MERGER ANALYSIS
UNDER THE U.S. ANTITRUST LAWS
William Blumenthal *
King & Spalding
Washington, D.C.
This outline summarizes the basic principles of merger analysis under the federal antitrust laws.
It is organized as follows: Part I summarizes the text and purpose of Section 7 of the Clayton
Act, the principal provision governing mergers, and it briefly identifies other relevant antitrust
provisions. Part II addresses standards governing market definition in merger matters. Part III
identifies issues in identifying market participants and measuring the extent of their participation.
Part IV addresses the standards governing the assessment of the competitive effects of horizontal
mergers. Part V addresses entry considerations, and Part VI addresses efficiency considerations.
Part VII addresses issues presented by transactions involving failing firms. Part VIII addresses
the standards governing the assessment of the competitive effects of vertical mergers. Finally,
Part IX reviews the requirements for filing premerger notification under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976.
I. STATUTORY FOUNDATIONS OF U.S. MERGER LAW
A.
Section 7 of the Clayton Act
The principal federal statutory provision governing mergers is Section 7 of the Clayton Act, 15
U.S.C. § 18, which provides:
No person engaged in commerce or in any activity affecting commerce shall acquire,
directly or indirectly, the whole or any part of the stock or other share capital and no person
subject to the jurisdiction of the Federal Trade Commission shall acquire the whole or any
part of the assets of another person engaged also in commerce or in any activity affecting
commerce, where in any line of commerce or in any activity affecting commerce in any
section of the country, the effect of such acquisition may be substantially to lessen
competition, or tend to create a monopoly.
The text of Section 7 is constitutional in scope. Nearly all substantive merger law is derived
from this single sentence. For example, the extensive body of law governing market definition
derives from the statute’s references to “line of commerce” and “section of the country.”
*
The author is grateful to Peter M. Todaro and Kathryn E. Walsh, also of the Washington office
of King & Spalding, for providing assistance in compiling and updating this outline from the author’s
prior materials.
B.
Other Statutes
Although most merger enforcement actions are based on Section 7 of the Clayton Act, mergers
may also be challenged under Section 1 or Section 2 of the Sherman Act, 15 U.S.C. §§ 1-2, or
Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45.
1.
Section 1 of the Sherman Act declares, “Every contract, combination in the form of
trust or other, or conspiracy, in restraint of trade or commerce[,] . . .” to be illegal. 15
U.S.C. § 1; see, e.g., United States v. First Nat’l Bank & Trust Co. of Lexington, 376 U.S.
665, 671-72 (1964); United States v. Rockford Memorial Corp., 898 F.2d 1278, 1281-82
(7th Cir. 1990).
2.
Section 2 of the Sherman Act makes it illegal to “monopolize, or attempt to
monopolize, or combine or conspire . . . to monopolize. . . .” 15 U.S.C. § 2; see, e.g.,
United States v. Grinnell Corp., 384 U.S. 563, 575-76 (1966).
3.
Section 5 of the Federal Trade Commission Act prohibits “[u]nfair methods of
competition . . . and unfair or deceptive acts or practices. . . .” 15 U.S.C. § 45; see, e.g., In
re American Medical Int’l, 104 F.T.C. 1, 110 (1984).
C.
Agency Guidelines
1.
The 1992 Merger Guidelines issued by the U.S. Department of Justice and the
Federal Trade Commission are the most recent comprehensive statement outlining the
agencies’ analysis of horizontal mergers.
2.
The Department’s 1984 Merger Guidelines are the agencies’ most recent
comprehensive statement on evaluating vertical mergers, but they should be “read in the
context of” the 1992 Guidelines. U.S. Department of Justice and Federal Trade
Commission Statement Accompanying Release of Revised Merger Guidelines (Apr. 2,
1992), reprinted in 2 ABA ANTITRUST SECTION, ANTITRUST LAW DEVELOPMENTS 1368
(3d ed. 1992).
D.
Purpose of Section 7
1.
