This memorandum provides basic guidelines to help alert portfolio managers to certain limitations on the acquisition of the voting securities of a given entity. The Hart Scott Rodino Act (“HSR”) provides a federal regulatory scheme to monitor the acquisition of voting securities and assets, in an effort to monitor whether such acquisitions may have anticompetitive effects on the marketplace.
A. No Filing Required for Acquisitions of Less than $63.4 Million
Under current HSR legislation, all acquisitions involving the voting securities of an entity are permissible without notifying the Federal Trade Commission or the Department of Justice (together, the “Antitrust Agencies”), if the acquisition is valued at less than $63.4 million. Therefore, if a fund sought to acquire a position of $63.4 million or more of the voting securities or assets of another entity or if a certain acquisition will result in the fund holding $63.4 million or more, the acquisition must be reported to the Antitrust Agencies before the acquisition is completed. Once the acquisition is reported, the Antitrust Agencies have 30 days to review the acquisition. If the Antitrust Agencies determine that the acquisition does not harm competition, the parties to the acquisition are notified and the acquisition may then be completed.
B. Non Voting Securities, Convertible Securities
The HSR rules are concerned with the acquisition of securities which carry voting rights; however such rights must convey a right to vote for members of an entity’s board of directors or persons exercising similar functions. If the securities at issue do not convey the right to vote for members of the board of directors or persons exercising similar functions, the HSR legislation does not require reporting in connection with the acquisition of such voting securities. In addition, HSR legislation does not require reporting of any acquisition of debt and/or convertible securities that do not carry the voting rights described above. However, because conversions are treated as acquisitions, subsequent conversions of convertible securities may be subject to reporting. In the event a conversion of convertible securities into another form of security, which has voting rights that are a subject of concern under the HSR rules, results in a fund holding a position in the post conversion voting securities valued in excess of $63.4 million, the conversion event may be deemed a transaction that is subject to HSR reporting requirements. Therefore, prior to any such conversion, a valuation of the fund’s position in the voting securities of the issuer must be assessed. If conversion will result in the fund exceeding the $63.4 million threshold, absent an available exemption, an HSR filing must be made and clearance granted by the relevant Antitrust Agency before any such conversion into the voting securities of the issuer is completed.
C. Penalties for Not Reporting Relevant Acquistions
The failure to file a notification with the Antitrust Agencies when applicable is a violation of federal law and subjects the acquiring party to a fine of $16,000 per day until such filing is completed.
D. Safe Harbor Acquisitions
HSR legislation does allow for the acquisition of voting securities valued at $63.4 million or more if such acquisition represents 10% or less of the total outstanding voting securities of the entity whose voting securities are being acquired. This exception is called the “passive investor exemption” and is allowed so long as the acquiring company does not actively participate in the management of the acquired company.
Another available exemption is the “institutional investor exemption.” An acquisition of voting securities under this rule is exempt if the acquisition: (1) is made directly by an institutional investor; (2) is made in the ordinary course of business; (3) is solely for the purpose of investment; and (4) as a result of the acquisition, the acquiring company would hold 15% or less of the outstanding voting securities of the issuer. The institutional investor exemption is available for investment companies registered with the U.S. Securities and Exchange Commission under the Investment Company Act of 1940. Other entity types qualify for the exemption and a laundry list of such entity types is set forth in the HSR rules. Limitations on the use of this exemption can apply; therefore legal counsel should be consulted before proceeding with any transaction based on this exemption.
E. Aggregation Rules for Multiple Funds Managed by the Same Portfolio Manager
When evaluating whether the acquisition of voting securities and/or assets of an entity satisfy the HSR threshold, a portfolio manager managing multiple funds should note that under the HSR rules, the investors of the fund are typically considered the beneficial owners of the fund, even though the portfolio manager may have broad investment discretion and the right to vote the securities in the fund by proxy.
Under the HSR rules, the existence of beneficial ownership is determined in the context of particular cases with reference to certain factors which convey the indicia of beneficial ownership, which include the right to obtain the benefit of any increase in value or dividends, the right of gain or loss in value, the right to vote the stock or determine who may vote the stock and investment discretion (including the power to dispose of the stock). The analysis will also look at whether the investors have the right to terminate the portfolio manager. If an analysis of these factors favors the conclusion that the investor rather than the portfolio manager is the beneficial owner of the fund, then the portfolio manager does not have to aggregate the positions in such entity across multiple funds, so long as none of the funds are controlled by the same investor. Despite the list of factors listed above, the antitrust agencies will typically hold that the investors are the beneficial owners even if the portfolio manager retains investment discretion and the right to vote the securities in the fund by proxy.
The HSR rules hold that an investor is deemed to control a fund if such investor: (a) holds 50% or more of the interests of such fund or (b) is entitled to 50% or more of the profits or losses of such fund upon dissolution. By way of example, if an portfolio manager managed three funds in which no one investor held 50% or more of the interests or was entitled to 50% or more of the profits or losses upon dissolution of the fund, the portfolio manager could acquire an amount of voting securities and/or assets of an entity up to the HSR threshold amount and/or in accordance with any available exemptions on behalf of each fund without regard to the HSR aggregation rules. Thus each fund could hold slightly less than $63.4 million of the same issuer and no filing would be required. Accordingly, each such fund could acquire up to 10% of the voting securities of an issuer if the fund was relying on the passive investor exemption.
However, in the case where two or more funds are controlled by the same investor, the portfolio manager must aggregate the holdings of such commonly controlled funds in order to determine whether the HSR threshold has been met. By way of example, if a portfolio manager managed three funds and two of the funds were controlled by Investor X, in order to determine if the HSR threshold has been met in a potential transaction, the portfolio manager must aggregate the current holdings in the target entity and the proposed acquisition amounts for the two commonly controlled funds. Under this scenario, in the absence of an applicable exemption, the aggregate position in the target entity for the two commonly controlled funds cannot exceed the HSR threshold without a prior filing. With regard to the third fund in the example which is not controlled by Investor X, the portfolio manager can treat this fund as a separate entity and thus may acquire voting securities and/or assets of the target entity up to the HSR threshold amount and/or in accordance with any available exemptions.
F. Conclusion
A number of additional exemptions are available that can be used on a case by case basis depending on the structure of the transaction and the relevant line of business conducted by the target entity. In addition, with regard to portfolio managers managing multiple funds, certain aggregation rules also apply when investors hold positions in funds in combination with immediate family members. Under certain circumstances, the holdings of immediate family members must be aggregated in order to properly evaluate whether the HSR threshold has been met.
Whenever possible, legal counsel should be consulted in the early stages of a proposed transaction so that a full analysis of the structure of the transaction and HSR rules can be made in order to determine whether an HSR filing is required.
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