Pre-Merger Notices And The ‘Passive Investor’ Exception

The Federal Trade Commission may be taking a harder line than had been its custom on the question of what is a “passive investor” under the Hart-Scott-Rodino Act. That is the natural take-away for hunters of alpha upon the Cracker Barrel settlement.

Fund managers following an activist investment strategy would do well to heed. In a philosophical sense, you might take some solace in the notion that regulators and prosecutors can’t, as the saying goes, “get inside your head.” They can’t know what your intention truly was at the moment you acquired certain shares. But in the legal/regulatory world, regulators can and do presume intentions from actions, and the consequences can be nasty for those on the wrong side of it.

Rules and an Exception
Biglari Holdings Inc., the restaurant holding concern formerly known as Steak ‘n Shake, has agreed to pay $850,000 as a civil penalty settling charges that it acquired a large stake in Cracker Barrel while in violation of the H-S-R premerger notification rules.

The H-S-R rules allow an exception for a holding of up to ten percent of voting securities if the acquisition that produced that stake had been made as a passive investment, that is, entered into with “no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”

The HSR threshold rules have been modified over time, but at the times pertinent to this FTC complaint, they required a stock buyer and potential acquirer with total assets above $131.9 million to file premerger notification forms and observe a waiting period when its acquisitions threaten to bring it above the threshold of $66 million in the voting securities of a publicly owned company.

The idea of course is to prevent ambush takeovers: ambushing the incumbent management and antitrust authorities alike. Given that as the purpose of the Act, the exception is an intuitively plausible one. But there is that tricky business of inferring intention.

Inferring Intention
Or is it so tricky? In June 2011, Biglari bought Cracker Barrel securities which, in addition to earlier purchases, put it in excess of the $66 million threshold. It did not file the forms or do the required waiting.

On June 14, the CEO of Biglari Holdings, Sardar Biglari, called the CEO of Cracker Barrel. He indicated he had ideas on improving shareholder value, and requested an in-person meeting. That meeting took place on June 23, and Biglari asked that he and an associate, Phil Cooley, be appointed to the Cracker Barrel board.

Finally, on August 26, Biglari Holdings filed a request under the HSR Act to acquire additional voting securities, and that triggered the waiting period.

The final judgment, entered pursuant to stipulation on September 25, does not carry with it any admission of guilt on the part of Biglari. But the rest of us might take regard this as a takeaway: if you request seats on the board, you’ll have a rough time later maintaining that, at the time you did so and for two months thereafter, you had no intention “of participating in the formulation, determination, or direction of the basic business decisions of the issuer.” That’s what board seats are for!

Finally, yes, you dear reader may already be telling yourself: Biglari isn’t a hedge fund or any sort of investment fund. It is holding company, owning operational concerns that are actual or potential competitors of Cracker Barrel.

Yet investment funds are not immune from penalties under H-S-R, as Scott Sacane and the entities under his control discovered in 2005, when they “inadvertently” crossed premerger thresholds relating to their acquisition of Aksys and Esperion shares.