Commentators offer differing views on the purpose of Section 7 and of the antitrust
laws more generally. See ABA ANTITRUST SECTION, MONOGRAPH NO. 12, HORIZONTAL
MERGERS: LAW AND POLICY 6-26 (1986) [hereinafter ABA MERGER MONOGRAPH]. The
views fall along a spectrum. “One pole is represented by the view that the sole purpose of
the antitrust laws is to maximize economic efficiency.” Id. at 7 (collecting authority at
n.27). The opposite pole is represented by the view that the antitrust laws are based upon
both economic and sociopolitical values. See id. at 7-9 (collecting authority). An
intermediate position reflects the view that the antitrust laws are based upon economic
values, but that those values include factors beyond efficiency, most notably distributional
factors such as the prevention of wealth transfers from consumers to producers. See id. at 8
-2-
n.30. Resolution of the purpose of the statute is crucial, because “[o]nly when the issue of
goals has been settled is it possible to frame a coherent body of substantive rules.” R.
BORK, THE ANTITRUST PARADOX 50 (1978).
2.
The 1992 Guidelines provide: “The unifying theme of the Guidelines is that mergers
should not be permitted to create or enhance market power or to facilitate its exercise. . . .
[T]he result of the exercise of market power is a transfer of wealth from buyers to sellers or
a misallocation of resources.” 1992 GUIDELINES § 0.1.
3.
At the time of the 1992 Guidelines’ release, some individuals within the enforcement
agencies appeared to disagree over the purpose of Section 7 as reflected in the preceding
paragraph.
a.
The FTC staff wrote: “The 1992 Guidelines clarify that mergers may be
condemned either because they lead to a misallocation of resources (efficiencies) or a
transfer of wealth from buyers to sellers (welfare of consumers).” FTC Bureau of
Competition Pocket Guide, reprinted in FTC: WATCH No. 364, at 2 (Apr. 6, 1992)
[hereinafter FTC Pocket Guide].
b.
The Guidelines’ provision, however, is open to another interpretation: mergers
may be condemned only because of adverse effects on economic efficiency, which
effects result in resource misallocation and typically (but not invariably) coincide
with wealth transfers. Under this view, wealth transfers would not provide an
independent basis for challenge. This interpretation was offered by at least some
persons within the Antitrust Division.
4.
The difference of interpretation will not matter with respect to many transactions,
since adverse efficiency effects are usually accompanied by wealth transfers. The
difference may matter, however, with respect to markets characterized by very low demand
elasticity; and it will matter fundamentally to the interpretation of certain other provisions
of the Guidelines -- most notably, whether efficiency gains from a merger must be passed
on to consumers, see infra part VI.B.
E.
Motivation of Private Conduct
1.
Section 7 is a predictive statute, see, e.g, United States v. General Dynamics Corp.,
415 U.S. 486, 501 (1974) (“companies that have controlled sufficiently large shares of a
concentrated market are barred from merger by § 7, not because of their past acts, but
because their past performances imply an ability to continue to dominate”), and guidelines
or legal rules intended to implement Section 7 necessarily must attempt to predict the effect
of a transaction upon future economic performance. Such prediction requires a vision of
how markets work -- an economic model, whether explicit or implicit. Such a
vision/model, in turn, requires certain assumptions about how people behave.
-3-
2.
The 1992 Guidelines provide: “Throughout the Guidelines, the analysis is focused on
whether consumers or producers ‘likely would’ take certain actions, that is, whether the
action is in the actor’s economic interest.” 1992 GUIDELINES § 0.1.
3.
The Guidelines’ approach is consistent with the common assumption in economic
theory that persons and businesses are rational and profit-maximizing. That assumption has
increasingly come under attack or has been relaxed, however, in much of modern economic
theory. The theory over the past decade has made great strides in explaining what has been
evident to practitioners for a long time -- that corporate clients often act in a manner that
appears irrational or inconsistent with profit maximization.
a.
Thus, the so called “principal-agent literature” explains that in hierarchies such
as corporations, managers will act in their personal interests rather than the
enterprises’ interests unless appropriate incentive structures are devised -- often a
difficult task. As a result, corporations may act in a manner that is irrational or nonmaximizing from the corporation’s perspective. See, e.g, J. Stiglitz, Principal and
Agent, in ALLOCATION, INFORMATION, AND MARKETS (1989) (collecting authority);
B. Holmstrom & J. Tirole, The Theory of the Firm, in 1 HANDBOOK OF INDUSTRIAL
ORGANIZATION 86-106 (1989) (same).
b.
