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Sometimes It's Hard for Owners to Talk to Companies

by Matt Levine

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Public companies are, in one popular view, owned by their shareholders. A company’s managers have a duty to act in the shareholders’ interests. The managers answer to the directors, who are elected by the shareholders. The shareholder democracy isn’t perfect, the duties to shareholders aren’t absolute, the concept of ownership is inexact, and some companies play by different rules, but this is more or less a reasonable model for how companies work.

Since the shareholders are the owners, and since the managers’ job is to make them happy, it makes sense that the managers might meet with shareholders every now and then to keep the shareholders up to date, see how they’re feeling, listen to their opinions, ask if there’s anything that the managers could be doing better, whatever. Of course, you can do this in big formal annual shareholder meetings, but that is sort of a stilted environment, and there are lots of small shareholders with idiosyncratic concerns who tend to dominate those meetings. If a big shareholder wants to talk about the business privately, well, the shareholders are the managers’ bosses, and it is only polite to meet with your bosses from time to time to see what’s on their minds.

So these meetings happen. But they’re kind of a mess.

One reason that they’re a mess is that it is very awkward for management to tell shareholders things. We talk about this concern from time to time; we talked about it just yesterday in the context of Tesla’s proposed merger with SolarCity, an idea that Tesla boss Elon Musk had previously “bandied about” with big shareholders. The general idea is that regulators don’t like it when managers give one shareholder any “material” information that they haven’t given to all the other shareholders. So the chief executive officer of Company A isn’t supposed to call up big Shareholder B and say, “Oh hey, by the way we’re going to acquire Company C.” Because then Shareholder B might trade on that tip, which would be unfair to the other shareholders.1 

That sounds straightforward, but the harder issue is whether the CEO can call up Shareholder B and say “Hey, you’re a smart guy with a lot of shares — we’re thinking about buying Company B: Do you think that’s a good idea, or what?” That question conveys information to the shareholder, which is awkward. But it is also a real question. The managers should care what the shareholders think. There are formal ways to ask what they think, but those formal ways are kind of bad. Like, the managers could negotiate a merger agreement, announce the merger, and then hold a shareholder vote. But once you’ve done that, you are pretty committed; having a merger voted down is awkward and expensive and messy. Asking a few big shareholders informally first can save a lot of heartache. But it is arguably a bit rough on all the shareholders you didn’t ask, who didn’t know about the merger in advance. 

There are some rules, or at least rules of thumb, about how to handle these issues, but they remain vexing.2 

But the U.S. Department of Justice has another objection to meetings between managers and shareholders, one that is even stranger, and that has nothing to do with what managers might tell the shareholders. It has to do with what the shareholders might tell the managers, and it’s an antitrust objection.

Sort of. There is a rule of antitrust law, the Hart-Scott Rodino Antitrust Improvements Act of 1976, that says that you have to notify the government and wait 30 days, give or take, before you acquire a company. The idea is that if one company in an industry wants to acquire another company in that industry, the government gets a month to examine the deal and decide if it’s bad for competition. If it is, the government can block the deal before it happens, instead of having to come in afterwards and try to unscramble a merger that has already happened. And since there are lots of ways to acquire influence over a company, the rule doesn’t apply just to mergers: Any time you buy more than about $78 million worth of stock in any company, you have to file and get government approval.3  

But that is sort of silly and overbroad: The point of this rule is to prevent one competitor from buying a big chunk of another competitor and using its influence for anticompetitive purposes. The point isn’t to prevent, like, a Vanguard Group index fund from buying a lot of stock in a company just because it happens to be in an index. (Though, as we often discuss, there are those who think that Vanguard does use its influence for anticompetitive purposes, and should be prevented from buying stock in companies in the index!) So there is an exemption from HSR for investors who buy less than 10 percent of the stock “solely for the purpose of investment,” which is meant to capture normal market shareholding, as opposed to the sort of strategic acquisition that could be bad for competition.

