By Michael Flaherty and Diane Bartz
(Reuters) - The U.S. Department of Justice on Monday sued ValueAct Capital for violating notification requirements related to Halliburton Co's (N:HAL) deal to buy rival Baker Hughes Inc (N:BHI), in a case that the activist hedge fund says it will fight.
The lawsuit centers on a 40-year old U.S. law that exempts investors who buy up to 10 percent of a company's voting securities from disclosing purchases made only for passive investment purposes.
The Department of Justice alleges that ValueAct was an active investor from the time it started to build its position in both companies shortly after the November 2014 merger agreement, and that the hedge fund violated the law - known as the Hart-Scott-Rodino (HSR) Act - by waiting too long to disclose its intentions.
"Plainly the regulators are trying to send a message that their view of what constitutes passivity is far more restrictive than what some portfolio managers apparently believe," said Christopher Davis, a partner at law firm Kleinberg Kaplan who chairs its mergers practice.
The lawsuit said ValueAct used its access to senior Halliburton and Baker Hughes executives to formulate the merger and other strategies. The government is seeking a civil penalty of at least $19 million - a penalty it deemed "significant."
"ValueAct was not entitled to avoid HSR requirements by claiming to be a passive investor," Assistant Attorney General Bill Baer of the Justice Department’s Antitrust Division said in a press release.
ValueAct, a $16 billion activist hedge fund, said it will contest the case, a departure from similar violation lawsuits that ended with investors settling with the government.
"We fundamentally disagree with the Department of Justice’s allegations in this case," the San Francisco-based hedge fund said in an emailed statement.
The lawsuit is another recent blow to ValueAct, which since August has had to stomach huge paper losses on its investment in embattled drug company Valeant Pharmaceuticals International (N:VRX), which is under federal investigation.
ValueAct said having a relationship with a company's management, conducting due diligence and engaging with other stock owners are basic principles of shareholder rights.
At issue is what defines passive investing. For ValueAct and other activist shareholders, engaging with management teams directly is a key part of their strategy to push for changes that activists feel is needed to boost a company's stock price.
In the government's case against ValueAct, federal officials used emails to underscore their case that the hedge fund crossed the "passive" boundary as early as a month after the Halliburton agreement.
The lawsuit says that on Dec. 5, 2014, the day ValueAct's Halliburton holdings crossed the HSR Act threshold, a ValueAct partner sent an email to ValueAct's founder and CEO Jeffrey Ubben suggesting a new compensation structure for Halliburton's chief executive.
The partner suggested that the compensation plan of Valeant's CEO - a plan that is heavily weighted toward stock-based incentives - would be a good model for Halliburton's chief executive, the government says in its complaint, to which Ubben agreed.
Halliburton is still awaiting regulatory approval for the acquisition, which was worth $35 billion when it was announced but has since fallen by nearly half, hit by the plunge in oil prices.
The Hart Scott Rodino Act provides the U.S. Federal Trade Commission and the Department of Justice with information about large mergers and acquisitions.
Last August, Third Point LLC settled U.S. FTC charges that it failed to properly seek HSR clearance while it built a stake in Yahoo Inc (O:YHOO) in 2011. The hedge fund did not pay a penalty but entered a five-year agreement to make appropriate disclosures.
In the case of ValueAct, the hedge fund bought Halliburton and Baker Hughes shares shortly after the merger, having previously been a Halliburton shareholder.
In January 2015, ValueAct said in a regulatory filing that it owned more than 5 percent of Baker Hughes shares. In October that same year, with oil prices plunging and confidence in the deal sagging, it amended the filing to say that it was going to take an activist position in Baker Hughes. The following month, ValueAct filed its HSR disclosure, a person familiar with the matter said.
ValueAct's Halliburton-Baker Hughes holdings have cost the fund dearly in paper losses, Reuters previously reported.
The Justice Department noted on Monday that ValueAct filed “corrective notifications” for three acquisitions in 2003 and two years later, failed to inform the government of three acquisitions, paying a $1.1 million civil penalty.