On 21 September 2020, the Federal Trade Commission (FTC) announced for comment sweeping changes to the Hart-Scott-Rodino (HSR) Act rules. First, the FTC proposed changing the definition of "person" to include HSR associates. This proposed change will result in certain acquisitions (especially those involving investment funds and master limited partnerships (MLPs)) which are not currently HSR-reportable becoming HSR-reportable. Second, the FTC proposed adding a new HSR de minimis exemption that would apply to acquisitions of 10 percent or less of a corporation's voting shares so long as the acquiring person does not have a "competitively significant relationship" with the corporation. The FTC's proposed approach to assessing "competitively significant relationships," however significantly reduces the number of transactions that could actually qualify for this exemption.

The HSR Act generally

Pursuant to the HSR Act, certain acquisitions of voting shares, assets, or noncorporate interests require the parties to file notifications with the U.S. antitrust agencies and observe a pre-closing waiting period if the acquisition would satisfy applicable HSR threshold tests and not qualify for an HSR exemption.

Under the size of transaction threshold test, an acquisition is only reportable if it has a value in excess of US$94 million (adjusted annually) under the HSR valuation and aggregation rules. If an acquisition has an HSR value in excess of US$376 million (adjusted annually) it is HSR-reportable unless it qualifies for an exemption. If the acquisition has an HSR value of US$376 million or less, a size of person test would also apply, and, if not satisfied, the acquisition would not be HSR reportable. The size of person test would generally be satisfied if the HSR ultimate parent entity (UPE) of one party has at least US$188 million (adjusted annually) in annual net sales or total assets and the UPE of the other party has at least US$18.8 million (adjusted annually) in annual net sales or total assets. Even if the applicable threshold tests are satisfied, an acquisition would not be HSR-reportable if it qualifies for an HSR exemption.

Proposed rule change: Broadening the definition of "person"

Impact on investment funds and MLPs

Currently to determine whether the HSR threshold tests would be satisfied and who would have to make a required HSR notification, it is necessary to identify the "acquiring person" (namely the acquiring entity, its UPE, and all entities under the HSR control of its UPE) and the "acquired person" (namely the target, its UPE, and all entities under the HSR control of its UPE). It is therefore not necessary, when assessing whether an acquisition by a fund is HSR-reportable, or in completing the HSR notification when an acquisition by a fund is reportable, to aggregate the holdings of affiliated funds in a fund family if the relevant funds do not share the same HSR UPE. In its proposed rule-making, the FTC notes that "[t]reating these non-corporate entities as separate entities under HSR is often at odds with the realities of how fund families and MLPs are managed"[1] and has resulted in two problems. First, the HSR filing is of limited utility in aiding the antitrust agencies' assessment of the competitive impact of a transaction because the acquiring fund's HSR form will not include sufficient information about the identity and holdings of the fund's HSR associates and the entities under the HSR control of these associates. Second, because funds not under common HSR control are not aggregated when assessing whether the HSR threshold tests would be satisfied, today HSR filings are not required even when a fund family collectively will acquire and hold in excess of US$94 million worth of a company's voting shares if the participating funds are not under common HSR control with each other and if each would acquire and hold less than US$94 million worth of the company's voting shares independently.

To address these concerns, the FTC has proposed expanding the HSR definition of "person" to include not only UPEs and all entities under their HSR control, but also the UPEs' HSR associates. The "associate" concept applies to investment vehicles (such as venture funds) and MLPs and requires the determination of all entities under common management with the acquiring person. With this change, a fund must identify other funds that share the same investment manager and aggregate the holdings of those funds, the investment manager, and entities under common HSR control with such entities when assessing whether the HSR threshold tests will be met and completing any necessary HSR notifications. As the FTC illustrated, "Fund Vehicle 1's investment manager also manages the investments of Fund Vehicle 2, making Fund Vehicle 1 and Fund Vehicle 2 associates"[2] whose size and holdings must be taken into account when evaluating whether threshold tests are met.

Increased HSR Filing Obligations for Investment Funds and MLPs

The expanded definition of "person" to include HSR associates will result in certain acquisitions by funds or MLPs that were not previously subject to the HSR Act's reporting requirements to become reportable. For example, assume that partnerships A, B, and C are affiliated funds (i.e., they operate within the same fund family) and are managed by the same managing entity. A, B, and C are therefore HSR associates of each other. Assume that each is its own HSR UPE because no one entity is entitled to at least 50 percent of the profits or assets of each and thus no one satisfies the HSR control test for U.S. partnerships. When assessing whether the HSR size of transaction test would be satisfied when each invests in Company X (an entity that is its own HSR UPE), today it is not necessary to aggregate the investments of Funds A, B, and C, and if none will acquire and hold in excess of US$94 million of Company X voting shares, none would have an HSR filing obligation. Under the FTC's proposed new rules, however, it would be necessary to aggregate the three entities' investments in Company X, and if the aggregated holdings of Funds A, B, and C of Company X voting shares would exceed US$94 million, an HSR filing and waiting period would be required (if the size of person test if applicable is satisfied and no exemption applies).

