The requirements of the Hart-Scott-Rodino (“HSR”) Act and Rules are well known to companies that engage in significant M&A transactions. But less well known is their applicability to acquisitions of stock by individuals as part of compensation practices. Especially where relatively young and successful companies are involved, HSR obligations may unexpectedly arise where equity compensation is given to founders, board members, executives, and other employees (whom we will group together and call “Insiders”). Companies and individuals potentially caught in the HSR process for this reason should ensure they are aware of the trigger rules, as a failure to file can result in significant fines.
HSR Act Basics
The HSR Act and Rules require parties to notify the Federal Trade Commission and Department of Justice Antitrust Division in the event of certain transactions and pay a filing fee. After filing, the parties must wait up to 30 days (or more, if there are substantive antitrust concerns) before consummating the transaction. HSR filings are most often required for mergers and acquisitions for control of a company, but can also apply to transactions involving minority positions held by Insiders who acquire stock in their own company. It does not matter how the individual acquires the stock —whether on the open market, through an employee stock purchase plan, exercising options, or the vesting of Restricted Stock Units (“RSUs”) as part of a compensation package. HSR reportability will generally turn on the present value of an Insider’s holdings before the next acquisition or vesting date, combined with the value of the equity to be transferred. As HSR filings are required from both the company and the Insider, compliance is an ongoing process.
HSR filings potentially enter the picture if an Insider will hold more than $84.4 million (this figure is adjusted annually) in total company voting securities at the time of acquisition or vesting. Such individuals must aggregate what they will be acquiring with what they already hold—valued currently, not based on the time of the prior acquisition. This requires aggregating direct holdings, holdings through controlled entities and trusts, as well as holdings of spouses and minor children. If the present value of current holdings plus what will be acquired exceeds $84.4 million, HSR filings may be required, unless an exemption applies.
HSR obligations will not apply to an otherwise covered transaction if an HSR exemption applies. Common exemptions in Insider compensation situations are described below. The HSR Rules are highly technical, and you should always consult with HSR counsel before concluding that an HSR filing may not be required.
- Cashless Exercise. If the Insider exercises stock options and on the same day sells the acquired shares, he or she is not deemed to have made an acquisition. Similarly, an Insider who sells RSUs on the day of vesting also has not made an acquisition.
Example: Company President’s compensation package includes the vesting of RSUs on March 14. Company President arranges for the vested shares to be sold immediately upon vesting. Company President does not have an HSR filing obligation for the vesting RSUs.
- Pro Rata. An Insider’s acquisition of stock is also exempt if the acquisition does not result in an increase of the Insider’s per centum share of the outstanding voting securities of the company.
Example: Company Founder holds 33.3% of company voting securities. During a financing round, Company Founder acquires additional shares, but his pro rata share of the company does not increase, and he still holds 33.3% (or less). Company Founder does not have an HSR filing obligation at this time.
- Controlling Shareholder. A person who holds at least 50% of the company’s voting securities is deemed to control the company, and therefore subsequent acquisitions are not reportable. However, a decrease in holdings at any time below 50% may lead to a subsequent reporting requirement.
Example: Company Founder holds 50% of the company’s voting securities. Company Founder may acquire additional shares without having an HSR filing obligation. After the company’s IPO, Company Founder’s percentage decreases to 25%. Company Founder no longer controls the company, and her next acquisition may require an HSR filing.
- Non-voting Securities. Securities that do not carry a present right to vote for directors are not reportable, nor aggregated with voting securities.
Example: Company CEO receives a grant of RSUs as part of his compensation package. The RSUs do not carry voting rights until they vest, one year after the grant date. The grant of the RSUs is not reportable, but the vesting of the RSUs may be.
- Automatic Conversion During IPO. An Insider who acquires non-voting securities before the company is in registration to start the IPO process and the quiet period begins, and who did not acquire the non-voting securities in anticipation of the IPO, is not deemed to make an acquisition when those shares automatically convert to voting shares at the time of the IPO.
Example: Company VP acquires non-voting securities in company start-up before an IPO was contemplated and before the start of the quiet period. With the IPO, Company VP’s non-voting securities will automatically convert to voting securities. Company VP does not have a reporting obligation for the conversion, but may if she is otherwise acquiring stock.
- Passive Investment. The passive investment exemption applies to acquisitions where the acquiring person will hold 10% or less of the company’s stock and will hold the shares “solely for the purpose of investment.” However, the passive investment exemption is applied very narrowly and does not apply to company directors or officers, or any individual with the “intention of participating in the formulation, determination, or direction of the basic business decisions” of the company and, therefore, will often be unavailable.
- Five Years to Buy. Once an HSR filing is made, an Insider could continue to acquire additional company shares for up to five years without having additional HSR filing obligations. Importantly, the Insider’s holdings cannot exceed the next higher threshold.
Example: Company VP filed HSR before acquiring additional company voting securities on the open market and through the exercise of options. Company VP filed for the $50 million, as adjusted, threshold—currently $84.4 million. As long as Company VP’s holdings cross $84.4 million within the first year, Company VP can acquire additional shares, without re-filing, for another four years, as long as he does not cross the next higher threshold.