But that exemption, too, is uncertain and contested because it is hard to know what sorts of activities are consistent with normal shareholding “solely for the purpose of investment,” and what sorts of activities raise antitrust concerns. Obviously, if one public company acquires shares in a competitor and then calls it up to demand price changes, that would be bad. Not quite as obviously, if an investor buys shares and then runs a proxy fight to replace the company’s board of directors, that also doesn’t qualify as “solely for the purpose of investment.” Just investing in a company is one thing; trying to take over its management is another.

But what about talking to the company? Meeting with managers, asking about their plans, suggesting some ideas of your own? On the one hand, I mean, sure, you could spend your time in those meetings suggesting anticompetitive things: big mergers, price increases, whatever. On the other hand, it seems weird to conclude that meeting with management isn’t a normal part of investing, that owning shares “solely for the purpose of investment” precludes a sharing of ideas. The investors, again, are the owners; why shouldn’t they talk to their agents about how the business is doing?

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Anyway yesterday the Justice Department reached an $11 million settlement with ValueAct, an activist fund that bought stock in Halliburton and Baker Hughes after they announced their plans to merge, without (initially4 ) making an HSR filing, and then talked to both companies’ managements about the merger and their businesses generally:

“ValueAct acquired substantial stakes in Halliburton and Baker Hughes in the midst of our antitrust review of the companies’ proposed merger, and used its position to try to influence the outcome of that process and certain other business decisions,” said Principal Deputy Assistant Attorney General Renata Hesse, head of the Justice Department’s Antitrust Division.  “ValueAct was not entitled to avoid the HSR requirements by claiming to be a passive investor, while at the same time injecting itself in this manner.  The HSR notification requirements are the backbone of the government’s merger review process, and crucial to our ability to prevent anticompetitive mergers and acquisitions.”

We talked about this case back in April, when the Justice Department first sued ValueAct. It’s a weird case. For one thing, while it sort of floats around next to a controversial merger — the Justice Departmentultimately blocked the Baker Hughes-Halliburton deal — it isn’t actually about that merger. The merger-notification violation here wasn’t a failure to notify the Justice Department about the merger. It was a failure to file by an investment fund that bought stock in two public companies after those companies had agreed to merge. Hesse’s last sentence, about the HSR notification being “crucial to our ability to prevent anticompetitive mergers and acquisitions,” might be true in general, but it has nothing to do with this case. The Justice Department could — and did — prevent the Baker Hughes-Halliburton merger without ever giving any thought to ValueAct.5 

More interesting, though, is the activity that the Justice Department thinks is inconsistent with owning stock ”solely for the purpose of investment.” From its “Competitive Impact Statement“:

ValueAct intended from the time it made these stock purchases to use its position as a major shareholder of both Halliburton and Baker Hughes to obtain access to management, to learn information about the companies and the merger in private conversations with senior executives, to influence those executives to improve the chances that the Halliburton-Baker Hughes merger would be completed, and ultimately influence other business decisions regardless of whether the merger was consummated. ValueAct executives met frequently with the top executives of the companies (both in person and by teleconference), and sent numerous e-mails to these the top executives on a variety of business issues. During these meetings, ValueAct identified specific business areas for improvement. ValueAct also made presentations to each company’s senior executives, including presentations on post-merger integration.

So … which part is bad? Is it meeting with top executives? Frequently? Is it learning information about the companies? Is it trying to influence business decisions? Is it pushing the managers to complete a merger that they had already announced, and that ValueAct supported?

I guess all of those things are something other than “passive,” though they are something other than “activist” too. They are just acting like an owner. As ValueAct said in April:6 

ValueAct strongly believes in the most basic principles of shareholder rights. This includes having a relationship with company management, conducting due diligence on investments, and engaging in ordinary course communications with other shareholders.

So … are you allowed to do that? If you are a big shareholder, are you allowed to meet with management and discuss ideas, without first filing for antitrust clearance? It is a little hard to tell; certainly ValueAct’s reputation as an activist didn’t help.7  But on the face of it, the government seems to think that meeting with management to talk about business plans is something that normal investors don’t do, and that requires, or at least might require, antitrust approval.8  

The Justice Department’s position seems like an expansion of the HSR requirements, which remember were intended to prevent competitors from acquiring each other, not to prevent shareholders from talking to management. Even about mergers. So what is going on here? 

