On September 21, 2020, the Federal Trade Commission (FTC) announced two proposed changes to the Hart-Scott-Rodino (HSR) Act of 1976, as amended, implementing rules. These changes could significantly increase the reporting obligations of affiliated investment funds. The FTC's invitation for comments provides an opportunity to shape the contours of the final rules.
The proposed amendments are likely to limit the availability of certain existing exemptions to minority investments, in particular the passive investment exemption and size-of-person test. In other words, unless modified, both of the proposed rules could expand the number of filings, rather than limiting them.
Proposed Expansion to Definition of Person
Background. Under the HSR Act, acquisitions that meet certain monetary thresholds in terms of the size of transaction and the parties' annual net sales and total assets must be reported to the FTC and Department of Justice Antitrust Division (DOJ), and observe a mandatory waiting period, prior to closing unless an exemption applies. The current minimum size of transaction that can trigger a filing obligation is $94 million.1
Current Definition of Person. The HSR rules currently define the term "Person" to mean an Ultimate Parent Entity (UPE) that is not controlled by any other entity.2 Control of a limited partnership is conferred by having the right to 50 percent of the profits or assets upon dissolution. Most investment funds are therefore their own UPE because no limited partner holds a majority of the economics.
Under the current rules, an acquiring fund that is its own UPE takes into account only the value of its investment in determining whether the $94 million size of transaction test is satisfied (and does not aggregate the value of any co-investments by its affiliated funds).
If an investment fund that is its own UPE needs to make an HSR filing, then for the most part the information it reports under the current rules is limited to itself and its controlled investments—such as disclosure of the individual fund's financial statements; a list of its individually controlled portfolio companies and their financial statements, U.S. revenues and geographic operations; competitive analyses of the acquisition prepared by the fund's investment committee or advisors; and certain controlling acquisitions made by the individual fund within the last five years.3
Proposed Expanded Definition of Person. FTC has proposed redefining the term "Person" to include all associates of the UPE who have their operational and investment decisions determined by the same common manager. In the case of a private equity investment fund, the associates would include the fund's manager and all other funds under common management control.
This change will almost certainly result in many more filings than are required under the current rules. For instance, if a common manager has operational and investment decision authority over a main investment fund, an offshore fund and a friends-and-family fund, then all of these entities would be associates of each other. In contrast to the current rules, the investments by each of the three funds would need to be aggregated to determine whether the $94 million size of transaction test is met. Even if the main fund is investing less than $94 million, an HSR filing would be required under the new rule if the investments by the offshore fund and friends-and-family fund increased the total aggregate investment to more than $94 million.
In addition, again in contrast to the current rules, any filing would require the disclosure of information relating not only to the main investment fund but also to the manager, offshore fund, and friends-and-family fund. Each of these entities would need to provide their most recent financial statements, any deal related competitive analyses and information on controlled portfolio companies (including the allocation of their U.S. revenue by NAICS code, a table showing their 5 percent or greater shareholders, minority investments of 5 percent or more in any entities that report in the same NAICS codes as the target, and prior acquisitions of entities that report in the same NAICS codes as the target).
Proposed De Minimis Exemption
Background. Under the current rules, investments resulting in the acquiring person holding 10 percent or less of an issuer's voting securities are exempt as long as the acquiring person made the acquisition "solely for the purpose of investment."4 The agencies have interpreted the intent prong of this exemption very narrowly. Merely holding and voting stock is sufficiently passive, but certain communications with management and other common stockholder actions (e.g., gauging interest from outsiders about being a candidate for an executive officer position) have been found to be inconsistent with the exemption.5 Consequently, some investors are hesitant to utilize the exemption, particularly as alleged misapplication of the exemption has been a focus of recent enforcement activity by the agencies.
In 1988, citing compliance concerns, burden on investors, and interference with securities disclosure laws, the FTC considered alternatives to replacing the investment-only exemption. One of the alternatives was a 10 percent de minimis exemption with no conditions. Ultimately, a final rule was never adopted.
New De Minimis Exemption. The FTC is revisiting a de minimis exemption as an alternative to, rather than a replacement of, the solely for the purpose of investment exemption in Section 802.9 of the HSR Rules. Unlike the 1988 proposals, the new approach to a de minimis exemption would exempt acquisitions resulting in an acquiring person holding 10 percent or less of an issuers' voting securities only if the following conditions are met:
In connection with the exemption, the FTC proposes the following definition of the term competitor: "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." NAICS codes at the six-digit level broadly cover industries, not relevant product markets. As a result, the new de minimis exemption is not likely going to be available to investment groups who focus on specific industries. For example, a private equity management company may focus on the IT industry and have a variety of investments in software companies that all report under NAICS 511210 Software Publishers. If one of its funds decides to newly invest in 5 percent of the voting securities of a video game developer that reports in NAICS 511210, the exemption will not apply if it has an investment of 1.5 percent in a non-competing supplier of human capital management software that also invests in NAICS 511210.