Because information is costly to obtain and process, persons may act in a
manner that is “boundedly rational” -- that is, they intend to be rational, but are
limited in the effort. See, e.g., D. KREPS, GAME THEORY AND ECONOMIC MODELING
ch. 6 (1990). Cognitive biases affect judgment. See M. NEALE & M. BAZERMAN,
COGNITION AND RATIONALITY IN NEGOTIATION (1991).
c.
Game theory, upon which the Guidelines’ competitive effects section is largely
based, see infra part IV, increasingly is making efforts to model “irrationality.” See,
e.g., D. KREPS, A COURSE IN MICROECONOMIC THEORY 480-89 (1990); see also R.
THALER, QUASI RATIONAL ECONOMICS (1991).
4.
As a theoretical matter, then, notwithstanding the Guidelines’ underlying assumption,
market behavior may not be based on “whether the action is in the actor’s economic
interest,” 1992 GUIDELINES § 0.1. As an evidentiary matter, predicting whether
“consumers or producers ‘likely would’ take certain actions,” id., is extremely difficult
without the benefit of behavioral assumptions and therefore is open to substantial dispute.
II. MARKET DEFINITION
Because Section 7 is violated only by transactions that may substantially lessen competition “in
any line of commerce . . . in any section of the country,” a merger must be examined in terms of
its likely effect within a “relevant market” having both a product and a geographic dimension.
See Brown Shoe Co. v. United States, 370 U.S. 294, 324 (1962). The Supreme Court has held
that “[d]etermination of the relevant market is a necessary predicate to a finding of a violation of
-4-
the Clayton Act because . . . [s]ubstantiality can be determined only in terms of the market
affected.” United States v. E.I. du Pont de Nemours & Co., 353 U.S. 586, 593 (1957).
A.
Demand Substitution
1.
Demand substitution is the substitution by consumers of one product for another
product. Courts have long recognized demand substitution as the leading basis for product
market definition. See Brown Shoe Co. v. United States, 370 U.S. 294, 325 (1962) (“the
outer boundaries of a product market are determined by the reasonable interchangeability
of use or the cross-elasticity of demand between the product itself and substitutes for it”);
United States v. E.I. du Pont de Nemours & Co. (Cellophane), 351 U.S. 377, 394-95 (1956)
(products that are “reasonably interchangeable by consumers for the same purposes” are in
the same market.).
2.
There are differing visions as to how demand substitution should be taken into
account operationally. See ABA MERGER MONOGRAPH, supra part I.D.1, at 89-110.
a.
Most commonly, demand substitution is measured by the cross-elasticity of
demand which compares the change in the quantity demanded of one product given a
price change of another product. If a change in the price of one product causes a
large change in the demand of another product, the two products have a high crosselasticity of demand and are treated as being in a single market. See id. at 89-96.
b.
The geographic component of market definition is often defined by looking at
the historical insularity of a given geographic area for a specific group of products.
Under the Elzinga-Hogarty Test, a market is measured by determining both the
inflows of products (where products consumed within the area are produced) and the
outflows of products (where products produced within the area are consumed). A
market is properly defined when little of the specified group of products flows in or
out of the specified geographic area. See id. at 96-101. Although questioned by
many, this approach remains common in hospital merger cases. See, e.g., FTC v.
Freeman Hospital, 69 F.3d 260 (8th Cir. 1995).
c.
A market can also be defined as a group of products and corresponding
geographic area within which prices tend toward equality. Close price relationships
are evidence that products or geographic markets are in the same market. See ABA
MERGER MONOGRAPH, supra part I.D.1, at 102-05.
d.
Finally, markets can be defined by looking at the ability of a hypothetical
monopolist to exert market power (e.g., raise prices profitably). If a price increase
across a specified group of products would be unprofitable because enough
consumers would switch to other products outside the group, then the specified group
does not constitute a market. If, on the other hand, the price increase across a
specified group would be profitable for the hypothetical monopolist, then the group
constitutes a market. See id. at 105-10. The 1992 Guidelines’ approach of looking at
-5-
the effect of a “‘small but significant and nontransitory’ increase in price” relies on
this method.
B.
Supply Substitution
1.
Although there is no question that demand substitution is a fundamental consideration
in market definition, there is substantial debate as to whether supply substitution should
also be considered in market definition.
a.
