In the last post of this series, I posed a challenge: to find the UPE, or ultimate parent entity, and acquired person in a hypothetical.  To find the answer, three steps are necessary:

1. Identify the acquired entity, that is (1) the enitity whose assets are being acquired, or (2) issuer whose voting securities are being acquired, or (3) the unincorporated entity whose membership interests are being acquired.
2. Trace the chain of control up, using the definitions for control for corporations, unincorporated entities, and trusts, until the entity is reached which itself is not controlled by another entity. That is the UPE. (Individuals are never controlled, and therefore always UPEs.)
3. Trace the control down from the UPE (or UPEs) until all controlled entities are identified. They are the entities “included” in the person. The person is the UPE plus all entities controlled by it, directly or indirectly, 801.1(a)(1). Without finding all entities included in the acquired or acquiring person, the size-of-person test cannot be applied.

Remember 801.1(c)(8): A person holds all assets and voting securities held by the entities included within it; in addition to its own holding, an entity holds all assets and voting securities held by the entities which it controls directly or indirectly.

In the hypothetical the acquired entity is H Inc. It is the corporation whose voting securities are being acquired. Tracing the chain of control up, you’ll find three UPEs (marked with UPE crowns): Mrs. Z, Mr Z, and A Inc.

click to enlarge

Some explanations:

• Mrs. Z and Mr Z are both UPEs, even though neither of them individually meets the definition of control for corporations (holing 50%+ voting securities of H Inc, or having the right to appoint 50%+ of directors). The reason is that the holdings of spouses (and their minor children) are aggregated under Rule 801.1(c)(2).  Mrs. Z and Mr Z are therefore treated as if they were each holding 55% of H Inc’s voting security, which is enough to give them control. Since individuals can’t be controlled by another entity, they are each a UPE and will have to file as acquired persons. Only one notification form is required for spouses, however, 803.2(a).
• F LLC controls H Inc because it has the right to appoint 50% directors (even though it holds less than 50% voting securities).
• Mr Y does not control F LLC: While he has the right to appoint the entire management board of F LLC, for HSR purposes unincorporated entities are “controlled” only by entities with a right to 50% of profits or assets upon dissolution. This distinguishes the treatment of unincorporated entites from that of corporations.
• Instead F LLC is controlled only by E Inc., which has a right to 99% of F LLC’s profits or assets upon dissolution.
• But who controls E Inc? There is no single entity that either holds 50%+ of E Inc’s voting securities or has a right to appoint 50%+ of directors. The four shareholders of E Inc are Mr Y (1% voting securities or vs), B Inc (29% vs), C Inc (30% vs), and D Inc (40% vs). B and C are controlled by A Inc, their sole shareholder, and D Inc is controlled by both C Inc and L Inc (each 50% vs). This means that A Inc. indirectly controls E Inc., since A Inc, through B, C, and D controls a total of 99% of the voting securities of E Inc. Even though E Inc at first blush looks like it is controlled by no other single entity, it is indirectly controlled by A Inc. (L Inc does not indirectly control E Inc, even though it controls D Inc, since D Inc has only a 40% stake in E Inc.)
• Finally, at the top, A Inc. is a UPE because it is not controlled by anyone else: Mrs. X 25% stake is insufficient, as will be the stakes of all the public shareholders included in the 75% public float.

Once the UPEs have been identified the next step follows: tracing control down until all controlled entities have been identified. The following graph shows the analysis for A Inc only. (The other two UPE’s, Mrs. Z and Mr Z, each control H Inc, I Inc, and J Inc.)

click to enlarge

The only additional explanation required here concerns G GP, the general partner entity of G LP (G GP is some unincorporated entity, like an LLC). G GP is controlled by E Inc, which has the right to 51% of G GP’s profits or assets upon dissolution. But G GP does not control G LP for HSR purposes, even though in practical terms G GP will make all business decisions of G LP, as its general partner. The Rules’ definitions of control are rigid and formalistic:  G GP determines the competitive behavior of G LP, but only profits and assets upon dissolution are considered HSR control. Since 99% of those rights rest with the dispersed limited partners, no one controls G LP. (This is a common situation for investment funds organized as limited partnerships, or other unincorporated entities where governance rights and economic rights are divorced from each other.)

