As M&A Challenges Abound – More Headaches for Dealmakers, Contributed by John Ingrassia, Proskauer Rose LLP
By John Ingrassia, Proskauer Rose LLP
It seems that press reports on the Hart-Scott-Rodino merger regulations are at an all-time high this summer. If merger challenges and monopolization investigations weren’t enough, the antitrust enforcement agencies have now turned their attention to expanding premerger notification requirements. The result is a new set of rules, with more to follow.
In the 25-plus years since Senators Philip Hart and Hugh Scott, Jr. and Representative Peter Rodino forever attached their names to merger review, companies have been required to get antitrust approval before being allowed to close their deals. The Hart–Scott–Rodino Antitrust Improvements Act (HSR) requires parties to notify the Federal Trade Commission and the Antitrust Division of the U.S. Department of Justice of certain transactions and observe a waiting period prior to closing. Months, sometimes more than a year for transactions that raise complex antitrust issues, must be spent satisfying the antitrust agencies that the deal will not harm competition. Over a thousand transactions a year go through this process. Even for transactions that do not present substantive antitrust concerns, HSR reporting and clearance takes time, delays the parties’ efforts to integrate their business, and can affect closing timelines.
Few would suggest that the agencies’ mission to protect consumers from anticompetitive mergers – especially block-buster transactions that fundamentally alter consumer choices – isn’t worth the inconvenience of giving enforcers an advance heads-up. But the agencies’ latest rule-making adds a new layer of burden to bear in trying to get deals done, especially for private equity firms.
These changes, which will take effect on August 18, along with the specter of further changes to be announced later this year, have lawyers’ phones ringing around Washington. Often the question is: “Do I really have to go through all of this?” Often the answer is yes.
Who Are My Associates?
Historically, HSR filings have been limited to entities in the chain of “control,” as narrowly defined by the rules. As a result, antitrust agencies have long lamented their limited access to information, for instance, from sister funds within a private equity firm. The new rules remove that limitation and now call for additional reporting relating to “associates’” investments in competing businesses. Gone are the clean bright-line tests limited to the rules’ narrow definition of control, in favor of a more nuanced rule that in some ways mimics the European approach to merger control reporting and its “decisive influence” standard. The FTC’s premerger notification office has been forthcoming in answering questions and has already made several presentations to practitioners on the changes. Still, it may be some time before the dust settles and we have an established set of clear guidance on precisely how to apply the new rules to organizations with complex internal structures.
For now, the days when a private equity firm could quietly acquire multiple competitors in a given industry, house them in separate funds and escape the scrutiny of antitrust regulators appear to be a thing of the past. The expanded reporting will most directly impact private equity firms and other firms with broad investment portfolios, as the new rules do not make a distinction between, for instance, private equity funds versus hedge funds or other types of investment vehicles. Reaction to the initial proposed rulemaking did result in a somewhat narrower and more workable final rule; however, the expanded reporting will undoubtedly create new burdens.
The associate concept seeks to bring within its reach all entities “under common operational or investment management” with a filer. This can include, for instance, sister funds within a fund family, master limited partnerships under common management, management companies managed by the same general partners, the general partner of a limited partnership, the managing member of a limited liability company, and the entities that control and are controlled by each of them. In each of these cases, filers will be required to report their associates’ holdings of 5% or more in companies that compete with the target. The prevailing view appears to be that, in many cases, the new rule will require the reporting of all interests across a firm of 5% or more in a business in the same industry as the target. However, as the premerger office charts out the boundaries of the rule, it is becoming clearer that not all firm entities will ultimately be deemed to be associates in all cases.
The FTC has said that the new rule will allow the agency to “analyze the holdings of entities that are under common investment or operational management with the person filing notification” and that the burdens imposed by the new filing requirements are outweighed by the benefit to the antitrust enforcement agencies. True, the agencies will have access to more information up front to evaluate transactions with competitive overlap, but the legal standards for challenging a transaction remain the same. Keep in mind that the authority already exists for challenging any transaction, HSR filing or not. The Antitrust Division filed two lawsuits in one week in May of this year challenging transactions that were not subject to the HSR Act in markets as disparate as chicken processing and point of sale terminals.1 It remains to be seen whether the new reporting will result in a meaningfully different risk profile for the transactions affected.
Watch Your Interlocks
For investment firms with an industry focus, this is also a time to revisit the Clayton Act’s prohibition on interlocking directorates — the practice of members of a corporate board of directors serving on the boards of multiple corporations. Section 8 of the Clayton Act, unchanged by the new rules, is aimed at preventing anticompetitive coordination and information exchanges through simultaneous officer or board membership. The issue arises frequently for sector funds that have competing companies in a portfolio under common management. Under the statute, no person, or representative of the same person or entity, may serve as a director or officer of competing companies where elimination of competition by agreement between them would violate the antitrust laws. The rule does not apply where the competitive sales are deemed to be de minimis.
Fund managers often find themselves facing Clayton Act Section 8 issues when taking positions in competing businesses and appointing common board members or officers, or board members or officers that are affiliated with a common investment manager. While Section 8 enforcement actions are not common, they can be high profile and far reaching. The FTC in 2009 forced Apple, Inc. director and Genentech, Inc. Chairman Arthur Levinson to resign from the board of Google and Google CEO Eric Schmidt to resign from Apple’s board. The overlap had the potential to stifle competition between companies that increasingly face each other in a swiftly evolving marketplace. Such interlocks may also be challenged under the Sherman Antitrust Act as part of a conspiracy in restraint of trade. This is especially true where the interlock serves as a means for competitors to exchange competitively sensitive information that can lead to understandings concerning price or decisions to bid or not bid for particular business or otherwise reduce competitive rivalry.
