Despite credit market turmoil and declines in deal activity, antitrust remains an important consideration in M&A transactions involving private equity buyers and sellers. The Obama administration has promised to increase the vigor and scope of antitrust enforcement in the U.S. in coming years with the recent appointments of Christine Varney (who will head the Antitrust Division at the Department of Justice (“DOJ”)) and Jon Leibowitz (who will be Chairman of the Federal Trade Commission (“FTC”)).
One common misperception is that a private equity fund is less likely to encounter antitrust issues than a “strategic” buyer because acquisitions by private equity buyers are less likely to involve the combination of competing businesses — the key focus of the antitrust laws. Another common misperception is that the only antitrust issue that should be of concern to private equity professionals is the need for a filing under the Hart-Scott-Rodino Antitrust Improvements Act (“HSR Act”). In fact, there are a number of areas where transactions involving private equity buyers have been the focus of antitrust scrutiny.
This newsletter discusses these particular areas of concern and illustrates why antitrust continues to be an important consideration for private equity transactions.
Acquisitions of Competing Portfolio Companies
Antitrust issues can arise when your private equity fund acquires an interest in a portfolio company that may compete with a company already in your portfolio or in the portfolio of an affiliate of the private equity fund sponsor. Even if your fund plans to run the companies independently, the antitrust authorities will often presume that common ownership leads to some degree of coordination in the marketplace, and may impose restrictions on your deal by, for instance, carving out governance restrictions or requiring divestiture.
For example, in January 2007, the FTC challenged an acquisition by Carlyle Group and Riverstone of an equity interest in the gasoline company, Kinder Morgan (“KMI”), because both firms already had significant interests in KMI’s direct competitor, Magellan. Because the acquisition would have given Carlyle and Riverstone board representation in both companies, the FTC ultimately required the parties to agree to a consent order prohibiting Carlyle and Riverstone from serving on any Magellan board or exerting any influence over Magellan. Moreover, the order required the firms to establish internal controls to prevent access to nonpublic competitively sensitive information, including the appointment of an independent monitor to ensure that the adopted procedures are effective.
Similarly, in February 2008, the DOJ filed a suit in federal court challenging the acquisition of Clear Channel by Bain Capital and Thomas H. Lee Partners (“THL”), alleging that Bain Capital and THL owned portfolio companies competitive with Clear Channel in the radio advertising market in four geographic markets. To resolve these concerns, the parties agreed to divest Clear Channel’s operations in the four overlapping markets to eliminate the “incentive and the ability” to reduce competition.
As these examples demonstrate, if your fund is considering an acquisition of a potentially competing company, you will need to evaluate carefully the competitive overlaps between your existing portfolio companies and the potential target, and consider what steps, if any, you would be willing to take to resolve potential “overlaps” or “conflicts of interest” created by having officers or directors of a portfolio company serving on the board of a potentially competing company. (In this regard, it is worth noting that Section 8 of the Clayton Act prohibits “interlocking directorates” between competing firms in certain circumstances; this provision may be implicated as well when portfolio companies are competitors.)
Antitrust and Club Deals
An acquisition may also be subject to antitrust scrutiny if your fund is considering bidding for a target in collaboration with multiple private equity firms as part of a consortium in a so-called “club deal.”
In early 2006, the DOJ sent informal inquiries to several private equity firms requesting information and documents regarding whether private equity firms had reached tacit or formal understandings not to compete for the same targets with the goal of reducing the final deal price. The DOJ also inquired whether the private equity firms had entered into “club” arrangements in which more than one private equity firm agreed to join forces to obtain.financing for an acquisition and diversify risk. To date, the DOJ has not taken any enforcement action against private equity firms as part of this investigation. Anecdotal evidence indicates that the DOJ may be continuing this investigation, however.