In closing it’s important to emphasize that control is not exclusive under HSR. An entity may be controlled by more than one other entity. For example, a corporation may have a 50%+ shareholder but another person who may appoint the majority of directors.  In fact, a corporation may be controlled by a maximum of 4 entities (ignoring spouses as shareholders):

• The first holding 50% voting securities,
• The second holding the other 50% voting securities,
• The third having the contractual right to appoint 50% of the board of directors, and
• The fourth having the contractual right to appoint the other 50% of the board.

An unincorporated entity can also be controlled by a maximum of 4 entities:

• The first having the right to 50% profits,
• The second the right to the other 50% profits,
• The third having the right to 50% assets upon dissolution, and
• The fourth the right to the other 50% assets upon dissolution.

(The right to assets upon dissolution refers to the residual distribution after all claims and preferences have been resolved; if the rights are not clear, determine control of an unincorporated entity as if it were being dissolved now.)

The next post in this series will deal with unincorporated entities in more detail, answering the question whether they are “assets” or “voting securities” under §7A.

Previous posts: §7 and HSR. The Basic Test. Parsing Acquisitions. Getting to the Person.

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The last post left off by listing the three steps required to parse an acquisition for HSR purposes: (1) Identify all acquisitions in the transaction, (2) eliminate the non-reportable ones, and (3) find the acquiring and acquired persons. It’s that last step this post is about.

The Rules provide a set of nestled definitions that lay out how you get from the the acquisition to the person. This involves an up-down movement through the corporate hierarchy of entities. Starting with the entity that acquires or is being acquired (remember this means the entity which holds the assets being acquired or the issuer whose voting securities are being acquired), you follow the chain of control up until you reach the peak, or ultimate parent entity (UPE), which is an entity that itself isn’t being controlled in HSR terms.

An entity is virtually anything, including individuals and any sort of business entity, except U.S., state, and foreign governments or their subdivisions or agencies (801.1(a)(2) – check this only if you come across something weird). Once the UPE is reached, every entity controlled by the UPE, directly or indirectly, is included in the person (801.1(a)(1)). That’s the down movement. The real work is determining control, which differs from what one might expect in important ways (801.1(b)). Here is a chart showing the nestled definitions:

click chart to enlarge

Corporations can be controlled in two ways: Either holding 50% or more of the outstanding voting securities, 801.1(b)(1)(i), or having the contractual power to appoint 50% or more of the directors, 801.1(b)(2). (To hold means to have beneficial ownership, direclty or indirectly.) Unincorporated entities, like partnerships or LLCs, can only be controlled in one way: Having a right to 50% or more of profits or assets upon dissolution, 801.1(b)(1)(ii). The right to appoint a management board or a similar governing body of an unincorporated entity does not give control over the entity for HSR purposes. That’s a point where HSR diverges from what one would expect if control were defined as the actual ability to affect competitive decisions (as it should for §7 purposes). In fact, a subjective test of control was originally proposed for HSR but ultimately rejected in favor of an imperfect but clear-cut rule. The same reasoning led the FTC to  look to profits/assets-upon-dissolution only when the treatment of unincorporated entities was revised in 2005.

In addition to these rules about control, there are few attribution rules, for example: [1] The holdings of a spouse are attributed to the other spouse. [2] A trust is usually controlled by the trustee(s), unless it isn’t (for example, because the trust is revocable), 801.1(c)(3)-(5). And [3] a person holds all assets or voting securities held by entities included within it—that is another way of expressing the down movement of including everything that the UPE controls, directly or indirectly, within the person.

So here is a little challenge: The graph below shows a corporate structure chart. The voting securities of H Inc. held by F LLC are being acquired. Who is the UPE? What is included in the acquired person?  To answer those to questions, it’s first necessary to identify the UPE in the up movement, tracing lines of control. Then, in a down movement, everything controlled by the UPE is swept into the acquired person. Find the answers in the next post.

click chart to enlarge

Previous posts: §7 and HSR. The Basic Test. Parsing Acquisitions.

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Before continuing this series of posts about the Hart-Scott-Rodino Antitrust Improvements Act (HSR), here are some links to useful materials. The most basic materials are the HSR statute, §7A Clayton Act (15 USC 18a), and the rules implementing HSR: Coverage Rules (16 CFR 801), Exemption Rules (16 CFR 802), and Transmittal Rules (16 CFR 803). You will need both statute and rules to follow along with these HSR Primer posts. The FTC’s Premerger Notification Office provides much helpful material, including links to the statute and rules, as well as to the Statement of Basis and Purpose and formal interpretations, here. The form and instructions can be found here. There are also useful introductory guides (using unadjusted thresholds), a searchable data base of informal interpretations, and a FAQ. As a reminder, these HSR Primer posts are eclectic and make no pretense to provide a complete guide to HSR reportability. 

