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That Stock Grant Could Cost More Than You Think -- The Application of the Hart-Scott-Rodino Act to Officer and Director Equity CompensationJanuary 1, 0001
It is likely that most officers and directors of U.S. public companies never think of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 -- often referred to as the Hart-Scott-Rodino Act or the HSR Act -- outside of its commonly understood application to mergers and acquisitions. These officers and directors need to be aware, however, that it has long been the position of the Federal Trade Commission that the HSR Act is applicable to any acquisition of voting stock -- including an acquisition by an individual -- that exceeds the Act’s jurisdictional thresholds. Due to this broad application of the HSR Act, an acquisition of voting stock by an officer or director of a U.S. company -- whether in the open market or as a result of an equity compensation plan -- could trigger a filing and waiting period obligation under the Act.
This Client Alert provides a general discussion of the pre-closing filing and waiting period provisions of the Hart-Scott-Rodino Act and their application to common types of acquisitions of voting stock by officers and directors of U.S. public companies. It is not our intent in this Client Alert to describe every situation in which an acquisition of voting stock would trigger an HSR Act obligation. Of course, because the application of the HSR Act to any acquisition will depend on the particular facts of that transaction, public companies and their officers and directors should consult with counsel before entering into a transaction that could trigger a filing under the Act.
Hart-Scott-Rodino Act Basics
The HSR Act may require any person (whether an entity or an individual) who proposes to acquire voting securities in a corporation to provide advance notice of that potential acquisition if the transaction exceeds the Act’s jurisdictional thresholds. The following points are fundamental to a basic understanding of the operation of the HSR Act:
- “Voting securities.” The securities acquired must have a present right to vote for the board of directors of the company. The actual ability to vote the stock is essential. An “acquisition” does not occur merely because a person acquires a right to acquire voting securities. As such, a purchase or an award of a warrant or an option to acquire voting securities of the company will not be HSR reportable; rather, the exercise of that option or warrant would be the HSR Act acquisition.
- “Acquisition.” An acquisition of voting stock may be subject to the HSR Act, regardless of the means of acquisition. Accordingly, acquisitions in the open market, by exercise of options or warrants, through an equity compensation program, or through an employee stock purchase plan must be considered when assessing HSR Act application.
Appreciation in the value of previously held stock, by itself, will not require reporting under the HSR Act. However, if an individual acquired an amount of company voting stock that was significantly less than the HSR Act threshold, but the value of that stock appreciated to just under an HSR Act threshold, then a very small acquisition of additional company voting stock could cause the individual’s holdings to exceed the HSR Act threshold and trigger an HSR Act filing obligation.
In most instances, the FTC will not consider a transaction to be an acquisition of voting stock if no action is taken by the individual (for example, where non-voting stock is forcibly converted to voting stock and the individual does not have sufficient advance notice of the event to allow for a pre-closing filing). It is important to note, however, that the acquisition of voting stock through a grant under a company’s compensation plan, such as a grant of restricted stock or the vesting of restricted stock units, may be subject to the HSR Act. As noted above, the HSR Act filing requirement is triggered by the acquisition of “voting securities”; accordingly, the application of the HSR Act generally will depend on when the individual actually received the right to vote the granted stock.
- “Aggregation.” Any acquisition of voting stock must be aggregated with all prior holdings of the company’s voting stock in determining whether the HSR Act jurisdictional threshold has been exceeded. In other words, if a person is $1 short of the HSR Act threshold, the acquisition of $1 of voting stock will be aggregated with all prior holdings of that person and will trigger the application of the HSR Act. The focus is on the value of all stock held at the time of the acquisition.
For purposes of the HSR Act, an individual’s holdings must be aggregated with the holdings of (a) a spouse; (b) any minor children; and, possibly, (c) any shares held in trust by the individual or his/her spouse or minor children.
- “Value.” In the case of voting stock, assessment of the HSR Act jurisdictional thresholds will be based on the current total value of the individual’s holdings, along with any holdings that must be aggregated with those holdings, at the time of the acquisition. The valuation of publicly traded securities to be acquired is usually determined by the acquisition price but the value of securities already held is determined by applying the lowest closing trading price within 45 days of closing.
- Penalty for failure to file. Despite its common application in situations that raise anti-trust concerns, the HSR Act applies equally to all acquisitions. This broad application requires individuals to comply with any HSR Act filing requirements. Further, the fine for failure to satisfy HSR Act filing requirements has been raised to a maximum of $16,000 per day, every day, from the date of the acquisition. Although there are cases where the FTC has assessed large individual fines, it is important to note that the FTC will rarely fine a first-time violator of the HSR Act filing requirement so long as the error was inadvertent and the filing is made promptly after discovery of the error.
The Hart-Scott-Rodino Act Jurisdictional Thresholds
An acquisition of voting securities may require that reports be filed with the FTC prior to closing of the acquisition (for this purpose, it is assumed that an exemption is not available). Whether reports must be filed will depend on the following:
- Acquisitions with a value of $65.2 million or less are not reportable: If, as a result of an acquisition, the acquiring person will hold an aggregate total amount of voting securities of a company with a value of $65.2 million or less, the HSR Act does not apply regardless of the size of the parties involved;
- Acquisitions with a value of more than $260.7 million are reportable: If, as a result of an acquisition, the acquiring person will hold an aggregate total amount of voting securities of a company with a value of more than $260.7 million, the HSR Act applies and the parties must file regardless of the size of the parties involved;
- Acquisitions with a value of more than $65.2 million but not more than $260.7 may be reportable, depending on the size of the company and the individual: If, as a result of an acquisition, the acquiring person will hold an aggregate total amount of voting securities of a company with a value of more than $65.2 million but not more than $260.7 million, the HSR Act applies if the following tests are met:
- One party to the transaction, or its parent company, has $130.3 million or more in total assets or annual net sales; and
- The other party, or its parent company, has $13.0 million or more in total assets or annual net sales. (Where the acquired person is not engaged in manufacturing, and is not a $130 million person, one only looks at value of assets.)