Authority is split into three camps: (i) define the relevant market by reference
to both supply-side and demand-side criteria; (ii) define the relevant market solely by
reference to demand-side criteria, but consider supply substitution in identifying
market participants and measuring the market; and (iii) define and measure the
relevant market solely by reference to demand substitution. See ABA MERGER
MONOGRAPH, supra part I.D.1, at 110-16. The 1992 Guidelines adopted approach
(ii).
b.
The three approaches can lead to substantial differences in measured market
concentration. Consider this example: Widgets and gizmos are used for entirely
unrelated purposes, but can sometimes be produced in the same facilities, depending
on the supplier’s particular production process. Firm R, which produces widgets in a
dedicated facility, proposes to merge with Firm S, which produces widgets and
gizmos in a common facility. Firms P and Q also produce widgets in dedicated
facilities. Firm T also produces widgets and gizmos in a common facility. Firms U
and V currently produce only widgets, but could immediately shift to the production
of gizmos in common facilities. Firms W, X, and Y produce only gizmos in
dedicated facilities. In assessing the effect of the merger of Firms R and S on
widgets, what is the relevant product? Under approach (i), the product would
probably be both widgets and gizmos because of the common production facilities’
and all firms would be in the market. Under approach (ii), the product would be
widgets only, and Firms P-V would be in the market. Under approach (iii), the
product would be widgets only, and Firms P-T would be in the market.
2.
The 1992 Guidelines provide: “Market definition focuses solely on demand
substitution factors -- i.e., possible consumer responses. Supply substitution factors -- i.e.,
possible production responses -- are considered elsewhere in the Guidelines in the
identification of firms that participate in the relevant market and the analysis of entry.”
1992 GUIDELINES § 1.0.
3.
Courts have recognized supply substitution as a factor in market definition. See, e.g.,
Brown Shoe, 370 U.S. at 325 n.42 (“cross-elasticity of production facilities may also be an
important factor in defining a product market”); Carter Hawley Hale Stores, Inc. v.
Limited, Inc., 587 F. Supp 246, 253 (C.D. Cal. 1984), aff’d, 760 F.2d 945 (9th Cir. 1985)
(garment manufacturer can easily switch production to different quality and sizes of
clothing).
-6-
C.
Threshold Levels: Magnitude of Price Increase
1.
Market definition requires an analysis of substitution possibilities. The scope of
substitution possibilities, in turn, depends on relative price levels: “at a high enough price
even poor substitutes look good to the consumer,” R. POSNER, ANTITRUST LAW: AN
ECONOMIC PERSPECTIVE 128 (1976). Under the 1992 Guidelines’ framework, market
definition is performed by considering substitution in response to a hypothetical price
increase. The magnitude of the price increase will materially affect the extent to which
substitution occurs. See generally ABA MERGER MONOGRAPH, supra part I.D.1, at 118.
2.
The 1992 Guidelines provide: “In attempting to determine objectively the effect of a
‘small but significant and nontransitory’ increase in price, the Agency, in most contexts,
will use a price increase of five percent. . . . However, what constitutes a ‘small but
significant and nontransitory’ increase in price will depend on the nature of the industry,
and the Agency at times may use a price increase that is larger or smaller than five
percent.” 1992 GUIDELINES § 1.11; see also id. § 1.21 (for geographic market definition,
“what constitutes a ‘small but significant and nontransitory’ increase in price . . . will be
determined in the same way” as for product market definition).
3.
The Guidelines allow for deviation from five percent, but do not provide any standard
by which to determine when a different percentage is appropriate or what it should be.
Under the Guidelines, the decisionmaker has substantial discretion, the exercise of which
may materially affect the contours of the market. At a low percentage increase, few
products will be substitutes. At a high percentage increase, many products will be.
4.
In United States v. Engelhard, 970 F. Supp. 1463 (M.D. Ga.), aff’d, 126 F.3d 1302
(11th Cir. 1997), the court rejected the government’s use of five to ten percent as a price
increase threshold because the did not provide an accurate picture of the relevant product
market for attapulgite clay. Some customers had stated that they would not switch clays if
their suppliers raised prices by five percent, since the clay was a low percentage of their
overall product cost and switching clays involved potentially significant qualification costs.
970 F. Supp. at 1467. The court denied the government’s motion for injunctive relief.
D.
Threshold Levels: Uniformity of Price Increase
1.