In addition, the DOJ’s inquiries resulted in a number of follow-on shareholder lawsuits against private equity firms alleging anticompetitive bid-rigging and collusion.[1] While none of these cases has yet resulted in a negative outcome for a private equity firm, these cases subject the parties to significant delay and expense in connection with defending the litigation and leave open the question of whether a private equity fund can be subject to liability in a private cause of action for bidding as part of a consortium.
At the end of the day, it seems unlikely that courts will rule that club deals are “per se” unlawful — there are plainly a number of pro-competitive benefits to pooling the resources of multiple buyers and such collaboration can result in more, rather than less, competitive bidding. That said, private equity firms should be careful to ensure that any collaborations are fully “above board” and transparent because any suggestion of secret, behind-the-scenes collaboration or allocation agreements could potentially subject firms to expensive and risky antitrust litigation.
HSR Act Compliance Failures
Finally, if a proposed acquisition is of sufficient size, your fund will be required to comply with the sometimes counterintuitive rules governing acquisitions under the HSR Act. Under the HSR Act, an acquiror may have to make a filing with the antitrust authorities if it, following a transaction, holds assets or voting securities of the seller valued at greater than $65.2 million. A filing is generally required even in the case of relatively small percentage acquisitions of voting securities even where there is no change of “control” so long as the aggregate holding acquired exceeds the threshold amount. Incremental acquisitions of assets and voting securities (which may occur, for example, when warrants are exercised on convertible debt or equity securities are converted) are generally aggregated with prior holdings to determine whether a threshold is crossed.
While the basic rule is relatively straightforward, it is important to emphasize that the HSR rules are complex and contain often counterintuitive provisions and exceptions governing when an HSR filing must be made. Many deals require filings even though they raise no conceivable antitrust issues.
The current fine for failing to make a timely HSR filing is up to $16,000 per day from the day the transaction closes until a corrective filing is made. In recent years, the FTC has initiated a number of enforcement actions against private equity funds and hedge funds for failure to make timely filings, in some cases imposing substantial fines on funds and their managers.[2]
Consideration should also be given to non-U.S. filing requirements if the target company has sales or assets outside the U.S. Therefore, it is important to consult your legal advisor early on in the M&A process to ensure that the appropriate filings are made.
If you have any questions regarding this newsletter, please contact any of the lawyers listed below or your regular Davis Polk contact.
Paul W. Bartel, II, Partner
212-450-4760 | paul.bartel@dpw.com
John Bick, Partner
212-450-4350 | john.bick@dpw.com
Arthur Burke, Partner
212-450-4352 | arthur.burke@dpw.com
650-752-2005
Joel M. Cohen, Partner
212-450-4592 | joel.cohen@dpw.com
Ronan P. Harty, Partner
212-450-4870 | ronan.harty@dpw.com
Chris Hockett, Partner
650-752-2009 | chris.hockett@dpw.com
Nancy Sanborn, Partner
212-450-4955 | nancy.sanborn@dpw.com
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1. In Murphy v. Kohlberg Kravis Roberts & Co. et al., No. 06-cv-13210 (S.D.N.Y.), a group of investors filed suit against thirteen private equity firms claiming anticompetitive bid-rigging in several going-private transactions by (i) sharing information, (ii) engaging in communications regarding the values of bids to limit competing bids and therefore depress prices, (iii) entering into agreements to refrain from bidding once one firm or consortium had signed a merger agreement with a target, and (iv) locking up major industry lenders to preclude other prospective bidders from obtaining the financing necessary to make a competing bid. Although the case was later dismissed on procedural grounds for failing to meet the heightened pleading standard for alleging an antitrust violation established in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court left open the question of whether private equity firms can face liability in shareholder actions. Additional shareholder suits followed in other jurisdictions.