Part of it seems to be that the Justice Department really didn’t like the proposed Baker Hughes-Halliburton merger, and is punishing ValueAct because its (arguable, technical) HSR violations happened in connection with that merger. Part of it is that the Justice Department just likes enforcing rules; the HSR requirements are rules, and if ValueAct violated them, it has to pay, even if the rules are over-broad and the violations are debatable and don’t implicate the spirit of the rules.9  Part of it might even be that the Justice Department genuinely thinks that it is bad for competition when shareholders of multiple companies in the same industry try to influence those companies’ managers — though, if it thinks that, there are perhaps more interesting and more systemic targets than ValueAct.10  

But I can’t resist thinking that the Justice Department also, in its heart of hearts, just doesn’t like it when investors talk to companies. Those conversations are messy and dangerous; they fit uncomfortably within the tidy frameworks of securities and antitrust laws. They present all sorts of opportunities for contamination. What if the managers tell the investor something material? What if the investor suggests something anticompetitive? What if the investor just got out of a meeting with the company’s biggest competitor, and information leaks between the competitors by way of the investor?

When the Justice Department appealed the Newman insider-trading decision, I made a bit of fun of its clean, clinical vision of how investors analyze companies:

Effective professional analysis of the value of a company’s stock is a labor-intensive process that demands extensive research, an understanding of financial and other technical data, in-depth knowledge of the relevant industry, and sophisticated modeling. If certain analysts sidestep that labor by siphoning secret information from insiders in breach of their duties, thereby arriving at “predictions” of corporate performance that no model can equal, then other analysts will be discouraged from doing the work that is necessary for the markets to function effectively.

In the Justice Department’s vision, insiders manage companies, investors build models, and ideally they never meet. The investors’ job is “research” and “sophisticated modeling,” not talking to the managers about what they’re up to. Investing, on this view, is an abstract intellectual process, uncontaminated by the mixed motives and complex relationships and subtle cues of real human interaction. I don’t think it quite works that way, but I guess it would be neater for the regulators if it did.

  1. This is probably a problem of Regulation FD – meaning that it’s bad for the CEO to do it — and not a problem of insider trading. But it might be insider trading, depending on whether the CEO and Shareholder B are, like, friends. Obviously this is not legal advice!

  2. One popular approach is sometimes called “wall-crossing,” or a “nondisclosure agreement.” Like, the CEO calls up a shareholder and says “Hey, if I tell you something you have to promise not to trade on it.” If the shareholder says yes, you tell him; if not, you don’t. Obviously even just the request can tip him off that something is up, and this approach is imperfect; shareholders whose opinion you really want might not be willing to be locked up.

    The other popular approach is just, like, don’t tell the shareholder anything “material,” and assume that hypothetical discussions about potential mergers aren’t “material.” That is probably true, but of course if you have the hypothetical conversation and the shareholder buys stock in the target and a week later you announce the deal, that is awkward.

    Or you can sort of casually combine the approaches. Like, you have the hypothetical conversations, but mainly with long-term stable shareholders who you don’t think will make big trading moves based on those conversations. It is all a bit vague

  3. As I said last time we discussed ValueAct:
    The number changes every year, but it was $75.9 million as of December 2014 and $76.3 million as of February 2015, the times relevant to today’s ValueAct case. (See paragraph 42 of the complaint, which appears to be off by a year.) It is now $78.2 million.
    I say “the government” because there are two federal agencies involved in antitrust enforcement, the Federal Trade Commission and the Department of Justice.
    Also technically you don’t really need “government approval” to buy the stock — you just need to wait for the HSR waiting period to expire (or be terminated early), and if the government doesn’t object, you’re fine. If it does object, you can fight it in court

