August 17, 2009

Option Exercise = Hart-Scott-Rodino Obligation?

Recently, the FTC fined a CEO $1.4 million for failing to make a filing under the Hart-Scott-Rodino Act after he purchased company stock when he exercised options. Sounds crazy, right?

Apparently, it’s not so crazy – it has long been the position of the FTC that the HSR Act is applicable to any acquisition of voting stock, including an acquisition by an individual, that exceeds the HSR’s jurisdictional thresholds. Below is a summary and analysis of the case by Davis Polk:

The Federal Trade Commission recently fined John C. Malone, CEO and Chairman of Discovery Holding Company, $1.4 million to settle allegations that he violated the Hart-Scott-Rodino Antitrust Improvements Act in connection with acquisitions of Discovery shares in 2005 and 2008. The FTC alleged that Malone failed to file the notice required by the HSR Act in 2005 after making a reportable acquisition of Discovery shares, made a corrective filing in June of 2008, but subsequently acquired, via an exercise of two options, additional Discovery shares before the expiration of the required waiting period which followed the submission of the June 2008 corrective filing. As described below, this case holds several important lessons, including:

  • Even if a person has lawfully made prior acquisitions of shares of an issuer, the person may have to make an HSR filing before completing additional incremental acquisitions of shares.
  • The FTC’s informal interpretations of the HSR rules may change over time, and practitioners need to keep informed of these changes.
  • Depending upon the circumstances, the FTC may object to the use of an escrow account to permit a transaction to close prior to expiration of the HSR waiting period (with shares delivered into escrow). It is strongly advised to consult with the FTC’s Premerger Office before using an escrow arrangement as a means of closing a transaction prior to the expiration of the waiting period.


The HSR Act requires parties to mergers and acquisitions that exceed certain jurisdictional thresholds to make filings with the FTC and the Department of Justice (“DOJ”) and to observe a waiting period before closing. In this case, Malone previously held shares of Discovery, but it was the additional acquisitions, when aggregated with current holdings, that gave rise to the filing requirement.

The Commission’s press release, which includes a link to the complaint, can be found here. From the release: “The HSR Act and its filing requirements are well-known to companies and individuals making acquisitions. The significant civil penalties imposed here should reinforce the need to fully comply with the Act, including observing the waiting period,” said Marian Bruno, Deputy Director of the FTC’s Bureau of Competition.

Factual Allegations

As stated in the FTC’s complaint, Malone, in May of 2005, properly filed under the HSR Act for an acquisition of shares of Liberty Media Corporation (“Liberty”), and observed the waiting period prior to that acquisition. Two months later, Discovery was spun off from Liberty, and voting securities of Discovery were distributed pro rata to Liberty shareholders. The receipt of Discovery shares by Malone, as a result of the spin-off, was exempt from HSR Act reporting.

In August 2005, however, Malone purchased additional shares of Discovery on the open market. According to the FTC, a new filing should have been made in connection with this acquisition because (i) Discovery was, at that time, its own “ultimate parent entity,” and (ii) the sum of the value of Discovery shares already held by Malone and the value of the new shares acquired exceeded the initial HSR Act filing threshold (then $53.1 million). No such filing was made. As the FTC alleged, no exemption from filing was available based upon the fact that Malone previously filed for acquiring a minority stake in Discovery’s parent prior to its spin-off. Malone completed that August 2005 Discovery stock acquisition, and continued to make additional acquisitions of Discovery stock through April 2008, without ever filing for an acquisition of such stock.

In June 2008, Malone made a corrective filing for these prior acquisitions of Discovery stock. After making this, but before the waiting period which followed that corrective filing expired, Malone acquired, via two stock options, additional stock of Discovery.

Of particular interest within the FTC’s complaint for the alleged failure to make a timely HSR notification are:

  • Malone made a prior corrective filing for an “inadvertent” HSR Act filing violation, though that corrective filing was made in May of 1991.
  • In a letter explaining the reason for the failure to file in August 2005, Malone referenced a 2001 informal interpretation of the Premerger Office of the FTC which appeared to support the view that no filing was required. However, this informal opinion was disavowed in February 2005 by another informal opinion. Malone stated in the letter that neither he nor counsel on his behalf discovered the subsequent opinion. (The subsequent opinion was available only at the FTC’s website.)
  • Malone attempted to place the shares obtained via the two option exercises in escrow pending expiration of the waiting period following the June 2008 corrective filing. (The options were scheduled to expire before the termination of the HSR waiting period.) In the FTC’s view, however, the escrow arrangement was insufficient to insulate Malone from obtaining beneficial ownership of the shares immediately upon exercise of the options. The complaint further stated that neither Malone nor counsel contacted the Premerger Office to clear the mechanics of the option exercise and escrow arrangement prior to the expiration of the relevant waiting period.

The $1.4 million fine was approximately 1/8th of the maximum amount for his violation of the HSR Act. Specifically, Malone was deemed to be in violation of the HSR Act from August 9, 2005, the day of the first post spin-off open market purchase of Discovery stock, to July 14, 2008, the day on which the waiting period applicable to his June 2008 corrective filing expired. His maximum fine would have been approximately $11.7 million ($11,000 per day).

For more on HSR/antitrust, see our “Antitrust” Practice Area.