Filing Fees and Waiting Periods under the Hart-Scott-Rodino Act
Where the HSR Act thresholds are exceeded (and an exemption is not available), the company and the individual must make a filing with the FTC and the acquiring person must pay a filing fee of:
- $45,000 for transactions of less than $130.3 million;
- $125,000 for transactions of $130.3 million to $651.7 million; or
- $280,000 for transactions of $651.7 or more.
Further, the company and the acquiring person must observe a 30 calendar-day waiting period before closing the acquisition. This 30 calendar-day period may be terminated early by the FTC.
Most Common Hart-Scott-Rodino Act Exemptions for Individuals
- “Investment Only” Exemption. Under this exemption, which is often referred to as the “Passive Investor” exemption, an acquisition that would otherwise require HSR Act reporting is exempt if, after the acquisition, the acquiring person will hold ten percent or less of the outstanding voting securities of the company and the acquisition is made “solely for the purpose of investment.” This exemption is available regardless of the value of the acquisition. It is important to note, however, that this exemption is not available to officers or directors of the company issuing the securities or to any person who has any “intention of participating in the formulation, determination, or direction of the basic business decisions” of the company. As a result, it is possible that the exemption may be unavailable even for individuals who are not officers or directors of the company.
- “Pro Rata” Exemption. This exemption is available where “as a result of such acquisition, the voting securities acquired do not increase, directly or indirectly, the acquiring person’s per centum share of outstanding voting securities of the issuer.” This exemption may be useful for stock dividends or stock splits. In addition, it may be available for an individual’s purchase of securities in those situations -- including, based on the particular facts, acquisitions pursuant to an employee stock purchase plan -- where the acquisition did not increase the individual’s percentage ownership of company stock.
Some Events That May Result in a Hart-Scott-Rodino Act Filing Requirement
An officer or director may incur an HSR Act filing obligation in any of the following situations:
- an acquisition of voting stock upon exercise of a stock option or warrant;
- a grant of restricted stock where the grantee receives the right to vote the securities at the time of grant;
- the vesting of restricted stock units;
- a purchase of voting stock in an open market transaction;
- a purchase of voting stock pursuant to a dividend reinvestment plan; or
- a purchase of voting stock pursuant to an employee stock purchase plan.
SEC Reporting of Payment of Hart-Scott-Rodino Act Fees
A number of public companies have determined that it is appropriate to reimburse officers or directors for filing fees and legal fees relating to compliance with the HSR Act. This determination appears to be premised on the analysis that the “Passive Investor” exemption would be available to the individual but for their position with the company. In their executive compensation disclosure, public companies generally report these reimbursements as perquisites by providing:
- the dollar amount of the reimbursements in the Summary Compensation Table; and
- an itemized discussion of the amount of the reimbursement, along with a discussion of the nature of the HSR Act obligation, in a footnote to the Summary Compensation Table.
Most officers and directors -- and the U.S. companies for which they work -- do not consider the HSR Act outside of the antitrust context. The failure to consider the application of the HSR Act to an individual’s acquisitions of company voting stock, however, may result in that officer or director failing to comply with the filing and waiting period requirements of the Act and potentially incurring substantial fines. Public companies should consider including in their compensation analysis and their insider trading policies an appropriate process to track the ownership of voting stock by officers and directors and work with them to monitor HSR Act compliance.
 The value of such a trust must be included only if either (a) the trust is revocable or (b) the settlor(s) of the trust retain(s) a reversionary interest.
 These thresholds are increased annually by the FTC. The thresholds discussed in this Client Alert were established in February 2009.
 As a general matter, the larger person in this analysis will be the public company. It is important to note that the HSR Act looks to the companies “ultimate parent entity,” or “UPE.” For this purpose, a UPE is an entity not controlled by any other entity and, in the case of a corporation, “control” means either (a) holding 50% or more of the outstanding voting securities, or (b) having the contractual power to designate 50% or more of the directors. Further, as a general matter, the smaller person in this analysis will be the individual. For this purpose, an individual is always his or her UPE.
 When applying this test to an individual, the HSR Act looks to the person’s financial statements. As an individual generally will not have regularly prepared financial statements, the HSR Act would require the individual to create a pro forma balance sheet to determine whether he or she would meet the “size-of-person” test. If the individual in fact does not have a regular balance sheet, in creating such a balance sheet, the individual would not be required to include the value of any voting securities he or she already holds in the company. This may prevent the individual from meeting the size-of-person test. (There are other assets that also can be excluded.)
 This discussion assumes that an exemption is not available and the acquisition causes the officer or director to cross an HSR Act threshold.
 In this regard, the HSR Act may not apply to a true cashless, net exercise of an option where the option is exercised and the shares are sold instantaneously. Specifically, an option exercise will not be deemed to be an acquisition if (a) the officer sells all the shares acquired through the option exercise or sells other shares in an amount not less than the number of shares acquired through the option exercise, and (b) the sale is the same day as the exercise.
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