Parsing Acquisitions. The world according to HSR is flat. It is two-dimensional in two important respects:

• There are only Acquired Persons and Acquiring Persons. Every transaction is broken down into binary acquisitions with (one or more) Acquiring Persons and (one or more) Acquired Persons. (The topic of this post.)
• There are only voting securities and assets. Yes, even though the Rules now deal with interests in unincorporated entities. (This will be the topic of a future post.)

This binary view of acquisitions goes back to the magic language of §7A, and it means that within the transaction, each acquisition must be identified, and for each the acquired and acquiring person, before the  jurisdicitonal SOT and SOP can be applied. While the Rules identify entities (within persons) and issuers, the question of where an acquisition is located, and therefore the question of reportability, turns exclusively on the acquired and acquiring person. These terms are not identical with “buyer,” “seller,” “target,” or “parent” that corporate agreements might identify. In a second step, those acquisitions that will not lead to reportability can be eliminated. To see how this works, here are a series of basic situations.

Assets for cash. The most basic situation is an asset purchase, in which the Acquiring Person acquires assets (say a factory) from the Acquired Person for $350 million in cash. There are two acquisitions: the first of the factory (assets), and then of cash. Rule 801.2(e) make clear that both these acquisitions must be analyzed separately:

Whenever voting securities or assets are to be acquired from an acquiring (!) person in connection with an acquisition, the acquisition of voting securities or assets shall be separately subject to the act.

Once the acquisitions have been identified, the second step is to eliminate acquisitions that will not lead to reportability. The most important instance is that the payment of cash for voting securities or assets is not a reportable acquisition. The Rules make this point by stating that “cash shall not be considered an asset of the person from which it is acquired,” 801.21(a), with the effect that in the example above, there is only one acquisition: that of the factory (assets of Acquired Person).

Voting securities for cash. The second basic situation is a stock purchase, in which Acquiring Person acquires stock of Target from Acquired Person for cash. (As in the previous example, the cash paid as consideration is not considered an asset of the person from which it is acquired, and thus won’t lead to a reportable acquisition.) The important point is that Target is not the acquired person, even though it is the entity that is being bought. The reason is Target is controlled by Acquired Person, and that for HSR “Person” means ultimate parent entity—another delightful HSR construct that will be topic of a separate post. For now it’s sufficient to note Rule 801.2(b):

… the person(s) within which the entity whose assets or voting securities are being acquired [here: Target] is included, is an acquired person.

To be “included within” means controlled by in HSR.

Voting securities for voting securities. The next example shows the simplest case in which the binary view of acquisitions leads to breaking up a transaction into two acquisitions:

Here, A acquires the voting securities of Target from B in a stock-for-stock deal. B receives newly-issued voting securities in A as consideration. Again, there are two potential acquisitions, but since this time both acquisitions are of voting securities, 801.21(a) doesn’t apply. The result is that there are indeed two reportable acquisitions. A is the Acquiring Person with respect to the voting securities of Target, but the Acquired Person with respect to its own newly-issued voting securities. Conversely, B is the Acquired Person with respect to Target’s voting securities, but the Acquiring Person with respect to A’s voting securities. Rule 801.2(c) states:

For purposes of the act and these rules, a person may be an acquiring person and an acquired person with respect to separate acquisitions which comprise a single transaction.

And yes, in this situation, A and B would file just one form each as both acquired and acquiring persons (watch out for items 5-8, which require only a limited response from acquired persons).

To understand the complicated terms of acquisition, acquiring and acquired person under HSR, it’s helpful to consider the starting point: enforcement of §7 Clayton Act, which aims at acquisitions that lessen competition. For example, the transfer of cash is competitively neutral, and shouldn’t be the reportable, which explains 801.21(a). (The SBP says that “cash generally lacks competitive significance.”) Similarly, looking not to buyers or sellers or similar corporate terms, but—through the construct of acquiring and acquired persons—at who currently and after the transaction will control the assets or voting securities goes to the competitively-relevant question of how the transaction will affect the ability to make competitive decisions (such as raising prices). Who will make competitive decisions before and after the transaction? is a fun question to ask, but only an imperfect proxy for determining HSR reportability.

