HSR Requirement Catching More Investments Legislative Relief is Within Reach –

As the size of venture capital investments in individual companies and the number of M&A exits from those investments have soared in recent years, so too have the regulatory headaches associated with a terribly outdated pre-merger notification requirement. What’s more, this arcane requirement has been increasingly catching routine venture investments despite the fact that these transactions were never its intended target.

The Hart-Scott-Rodino (HSR) Act of 1976 requires parties in a merger, joint venture or reportable financing to file a lengthy pre-merger notification with the Federal Trade Commission and the Department of Justice if the value of the transaction is above $15 million. The acquiring party must also tender a $45,000 filing fee, which serves as the funding source for the agencies. The parties may not complete the transaction until the statutory waiting period either expires without action or is granted “early termination” by the agencies.

Remarkably, the transaction threshold has not been adjusted in the 24 years since the enactment of HSR. Significant relief would be provided this fall, if Congress passes an important piece of legislation to raise the threshold and make other vital reforms.

A bill introduced earlier this year would raise the transaction threshold for HSR filings from $15 million to $50 million. This boost represents an adjustment for inflation since 1976. The threshold will be bumped up again in 2005 and thereafter be indexed annually to the inflation rate.

The HSR relief bill will eliminate thousands of filings for acquisitions and venture investments each year. HSR was originally drafted to help the antitrust watchdog agencies screen M&A transactions for anti-competitive concerns. The static $15 million transaction threshold and the growth of venture investing have combined to create an unintended, yet increasingly common regulatory requirement for VC firms.

Because filings for venture investments represent relatively low dollar value transactions and thus do not raise anti-competitive concerns, they have been receiving rubber-stamp approval by the agencies for some time. In essence, the HSR requirement for these smaller transactions has served only to waste time for the agencies, and time and money for the parties to the transactions.

NVCA and other industry groups have been leading the charge to assure passage of this legislation. NVCA has initiated letter-writing campaigns and met with dozens of key congressmen and staff. Lawmakers from both parties view it as good policy and even the agencies have indicated general support, since the elimination of filings for small transactions will allow them to shift their attention to those transactions that actually may raise anti-competitive concerns.

In addition to the regulatory relief it will provide, part of the urgency to pass this legislation stems from the fact that the Administration’s budget contained a problematic and short sighted HSR “reform” proposal that the industry found unacceptable. Their plan would have eliminated fees for smaller transactions but would not have raised the transaction threshold. To make up for the lost fee revenue and to extract even more money from filings, the Administration proposal also called for significantly higher fees for larger transactions.

In order to ensure both the defeat of the Administration’s proposal and adoption of the new $50 million threshold and other reforms offered by the legislation, Congress fought hard to get the agencies to accept a new plan. A new three-tier filing fee system, with more modest fees for larger transactions, was included in the legislation as a compromise. This will allow the agencies to make up some of the revenue lost due to the higher transaction threshold without gouging industry.

As the Congressional session ends, the bill’s managers are seeking to attach it to an appropriations bill, which by law, has to be completed before the next fiscal year starts. Although anything can happen in the harried last days, the prospects for HSR relief this year are excellent.

Looking ahead, there’s still more to be done on HSR reform in order to eliminate the act’s inefficiencies and lessen its burden on industry.

An important reform – and one that will require considerable effort by HSR relief advocates – is to eliminate the filing fees and fund the agencies out of general government revenue. Obviously this idea has a great deal of traction within the business community and certain quarters of Capitol Hill where the HSR fees are viewed as an unfair tax on industry. Even the FTC and the DOJ may support it since M&A activity, which inevitably will go down at some point, will just as inevitably lower agency revenue as filings fall off. Resistance will come from appropriators in Congress who will be required to find revenue to fund the agencies somewhere else in the federal budget.

Another area has to do with the definition of “passive investor.” Currently, when a person acquires 10% or less of the outstanding securities of the target company they are considered a passive investor and are thus exempt from HSR filing requirements. This exemption, however, is dropped if the individual takes a board seat. Many people in Congress and in the agencies themselves believe this is too narrow of a definition.

If all goes as planned HSR relief will be enacted. This will not come a moment too soon as M&A activity continues to climb and exits continue to increase in importance to the VC community. HSR reform is yet another example of government playing catch up to the ever-accelerating New Economy. t

Richard E. Kroon is Chairman of Sprout Group . He also is Chairman of the Board of Directors for the NVCA.