As shown in the table below, similar conduct, other than investment intent, precludes the use of the solely for the purpose of investment exemption and the proposed de minimis exemption. In fact, in some cases the proposed de minimis exemption is more restrictive. For example, the existing passive investor exemption would exempt from a filing a situation where an acquiring company makes a 5 percent investment in a target company where that acquiring company already owns 5 percent of a competitor to the target company. Under the proposed de minimis exemption, a filing would be required in such a circumstance. Moreover, under the current rules, the competitor exclusion to the passive investor exemption only applies to actual competitors; under the proposed de minimis exemption, the exemption is not available where an acquiring company has an ownership interest in a firm with a NAICS overlap with the potential target company.
Availability of Exemption
Despite acknowledging that the agencies have not challenged a stand-alone investment of 10 percent or less since the promulgation of the HSR Rules in 1978 and have "rarely engaged in a substantive initial review" of such acquisitions, the FTC has proposed a very limited exemption. Notably, the proposed de minimis exemption does not exempt acquisitions of stock by corporate insiders (e.g., a founder and chief executive officer of a company) even where that corporate insider has no investments in any of the issuer's competitors. Therefore, option exercises, vesting of restricted stock units (RSUs), and executive stock compensation still may require notification, even though they present no competition concerns.
Other Implications of the Proposed Rules
The proposed amendments, if adopted, will impact the current application of the solely for the purpose of investment exemption and increase the likelihood that an acquisition by an investment fund will meet the size-of-person test.
Solely for the Purpose of Investment Exemption. The proposed rulemaking affects the passive investor exemption in two ways. First, the expansion of the definition of acquiring person to include associates of investment funds clarifies that that all holdings by associated funds must be aggregated when determining whether the 10 percent or less prong of the exemption is met. Second, the rule will create ambiguity as to the meaning of competitor in a passive investor analysis. Under the current approach, the exemption is not available if the investor is a competitor, but it is still available if the investor is not a competitor but has overlapping NAICS codes with the issuer. The new definition of competitor, which includes NAICS overlaps, may be applied to the passive investor rule, further eroding the availability of the exemption.
Size-of-Person Test. For transactions valued in excess of the current $94 million threshold but not exceeding the current $376 million threshold, the size-of-person test, which looks to each person's total assets and annual net sales, must be met in order for a filing to be required. To determine total assets of an acquiring person, one must look to the acquiring person's last regularly prepared balance sheet. If the acquiring person has no regularly prepared balance sheet, then the acquiring person may deduct the value of cash used as consideration for the voting securities to be acquired and for transaction expenses. When an investor creates a new fund UPE to make an investment, it often does not have a regularly prepared balance sheet or other assets besides cash that it can deduct from total assets. As a result, an HSR filing is often not required by a newly formed UPE making its first acquisition. However, under the proposed changes to the definition of person, the acquiring person includes the investment manager and all associates, meaning that the total assets of all of these entities must be considered when determining the size-of-person test is met and therefore reduces that chances that no filing will be required for the transaction.
 The size of transaction, annual net sales, and total assets monetary thresholds are adjusted by FTC in January of each year based on changes in gross national product.
 The term “Person” also includes any entities that the Person controls directly or indirectly.
 The acquiring fund may also need to disclose information about its affiliates, but only to the extent these affiliates report deriving U.S. revenue in the same North American Industrial Classification System (NAICS) code as the target.
 See 16 C.F.R. § 802.9. Section 801.1(i)(1) of the HSR Rules defines solely for the purpose of investment as having “no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.” The Statement of Basis and Purpose (SBP) promulgating the original rules provided that the following types of conduct could be viewed as inconsistent with the investment-only intent: 1) nominating 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. 43 Fed. Reg. 33,450, 33,465 (July 31, 1978).
 Feinstein, Debbie; Libby, Ken; and Lee, Jennifer, “’Investment-only’ means just that,” FTC Bureau of Competition, Aug 24, 2015, available at https://www.ftc.gov/news-events/blogs/competition-matters/2015/08/investment-only-means-just.
 PNO Informal Interpretation 18010003 (Jan. 29, 2018), available at https://www.ftc.gov/enforcement/premerger-notification-program/informal-interpretations/18010003.
 PNO Informal Interpretation 1202014 (Feb. 27, 2012), available at https://www.ftc.gov/enforcement/premerger-notification-program/informal-interpretations/1202014 (PNO rescinded interpretation on May 4, 2016).
 PNO Informal Interpretation 1908002 (Aug. 28, 2019), available at https://www.ftc.gov/enforcement/premerger-notification-program/informal-interpretations/1908002.