Voting securities beat assets. The indirect concern with control also explains the rule that voting securities are never assets, even though an investment in a company is certainly an asset for bookkeeping purposes. Rule 801.21(b) states:

Neither voting or nonvoting securities nor obligations referred to in section 7A(c)(2) [things likes bonds and mortgages] shall be considered assets of another person from which they are acquired.

This rule means that in terms of parsing acquisitions, voting securities beat assets, because the voting securities that are being acquired are considered to be acquired from the person in which the entity whose voting securities are being acquired is included (801.2(b)). That, incidentally, is the sort of sentence only long exposure to HSR can lead one to write or understand. So here is a graph to explain it:

Mr. X sells his minority stake in Issuer to Acquiring Person. He doesn’t have to file HSR (because he doesn’t control Issuer, or, in HSRish, because Issuer is not an entity included within him). But Issuer’s parent, Acquired Person, does have to file. (To make sure Acquired Person knows about the sale and its filing obligation, Acquiring Person would have to give Acquired Person notice in these situations, see 801.30(a)(5), 803.5(a).) If the minority stake were treated as an asset of Mr. X, Mr. X himself would be the acquiring person (and UPE), Issuer wouldn’t be included in the acquiring person (since Mr. X doesn’t control Issuer), and the potential competitive significance of the acquisition would not be apparent in the filing. That’s why voting securities are never asset.

To sum up, these are steps required to parse a transaction into HSR-relevant acquisitions. Once this work is done, the jurisdictional tests can be applied.

1. Identify all acquisitions of voting securities or assets [or interests in unincorporated entities].
2. Eliminate those acquisitions that won’t lead to reportability, such as cash. (There are others, like contributions to newly-formed subsidiaries, intraperson transfers, or certain aspects of joint venture transactions.)
3. Identify the acquiring and acquired persons for each remaining acquisition by finding UPEs. That’ll be the topic of the next post.

Previous posts: HSR and §7. The Basic Test.

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Continuing my series of posts about the Hart-Scott-Rodino Act, here is a discussion of the basic test of reportability under HSR.

§7A Clayton Act contains this magic language:

Except as exempted, no person shall acquire, directly or indirectly, any voting securities or assets of any other person, unless both persons file notification and the waiting period has expired, if [the commerce, size-of-transaction, and size-of-person tests are met].

The following is a graphic representation of this relatively simple structure.

The graph shows the basic steps in the analysis: (1) Acquistion of voting securities or assets, (2) Size of Transaction test (SOT), (3) Size of Person test (SOP), and (4) Exemptions. SOT and SOP require an application of the annually-adjusted jurisdictional thresholds (and I’ll post about them in more detail in the future). The basic structure shows that SOT and SOP are linked in such a way that SOP only applies to “medium” size transaction, and is inapplicable if the size of the transaction is either equal to or less than the lowest threshold (of currently $63.1 million) or exceeds the largest threshold (of currently $252.3 million).

The problem with applying this basic structure in determining reportability is that the actual tests are trivial, but the steps required to arrive at a point where the tests can be applied is difficult. HSR terms such as acquisition, acquiring and acquired person, voting securities, or assets are loaded; the rules to determine the size of a transaction are complicated and often require parsing through insanely convoluted aggregation rules to determine what must be included. The different issues also don’t always appear at a logically consistent point in the analysis. For example, the acquisition of debt bonds is not reportable, but is that because bonds aren’t “voting securities or assets” or because bonds are exempted under §7A(c)(2), or both? As a result, reportability is more akin to a complex web than to a flow chart. Sometime it makes sense to start with the SOT, sometimes an exemption is the best starting point (like §7A(c)(3)/802.30, intraperson transfers). Still, it is helpful to recall that there is a basic structure that underlies the analysis.

