The Federal Trade Commission, with the concurrence of the Department of Justice Antitrust Division, recently proposed changes to how U.S. and foreign entities are defined for purposes of determining the reportability of transactions under the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act).
The FTC proposed the changes to clarify when transactions involving minority shareholdings with one or more foreign parties are reportable. Yet it appears likely that the changes, if adopted, will raise at least as many questions as they answer for two transaction types:
- acquisitions of a foreign business with significant U.S. operations; and
- acquisitions by foreign investment funds managed by U.S.-based persons.
Exemptions to Reporting
The HSR Act requires parties to notify the FTC and the DOJ before consummating certain transactions above jurisdictional requirements (currently $90 million) unless the transaction is exempt.
Among the exemptions to the HSR Act are transactions between foreign parties involving foreign businesses (the “foreign to foreign exemption”). An acquisition by a foreign person of the voting securities of a foreign issuer is exempt from HSR reporting as long as the foreign acquiring person will not obtain control (50% or more) of the foreign issuer.
The FTC’s view is that the foreign to foreign exemption “recognizes that considerations of comity may be significant in the area of international business transactions. With respect to some acquisitions whose principal impact is foreign, it is appropriate for the agency, in its discretion, to exercise a self-imposed limitation and decline to subject them to the [HSR Act’s] requirements.”
The FTC believes that an “anticompetitive impact upon United States commerce is less likely to occur” when a foreign person is acquiring foreign voting securities.
A three-part test defines “foreign person” under the HSR Act:
- the entity must be incorporated in a foreign country;
- the entity must be organized under the laws of a foreign country; and
- the entity must have its “principal offices” outside the United States.
Determining ‘Principal Office’
It is the definition of “principal office” that the FTC and DOJ propose to change. Under the existing rule, a “principal office” is the “single location which the person regards as the headquarters office of the ultimate parent entity.” While some entities have several possible headquarters offices, it is generally possible to determine from publicly available information where an entity is headquartered.
By contrast, the proposed rule would look to “the location of an entity’s principal operations” instead of the location of the entity’s headquarters. As detailed in the proposed rule, if any of the following three factors are present, the entity will not be foreign: if half or more of the entity’s (1) officers or (2) directors are residents of the United States; or (3) if half or more of the entity’s assets are located in the U.S.
The FTC’s notice recognizes that residency may need to be defined; it does not address that third-party investors may not be privy to such private information nor that the entity would not be under any legal obligation to furnish such information. Indeed, privacy laws in some countries, including the European Union, may prohibit the disclosure of such information by the entity.
Fair Market Value of Assets
Even thornier is determining the fair market value of the entity’s assets and assigning them a location. The proposed rule requires valuation of both tangible and intangible assets.
Determining the fair market value of tangible assets is difficult, but assigning a fair market value to intangible assets—particularly trade secrets and other confidential information—and then apportioning their value geographically is near impossible. The proposed rule shifts the determination from an objective to a subjective inquiry, which will likely produce significantly different answers from one party to another.
The FTC’s proposal to apply the same analysis to non-corporate entities will affect investment funds that have been formed and headquartered outside the U.S. but managed by a U.S.-based general partner or investment managers. Such funds are currently deemed foreign persons under the HSR Act because of their jurisdiction of organization and their headquarters. Redefining them as U.S. persons will eliminate the foreign person exemption and cause additional transactions to be reportable under the HSR Act.
In sum, the proposed amendment substitutes a factually involved inquiry for the current simple factual determination. Under the proposed amendment, entities now must look to three separate criteria instead of one to resolve whether they qualify as an exempt foreign entity.
Such a change would likely result in more reportable transactions since there are more avenues for companies to meet the jurisdictional requirements for HSR Act compliance. The proposed rule was open to public comment through Dec. 30.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Tod Northman, a partner in the Cleveland office of Tucker Ellis LLP, has practiced transactional law for 25 years. In addition to mergers and acquisitions, his practice focuses on aviation and emerging technology, including autonomous vehicles.
Natalie Fine, an associate in the Chicago office of Tucker Ellis LLP, graduated from Loyola University Chicago School of Law in May 2019 and practices transactional law.