percentage terms) acquisition of an issuer could cause substantive antitrust concerns seems overblown and the requirement for filing in such situations from activist or semi-activist investors seems to create unnecessary filings, with the attendant expense (including fairly steep filing fees of $45,000 to $280,000).

As the law currently stands, however, activists – at least those who have gotten to the point of  considering the nomination of new directors – would be unwise to rely on the “investment-only” exception to avoid disclosure of their stakebuilding activities.  However, there are numerous other techniques for building a significant economic stake without triggering an HSR filing that are currently in use by other activist investors – including the use of forward contracts, cash settled derivatives, and multiple purchasing entities.  We would expect these techniques to become more popular, and would not anticipate that this ruling will lead to activists tipping their hand early on their stakebuilding activities.