Investment funds may face enhanced premerger reporting requirements under a new rule jointly proposed by the Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ). Published Dec. 1, 2020, the notice proposes two important changes to premerger reporting requirements under the Hart-Scott-Rodino (HSR) Antitrust Improvements Act and implementing regulations.
- It proposes expanding the definition of “person” to include “associates,” which is already defined in the HSR rules. The FTC and DOJ hope a broader definition of “person” would give them a better sense of the competitive implications of proposed acquisitions by investment funds.
- It proposes creating a de minimis exemption for acquisitions of 10 percent or less of the target’s voting securities. Acquisitions of this sort almost never raise competition concerns, so this exemption would help the FTC and DOJ conserve limited enforcement resources. That said, several limitations narrow the scope of this exemption, making it less useful than it might appear.
Expanding “Person” to Include “Associates”
The proposed, broader definition of “person” would subject more private equity-backed acquisitions to federal antitrust review and would require funds to disclose more information in their HSR forms.
The definition of “person” plays an important role in determining whether a transaction is reportable under the HSR rules. Those rules require an HSR filing for acquisitions meeting certain thresholds. One of those thresholds, the size-of-person test, looks to the assets and sales of both the “acquiring person” and the “acquired person.” If both “persons” are big enough, and if the transaction itself is of a sufficient size, the acquisition is reportable. So, as the definition of “person” expands, more assets and sales get counted in the size-of-person analysis, ultimately making more transactions reportable under the HSR rules.
Under the current rules, “person” has a relatively narrow definition. It refers only to the highest entity not controlled by another, the “ultimate parent entity.”
This narrow definition of “person” allows many acquisitions by investment funds to go unreported. Investment firms often structure new funds by placing them into newly created limited partnerships or limited liability corporations. Even when the firm manages the investment of these funds, no one controls them for HSR purposes. Thus, under the current definition of “person,” each fund is its own ultimate parent entity and therefore its own “person” even though it may be but one fund among many managed by the same investment firm. This creates a dynamic where separately owned funds managed by the same investment firm can make acquisitions of the same company or of several competing companies without having to make an HSR filing because no fund is large enough to meet the size-of-person test.
The proposed rule would disrupt this dynamic. “Person” would refer not only to an ultimate parent entity but also to its “associates.” Introduced in 2011, the associate rule requires certain acquiring persons such as private equity funds and master limited partnerships to disclose in their HSR forms other entities under common investment management that report revenues in the same NAICS codes as the target. For example, if a fund managed by a private equity firm makes an HSR filing for a 100 percent ownership interest in an office administrative services company, the fund must disclose in the filing all of its “associates” — that is, all other portfolio companies under management by the private equity firm that also earn revenues for office administrative services. The proposed FTC/DOJ rule would not alter the associates concept. It would instead import that concept into the definition of “person.” Under the proposed rule, person would include both the ultimate parent entity (the investment fund) and its associates (all the portfolio companies managed by the private equity firm that provide office administrative services). By broadening the definition of “person,” the new rule would require filers to aggregate assets and sales of the specific acquiring entity with those of all of its associates. Consequently, more private equity-backed acquisitions would require federal antitrust review than under the current rules.
The new rule would also enhance reporting requirements for private equity-backed acquirers. Because the acquiring person would include both the ultimate parent entity and its associates, filers would need to report more financial and operational information than they do now. Item 5 of the HSR form, for example, instructs the filing person to report its revenues broken down by NAICS codes. If the definition of “person” is expanded, many filers would need to disclose revenues for more companies in Item 5 than they do now.
Creating a (Limited) De Minimis Exemption
The other important potential change introduced in the FTC/DOJ proposed rule is the creation of a de minimis exemption for acquisitions of 10 percent or less of a target’s voting securities. The exemption would build on a pre-existing exemption for passive investments, which applies to acquisitions in which the acquirer (1) will hold 10 percent or less of a target’s voting securities, and (2) has no intention of influencing the basic business decisions of the target. The proposed de minimis exemption would effectively eliminate the second prong of the passive-investment exemption.
The de minimis exemption, however, would not be as broad as it might seem. It would not apply in any of the following cases:
- The acquiring person is a “competitor” of the target or any entity within it.
- The acquiring person holds more than 1 percent of any entity that is a “competitor” of the target or any entity within it.
- The acquiring person has an employee, principal or agent who is a director or officer of the target or any entity within it.
- The acquiring person has an employee, principal or agent who is a director or officer of a “competitor” of the target or any entity within it.
- The acquiring person has a vendor-vendee relationship with the target or any entity within it, and that relationship generates over $10 million in annual sales.
“Competitor” here would mean any person that either (1) reports revenues in the same NAICS codes as the target or any entity within it, or (2) competes in any line of commerce as the target or any entity within it. “Any line of commerce” is left undefined in the proposed rule, but the FTC instructs filers “to conduct a good faith assessment to determine whether any part of the acquiring person competes with or holds interests in entities that compete with the issuer” (emphasis added). This definition of “competitor” would sweep wide, covering any situation in which the acquirer competes with the target, no matter how small or commercially insignificant. And because “competitor” would sweep so widely, these five limitations would significantly narrow the scope of the proposed de minimis exemption.
Enhanced Premerger Review: A New Regulatory Reality?
Even though it would create a de minimis exemption, the proposed FTC/DOJ rule would require HSR reporting of more proposed mergers and acquisitions than now. Broad exceptions would limit the practical application of the proposed de minimis exemption. And the expanded definition of “person” would push more acquisitions over HSR reporting thresholds. The message behind the proposed rule is clear: investment-fund managers should brace themselves for a new regulatory reality in which more of their acquisitions need federal antitrust review.