In In re WatchGuard Securities (Pennsylvania Avenue Funds v. Borey, et al., No. C06-1737 RAJ (W.D. Wash.)), Vector and Francisco Partners (“FP”) each made formal bids over $5.00 per share to acquire WatchGuard Technologies, Inc. Vector eventually aborted its pursuit of WatchGuard, and FP lowered its bid to $4.25 per share. After the WatchGuard shareholders voted in favor of the merger, Vector announced its agreement with FP to fund half of the WatchGuard acquisition in exchange for a 50% interest after the merger. Several plaintiff shareholders filed antitrust claims against Vector and FP alleging that defendants had conspired to short-circuit the bidding process. As a result, the shareholders claimed, FP was able to lower its bid without worry of a competing bid, while Vector received a benefit from the lowered bid by funding 50% of the acquisition. In early 2008, these antitrust claims were dismissed with prejudice. The court determined that the agreement between FP and Vector was not “so plainly anticompetitive that no elaborate study of the industry is needed to establish [its] illegality” and that private equity bidders joining forces could actually “promote rather than suppress competition” by allowing bidders with insufficient assets to make a bid on their own to join forces to enter the bidding fray.
Finally, in Dahl v. Bain Capital Partners, et al., No. 07-12388-EFH (D. Mass.), shareholders alleged collusion among seventeen defendants, mostly private equity firms, to allocate the LBO market in nine club deals between 2003 and 2008 by submitting “sham” bids, agreeing not to submit bids, granting management incentives, and including “losing” bidders in the final transaction. In late 2008, the court denied defendants’ motion to dismiss for improper pleading under Twombly and Section 1 of the Sherman Act. The court found that the plaintiffs had “plausibly suggest[ed]” an illegal agreement in the nine specifically pled transactions based on the overlap of private equity firms in multiple transactions. Although the court did not pass judgment on the merits of the plaintiffs’ case, the decision must be considered by private equity firms contemplating future club deals.
2. In September 2005, the DOJ filed a civil antitrust suit against Scott R. Sacane for violating the HSR Act filing requirements in connection with his hedge fund’s acquisition of Aksys Ltd. and Esperion Therapeutics, Inc. Mr. Sacane agreed to pay a $350,000 civil penalty to settle the suit. The DOJ noted that the severity of the fine was due to the violations continuing for over two years. (DOJ Sacane Case Filing 9/26/05)
In May 2007, the DOJ filed a complaint against James D. Dondero (as the ultimate parent entity for purposes of the HSR Act, of Highland Capital Management, L.P., a hedge fund that specializes in senior bank loans) for failure to make required HSR Act filings in connection with his acquisition of Motient Corporation stock exceeding the HSR Act premerger filing threshold. To settle the case, Dondero paid a $250,000 civil penalty. The FTC noted that the Motient violation was Dondero’s second within the space of one year. (FTC Press Release 5/21/07)
In December 2007, FTC attorneys filed a complaint against ValueAct Capital Partners, L.P. an investment firm based in San Francisco, alleging failure to make required HSR Act filings in connection with the acquisitions of stock of Gartner, Inc., Catalina Marketing Group, and Acxiom Corp. To settle the suit, ValueAct, agreed to pay a civil penalty of $1.1 million. The FTC noted that ValueAct had previously failed to comply with HSR Act requirements in its acquisition of Martha Stewart Living Omnimedia and Mentor Corp., but because those failings were ValueAct’s first HSR Act violations, the FTC staff did not initiate an action to impose penalties for those violations. (FTC Press Release 12/19/07)
In December 2008, the FTC fined ESL Partners, L.P. $525,000 and ZAM Holdings, L.P. $275,000 for failure to make timely HSR Act filings prior to acquiring blocks of shares of AutoZone, Inc. The funds’ purchases of shares, when aggregated with shares previously held, triggered HSR Act filing requirements. The required filings were not made until the FTC contacted the funds to inquire as to why no filings had been made. The FTC press release noted that “[t]he Commission takes the premerger notification requirements of the HSR Act very seriously and will not hesitate to take action when companies or individuals shirk their filing responsibilities.” It is notable, however, that unlike Dondero and ValueAct, it does not appear that either fund committed any prior violation of the HSR Act. (FTC Press Release 12/15/08)