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Recent FTC Enforcement Action Reinforces Narrow ‘Passive Investor' Exemption to HSR Reporting Requirements
On September 25, 2012, Biglari Holdings, Inc. agreed to pay a civil fine of $850,000 to resolve Federal Trade Commission (FTC) contentions that it improperly relied upon the "passive investor" exemption to the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR Act") in connection with its investment in Cracker Barrel Old Country Store, Inc. during the summer of 2011. According to the government's Complaint, Biglari acquired voting securities in excess of the HSR Act's filing thresholds while seeking to place one or more directors on Cracker Barrel's board of directors.
The HSR Act applies to acquisitions of assets or voting securities in excess of certain thresholds unless an exemption applies. One such exemption (found in Rule 802.9) provides that acquisitions of 10 percent or less of an issuer's outstanding voting securities are not subject to the HSR Act's requirements, regardless of the value of the voting securities, so long as they are "made solely for the purpose of investment." The FTC interprets this exemption narrowly to preclude any intent to participate in the formulation of the basic business decisions of the issuer, and the non-exhaustive list of conduct the FTC has identified as being inconsistent with an investment intent (and creating a rebuttable presumption of non-passive investment) includes: (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.
Because the investor's intent is at issue, the FTC looks for evidence of intent, such as statements in a filing party's SEC documents and elsewhere to the effect that the investor may: seek control; formulate future plans to merge with, liquidate or reorganize the issuer; communicate with shareholders regarding a proposed transaction; and/or retain a proxy solicitation firm. The FTC has not deemed the mere fact of voting the stock for or against a corporate action to be evidence of a non-passive intent. Likewise, having a board observer is not sufficiently "active" to preclude reliance on the passive investment exemption.  However, even if the primary purpose of the transaction is investment, if the acquisition serves additional purposes, such as a subsequent acquisition to gain control, it is not exempt.
According to the Complaint, Biglari acquired voting securities valued in excess of the HSR Act's filing threshold on June 8, 2011, apparently relying on the passive investment exemption to acquire up to 10 percent of the issuer's voting securities without observing the HSR Act's requirements. However, as soon as five days later, Biglari filed a Form 13D for its holdings in Cracker Barrel with the SEC, and the next day Biglari's CEO called the CEO of Cracker Barrel to request an in-person meeting to discuss his ideas to improve shareholder value at Cracker Barrel. On June 23, 2011, officers of Biglari and Cracker Barrel met, and Mr. Biglari requested that he and another Biglari executive immediately be appointed to Cracker Barrel's board of directors. On August 26, 2011, Biglari filed a Notification under the HSR Act to acquire additional shares of Cracker Barrel, and the FTC granted early termination of the HSR waiting period on September 22, 2011.
The FTC has in the past obtained civil penalties from companies that improperly sought to rely on the investment only exemption for acquisitions of a competitor's voting securities, and fines have been assessed for technical violations of the HSR Act. However, outside of acquiring voting securities of a competitor, not much guidance exists for investors that seek to rely on the passive investment exemption. In fact, the FTC's website identifies improper reliance on the passive investment exemption as one of the scenarios giving rise to the highest numbers of "corrective" HSR filings. By bringing this enforcement action against Biglari, the FTC has shown that seeking to immediately install a director on the board is sufficiently close to "serving" or even "nominating" a candidate to the board to preclude reliance on the passive investment exemption.
An investor that has been acquiring voting securities in reliance on the passive investor exemption, and then contemplates conduct that may later be deemed inconsistent with the exemption, must file and observe the HSR Act's 30-calendar-day waiting period prior to acquiring even one additional share of the issuer's voting securities. The waiting period can be shortened in the discretion of the antitrust agencies if the transaction does not pose competitive issues, but in practice, investors who are not competitors but are otherwise not planning to rely on the passive investor exemption should allow up to 45 days to draft and submit the Notification, and then should observe the waiting period. In some situations securities of the issuer that do not convey a current right to vote for directors, for example options or warrants, may be acquired prior to the expiration of the waiting period.
 Statement of Basis and Purpose, 33 Fed. Reg. 33450, 33, 465 (July 1, 1978).
 ABA Section of Antitrust Law, Premerger Notification Practice Manual, 4th Ed. 2007, Int. #16.
 Formal Interp. 4, 6 Trade Reg. Rep. (CCH) Par. 42.475, at 42, 603 (Jan. 17, 1979).
 Complaint available at http://www.ftc.gov/os/caselist/1110224/index.shtm.
 Additional enforcement actions taken to enforce Rule 802.9's narrow "investment only" exemption include the 2004 action against William H. Gates with respect to an investment in ICOS Corporation in 2002 while he was a director of the issuer (http://www.ftc.gov/opa/2004/05/gates.shtm), and the 1995 action against William Farley with respect to an investment in West Point-Pepperell, Inc. in 1988 while he was allegedly considering an acquisition of control of the issuer (http://www.ftc.gov/os/caselist/8910036/index.shtm).