Increased HSR filing obligations for portfolio companies

The proposed definition of "person" could also result in more HSR filing obligations for funds' portfolio companies. For example, if Funds A, B, and C in the example above each hold less than 50 percent of the voting shares of Company Y and none can designate at least 50 percent of the directors of Company Y, none would be the UPE of Company Y. If Company Y is its own UPE, and does not satisfy the HSR size of person test, when it is involved in an acquisition valued at less than US$376 million an HSR filing is not required. However, under the FTC's new definition of "person," if Funds A, B, and C collectively hold at least 50 percent of Company Y's voting shares and collectively satisfy the size of person test, the same acquisition involving Company Y could be HSR reportable.[3]

Enhanced disclosures in HSR filing

Under the FTC's proposed rules, the HSR notification that funds and MLPs would have to file would contain significantly more information than is currently required. For example, if Fund A is its own UPE and has an HSR filing obligation today, it would generally provide information about and responsive documents in the possession of itself and the entities under its HSR control (including portfolio companies in which it holds at least 50 percent of the voting shares or can designate at least 50 percent of the directors) and only limited information about its HSR associates related to their holdings in the target or in entities that operate in the target's North American Industry Classification System (NAICS) codes. Under the FTC's proposed new rules, Fund A would have to include responsive information about and documents in the possession not only of itself and entities under its HSR control, but also of its HSR associates – Fund B, Fund C, the managing entity, and any entities under common HSR control with any of these associates, greatly expanding the scope of what needs to be provided and potentially resulting in delays to both filing and closing.

Proposed rule change: The de minimis exemption

The FTC proposed a new exemption that would apply when an acquiring person would acquire and hold 10 percent or less of the voting shares of a corporation (the "issuer) so long as the acquiring person does not have a "competitively significant relationship" with the issuer.[4] Under the proposal, this exemption would only apply if each of the following elements was satisfied.

1. The acquiring person is not a competitor of the issuer (including any entity under the HSR control of the issuer).
2. The acquiring person holds 1 percent or less of the voting shares or noncorporate interests of any competitor to the issuer (including any entity under the HSR control of the issuer).
3. "No individual who is employed by, a principal of, an agent of, or otherwise acting on behalf of the acquiring person, is a director or officer of the" issuer (including any entity under the HSR control of the issuer) or of any competitor to the issuer (including any entity under the HSR control of the issuer).[5]
4. "There is no vendor-vendee relationship between the acquiring person and the" issuer (including any entity under the HSR control of the issuer), "where the value of sales between the acquiring person and the issuer in the most recently completed fiscal year is greater than US$10 million in the aggregate."[6]

   Further limitations to relying on the proposed de minimis exemption

   First, the FTC's proposed definition of "person" would apply to application of the proposed de minimis exemption. Thus, Fund A would not be able to utilize the proposed de minimis exemption if Fund A and its associates (such as Fund B and Fund C) (i) collectively would hold over 10 percent of the voting shares of issuer or (ii) hold more than 1 percent of a competitor to issuer.

   Second, the FTC's proposed definition of "competitor" significantly limits the availability of the proposed de minimis exemption. The FTC proposes defining "competitor" as "any person that (1) reports revenues in the same six-digit NAICS industry group as the issuer, or (2) competes in any line of commerce with the issuer."[7] Because the NAICS codes can sometimes be quite broad, entities that do not actually compete with each other may use the same NAICS codes to report their U.S. revenues and would therefore be considered competitors under the proposed exemption. This is the case, for example with the software publishing NAICS code (511210) or asset licensing code (533110). Thus if an acquiring person (including its associates) holds more than 1 percent in a software company (X), for example, it could not utilize the proposed de minimis exemption when it acquires voting shares of another entity in the software business (Y), even if X and Y do not compete with each other.

   If the proposed definition of "competitor" is also applied to the existing "solely for the purpose of investment" (i.e., passive investor) exemption, it would narrow that exemption as well. Currently the "solely for the purpose of investment exemption" applies to an acquisition of voting securities "if made solely for the purpose of investment and if, as a result of the acquisition, the acquiring person would hold ten percent or less of the outstanding voting securities of the issuer . . . . "[8] Voting securities are held solely for the purpose of investment "if the person holding or acquiring such voting securities has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer."[9] Merely voting the stock is not inconsistent with an intent to be a passive investor. However, among the types of conduct the FTC has found to be inconsistent with an intent to be a passive investor is being a competitor to the target, holding 10 percent of a competitor to the target, or having a board seat on a competitor to the target. If applied to the "solely for the purpose of investment" exemption, the FTC's proposed definition of "competitor" would narrow application of this exemption because simply reporting U.S. revenues in the same broad NAICS (industry-based) codes would cause two entities competitors to be deemed competitors even where they do not actually compete.

   Conclusion

   The proposed rules envision sweeping changes to existing HSR constructs and will undoubtedly increase HSR filing obligations for both funds/MLPs and their portfolio companies. The filing assessment will necessarily require detailed attention to which entities qualify as "associates" of the acquired and acquiring persons as the holdings and size of such entities could determine whether HSR threshold tests are satisfied. Funds and MLPs will also face many challenges completing required HSR forms under the new rules since it may be time-consuming and burdensome to collect information required for an HSR filing from a portfolio company under an associate's HSR control.

   The proposed de minimis exemption is certainly a step in the right direction and could result in fewer filings for transactions that are not likely to have any anticompetitive effects. However, the limitations on the exemption (and especially the expansive definition of "competitor" that necessarily applies to entities that do not actually compete against each other) may in reality cause the exemption to be of limited practical applicability.

   Comments to the FTC's proposed changes to the HSR rules are due 60 days after the proposed rule-making is published in the Federal Register. As of the date of this alert, the notice was not yet published in the Federal Register. We will continue to monitor developments during and after the 60-day comment period.

Footnotes

[1] Proposed HSR Rulemaking at 5, supra note 1.