There is one test I don’t suggest you waste time on, and that I didn’t give equal space in the graph above: the commerce test of §7A(a)(1). It is so broad as to apply virtually always (if you have seen an acquisition of more than $50 million that doesn’t meet the commerce test, please drop a line). HSR applies not only to persons engaged in commerce (which means interstate commerce or foreign commerce, see §12 Clayton Act or §4 FTC Act, alternatively referenced in Rule 801.1(l)), but also to persons engaged in activities affecting commerce. This is stretching the Commerce Clause to its limits. There is no court guidance an what a person might look like that isn’t engaged in interstate commerce, but that affects it. HSR’s commerce test is also broader than other such tests in antitrust law: the Sherman Act requires that the prohibited activity affect commerce, Robinson-Pattman that the “sale” be in commerce, and §7 Clayton Act at least requires that both persons must be engaged in commerce or activities affecting commerce. Under HSR it is sufficient that either acquiring or acquired person, or any entity included in them, are so engaged, as §7A(a)(1) and Rule 801.3 make clear. The HSR commerce test wasn’t exactly designed to restrict the Act’s applicability, and the following graph showing the structure of the HSR commerce test is the last time I’ll mention it.

Previous post: HSR and §7

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If you think it’s bad having to admit at parties that you are a lawyer, try explaining that what you deal with is called the Hart-Scott-Rodino Antitrust Improvements Act of 1976. At least you won’t be stuck talking about work all night. But if there isn’t much glamor in HSR work, there certainly is the devil in it: The Act and the Rules accompanying it are hopelessly complicated and convoluted. Hopelessly? Not quite. There is the new edition of Axinn/Fogg/Stoll/Prager/Pisa. And I am planning a series of posts about HSR, and specifically about questions of reportability, to show some principles, shortcuts, and tricks that I have found helpful. I’ll add the disclaimer now that it will all be eclectic and some of it apocryphal. Probably none of it will be news to those who deal with HSR regularly. Please let me know your comments.

The big question of course is, to what extent does §7 guide the interpretation of HSR? §7 Clayton Act forbids acquisitions of voting securities or assets that will substantially lessen competition or tend to create a monopoly. The HSR Act, as a procedural statute, seeks to aid the enforcement of §7 by requiring the premerger notification of transactions that are likely to run afoul of §7. It is obviously easier to prevent a merger than it is to undo it. But how likely must a transaction be to violate §7 in order to justify premerger notification? There are two opposing interests at work: The interest of the enforcement agencies is to cast the net wide in order not to miss anything. The interest of merger parties is not to incur the costs of the premerger notification process needlessly. But it is also in our general interest not to make the premerger notification process too costly, since inefficiencies in the process by definition will deprive consumers of efficiency-enhancing benefits. The slightly simplified view of antitrust lawyers is that there are only two reasons for a merger or an acquisition: To enhance efficiency or to increase market power (thus potentially lessening competition and harming consumers). If a transaction that doesn’t fall under §7 is subject to premerger notification requirements, the efficiencies flowing from the transaction are delayed, temporarily depriving consumers of the benefit. This trade-off between prevention and efficiency is a necessary feature of a premerger notification program, and the only question is: how can we optimize the selection of mergers that should be notified and subject to a waiting period?

This graph shows the overlap between §7 and HSR reportability. HSR is overinclusive, since it requires the notification of transactions that have little or no potential of substantially lessening competition (that will be theme throughout these posts). But it is also underinclusive, since there are transactions that do (or could) lessen competition but that are not subject to reporting requirements. The primary example are transaction that fall below the minimum threshold of currently $63.1 million. The graph  shows the three tools that HSR gives the antitrust agencies: a waiting period of usually 30 days (15 days for cash tender offers), access to the parties’ relevant documents (specifically those discussing markets, market shares, competition, competitors and so forth), and Requests for Additional Information and Documentary Evidence, known as Second Requests, which function as subpoenas and interrogatories that the agencies may issue without recourse to the courts.

The size of the green circle, for transactions violating §7, is probably too large in the graph, as the following graph suggests. The information comes from the DOJ/FTC Annual Report for Fiscal Year 2007.

The statistics show that about 1.5% of all reportable transactions are ultimately challenged by the agencies. The empirical question raised is whether the competitive harm to consumer welfare of those 1.5% outweighs the cost of premerger notification imposed on the other 98.5% transactions. But phrasing the question that way skews it. It will be hard to quantify the preventive effect of the premerger notification requirement: anti-competitive transactions are restructured or abandoned because it is clear to the parties that the agencies would challenge them after HSR notification has been filed. My hunch is that the preventive effect is significant and significantly higher than it would be if all §7 enforcement occurred post-closing; the HSR Act therefore is not ludicrously broad in its reach.

Rather, the message is that in interpreting HSR’s notification requirement, the ultimate reach of §7 should be kept in mind and the reportability of transactions that cannot even potentially violate §7 avoided.

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