CIMs, Synergies, and Decks – Second Request?
The other big change to the rules concerns not just “associates” but all parties seeking to merge – it expands the volume of information that must be reported to the agencies at the outset of the merger clearance process. Item 4(d), an addition to the notification and report form, requires the submission of transaction offering materials, such as a Confidential Offering Memorandum, investment banker books, and certain transaction synergy or efficiency analyses and models. Some, but not all, of these materials were either already required or typically submitted as part of common practice. Existing HSR rules require the submission of certain documents that analyze a transaction with respect to, among other things, competition, competitors, markets, and market shares, but the new rules expand these requirements. An offering memorandum that does not address Item 4(c) elements such as markets or market shares would now be required under the new Item 4(d). Likewise, transaction synergy analyses were not specifically called for in the original Item 4(c), but are now required to be included with the merger notification. Certain pre-existing regular course documents not prepared for the transaction also are now called for.
The HSR notification and its contents are confidential and not subject to Freedom of Information Act requests, nor can they typically be shared with other government agencies. Still, Item 4(c), and now 4(d), documents are carefully reviewed by the FTC and DOJ to determine whether to open an investigation or move to challenge a proposed acquisition. To minimize potential exposure to antitrust liability and delay in completion of the transaction, care should be taken when preparing documents that examine the competitive impact of the transaction. As a general proposition, discussions of “power,” “leverage,” “dominance,” or “control” with respect to a market, market segment, particular customer, or customer group are best avoided.
If an agency investigates the transaction, it will begin through voluntary requests for information and interviews of customers, competitors, and others. The reviewing agency then will have three options: (1) terminate the HSR waiting period; (2) allow the waiting period to expire without action; or (3) if unresolved issues remain, open a formal investigation and issue a Request for Additional Information and Documentary Material, commonly referred to as a “Second Request.” A Second Request gives the agency a broad set of tools to provide a more complete view of the competitive impact of the proposed transaction. It is an intensive investigation that, at minimum, can delay the closing by several months and at worst can derail a deal. Initially, the Second Request will call for significant document and interrogatory responses. Later, depositions of the parties may be taken and third-party witnesses may be called. The information collected during the Second Request investigation may become evidence in an agency’s move to block the transaction or alter its structure.
With an eye on further changes, the FTC also announced a comprehensive review of the HSR rules to take place later this year, potentially further impacting the types of transactions that are subject to notification and review. Notably, the reporting requirements relating to intellectual property licenses are widely expected to be impacted by that process, as entering into an exclusive license for intellectual property rights is potentially subject to HSR reporting under current interpretations. Presently, where license royalties cannot reasonably be estimated because they are too speculative, the value of the license is deemed to be undetermined under the HSR rules. This means that the licensee is required to assess the fair market value of the license. The agency has expressed dissatisfaction with this process for two reasons. First, the underlying basis for a determination that the transaction-size threshold is not met is often not clear. Second, the elements of exclusivity with respect to the license can be subject to differing viewpoints. New rules or interpretations aimed as providing much needed clarity in this area are expected.
Another area ripe for review is the so called “passive investor exemption,” which allows certain acquisitions by passive investors to exceed the statutory transaction-size threshold. This carve-out permits investors to acquire up to a 10 percent voting stake in a company without being subject to agency review where the likelihood of competitive harm is low as a result of the passive nature of the investment. What it means under the rules to be a passive investor is often a complex assessment based on numerous factors and occasionally has led to enforcement actions and significant penalties. Former director of the FTC’s Bureau of Competition, Susan Creighton, made a statement relating to a September 2005 enforcement action that resulted in a $350,000 civil penalty which advises caution: “This significant penalty should put hedge funds, their managers, and securities traders on notice that they are not exempt from filing pre-merger notification forms when required to do so . . . . The defendant in this case is an experienced fund manager who should have known and fulfilled his obligations under the HSR Act.” Ms. Creighton noted in her statement that “future enforcement actions . . . resulting from a failure to file could be brought against a fund as well.”2 In 2007, just such an action was brought against ValueAct Capital Partners, L.P. and its affiliates for incremental stock purchases that exceeded the 10 percent passive investor exemption. The investment fund paid a $1.1 million civil penalty to settle the matter.
Because of their involvement in the management of the business, company insiders who acquire stock valued in excess of the transaction-size threshold as part of their executive compensation are often not eligible for passive investor treatment. Exempting such insiders compensated with the stock of their employers from the cost and delay associated with preparing and submitting HSR filings is good policy, even if they are not passive stockholders in the spirit of the exemption. This is an area where the bar is pushing for a simplification of the rules that would relieve such insiders from filing obligations under the HSR Act and an area that may also be a part of the broader ongoing review.
The new rules do include notable clarifications of the initial notice of proposed rulemaking first published a year ago with respect to the expanded reporting requirements. Still, some of the concepts the agency attempts to identify, such as offering materials or fund associates, are subject to differing interpretations. The precise scope of the additional documents and information to be submitted in filings under the new rules will necessarily develop over time as the agency issues informal interpretations relating to these issues. Hart-Scott-Rodino is an essential element of antitrust merger enforcement today. The antitrust agencies clearly are focused on keeping the HSR coverage and reporting rules and procedures up-to-date and relevant as changes occur in the way businesses is done and in the way transactions are conducted.
John Ingrassia is a Special Counsel in the Antitrust Group at Proskauer, resident in the firm’s Washington, DC office. Mr. Ingrassia has extensive experience with the legal, practical, and technical requirements of the Hart-Scott-Rodino Act, and is regularly invited to participate in Federal Trade Commission discussions regarding HSR practice issues.
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