  4.  Eventually ValueAct decided to be more activist in Baker Hughes, and made an HSR filing in November 2015. (It also sold down its Halliburton stake)

  5. The Justice Department seems to disagree. From its Competitive Impact Statement in connection with the settlement:

    Finally, although the HSR Act is a strict liability statute, the Department considers it an aggravating factor that the transactions at issue raised substantive competitive concerns. ValueAct became one of the largest shareholders of two direct competitors, and proceeded to actively and simultaneously participate in the management of each company. Moreover, ValueAct established these positions as Halliburton and Baker Hughes were being investigated for agreeing to a merger that threatened to substantially lessen competition in over twenty product markets in the United States, and planned to intervene to influence the probability that the merger would be completed or to determine the companies’ courses if it was not. As a result, the violations prejudiced the Department’s ability to enforce the antitrust laws.

    But … how? How did ValueAct’s ownership, or its failure to file for HSR, prejudice the DOJ’s ability to enforce the antitrust laws? Again, the DOJ did block the merger, and it doesn’t seem to have been too fazed by ValueAct’s advocacy.

  6. At the time, ValueAct said it would fight the case. But in an e-mailed statement yesterday it explained why it settled:

    ValueAct Capital fundamentally disagrees with DOJ’s interpretation of the facts in connection with our investments in Halliburton and Baker Hughes. However, due to the sudden and unanticipated 150 percent increase in the potential penalties associated with alleged Hart Scott Rodino violations effective August 1, we felt we had no choice but to resolve this case as quickly as possible. We are pleased to have come to a resolution to this litigation that will not impact our business or strategy going forward.

    The Wall Street Journal explains: The lawsuit sought as much as $19 million, based on the maximum fine of $16,000 for each day the fund was allegedly in violation of government rules. That ceiling is set to go up to $40,000 a day next month, which could have put ValueAct on the hook for nearly $50 million

  7. Here is a Cleary Gottlieb memo from May:

    On the one hand, one may read the ValueAct complaint as putting all opinion-conveying institutional holders on notice that they may be treading into territory that requires HSR notification whenever they pick up the phone to call the heads of IR at those companies where they hold in excess of $78.2 million of voting securities.  That may be overreading the implications of the DOJ’s action, however.  Another take is that ValueAct’s allegedly self-promoted reputation as an effective activist was the vital ingredient that, when added to the mix, led the DOJ to conclude that ValueAct failed to qualify as a passive investor. Indeed, the complaint highlights the ways that ValueAct allegedly portrays itself to the market as an activist fund that will use resources and tactics to cause change in the strategy and operations of companies. The implication of the ValueActcomplaint thus may be that hedge funds that market themselves out as “well-known … activists” are going to be held to a higher standard when it comes to the availability of the HSR Act’s passive investor exemption. 

  8. This impression is bolstered by the settlement itself, which requires ValueAct to make an HSR filing and wait for government approval before buying stock if it intends to “propose to an Officer or Director of the Issuer that the Issuer merger with, acquire, or sell itself to another Person,” or propose to the issuer “an alternative to a publicly announced merger or acquisition to which the Issuer is a party.” (Discussions of pricing and output strategies are also covered.) 

    ValueAct even has to file if its “investment strategy specific to such Covered Acquisition identifies circumstances in which the Defendant may” make those sorts of proposals. If you take that literally then it … always has to file? Like, when an occasionally activist fund buys $100 million of stock in a public company, presumably it has an implicit expectation that, if the company announces a terrible merger, then the fund will call up the company and yell at it and suggest that it do something else. Which sounds to me like identifying circumstances in which it might propose an alternative to a publicly announced merger.

  9. It doesn’t help that, as the DOJ points out, “ValueAct has previously violated the HSR Act six times.” Oops!

  10. After all, ValueAct owned a lot of Halliburton and Baker Hughes stock, but so does BlackRock — which also owns a lot of stock in Weatherford and Schlumberger and Transocean and most other oil-services companies. And there are those who quite vocally, and plausibly, believe that big passive investors are worse for competition than small focused activist ones.