An issue to which little thought has previously been given in the cases and
commentary was raised (perhaps inadvertently) by one sentence in the 1992 Guidelines -whether the percentage price increase, once selected, is to be applied uniformly across all
products in the market, or whether it is to be simply the average of a set of price increases
that will be applied at varying levels to different products in the market. Suppose, for
example, that the “small but significant and nontransitory” increase to be used in evaluating
a particular transaction in the widget market is five percent. Under the market definition
exercise, do we hypothesize that the price of all widgets will increase five percent? Or do
we hypothesize that widget producers will apply varying percentages, some more and some
-7-
less than five percent, such that the producers maximize profits and the price increase
across the market averages five percent?
2.
The 1992 Guidelines provide: “[T]he hypothetical monopolist will be assumed to
pursue maximum profits in deciding whether to raise the prices of any or all of the
additional products under its control.” 1992 GUIDELINES § 1.11; see also id. § 1.21 (similar
standard with respect to geographic locations).
3.
This provision was addressed by Commissioner Azcuenaga in her statement
dissenting from the issuance of the Guidelines:
The test used to identify the relevant market seems changed in a way that may be
difficult to implement and may make market definition less predictable. The 1984
Guidelines hypothesized a uniform price increase to identify the market. Under the
new Guidelines, the price increase is not necessarily uniform. Instead, the
hypothetical monopolist, ‘to pursue maximum profits,’ may increase prices for some
products and for some locales more than for others. . . . Requiring a determination of
the pricing policy of the hypothetical monopolist raises the level of complexity in
market analysis. With even a moderate number of products and locales, the analysis
may prove to be a daunting task. Various assumptions about factors influencing the
monopolist’s decision may lead to different pricing policies and, thus, different
definitions of relevant markets. While the approach may be appropriate in theory, it
is unclear how we might choose among the myriad of plausible price choices that the
hypothetical profit-maximizing monopolist might make. The relatively ‘crude’ test of
the 1984 Guidelines has the saving grace of simplicity, feasibility and predictability.
Dissenting Statement of Commissioner Mary L. Azcuenaga, On the Issuance of the
Horizontal Merger Guidelines, at 3 (Apr. 2, 1992).
4.
If the Guidelines mean what Commissioner Azcuenaga says they mean, her analysis
has merit. In order to define a market, one would have to determine the optimal pricing
policy of market participants acting in a coordinated manner, taking into account the
differing degrees of substitutability of each product in the market for all alternatives inside
and outside the market. To be sure, aircraft engineers use supercomputers to analyze
equally sophisticated problems in the design of airfoils, but rules of law do not normally
have a level of complexity comparable to fluid dynamics. As a practical matter, this
provision of the Guidelines will not be applied literally.
E.
Threshold Levels: Duration of Price Increase
1.
The scope of the market depends not only on the magnitude of the hypothesized price
increase, but also on the duration for which the increase is assumed to be in effect. In
general, purchasers can turn to a broader range of substitutes as they have more time to do
so. See generally ABA MERGER MONOGRAPH, supra part I.D.1, at 121-23. The 1982
Guidelines and the 1984 Guidelines used one year as the period for assessing the extent of
-8-
substitution for market definition purposes. (They used other time frames for other
purposes, such as entry or measurement of production substitution.)
2.
The 1992 Guidelines provide: “[T]he Agency, in most contexts, will use a price
increase . . . lasting for the foreseeable future.” 1992 GUIDELINES § 1.11.
3.
The Guidelines provide no indication of what constitutes “the foreseeable future.”
One interpretation would be “in perpetuity,” which would lead to markets broader than
under the former “one year” standard; this does not appear to be the interpretation that the
agencies intended. Other interpretations, which agency staffs have suggested in private
conversations, would be “for one product cycle” or “until the next purchase decision.”
F.
Threshold Levels: Base Price (I)
1.
Selection of the base price from which the hypothetical price increase is taken is
conceptually important in defining markets. The base price may be the prevailing price,
the competitive price (used to avoid the so-called Cellophane trap where the prevailing
price reflects market power), or something else. See generally ABA MERGER
MONOGRAPH, supra part I.D.1, at 123-28. The 1992 Guidelines address the Cellophane
trap directly changing the earlier approach of the 1982 Guidelines and 1984 Guidelines
which indicated that prevailing price would be used (at least as between prevailing price
and a lower competitive price).
2.
The 1992 Guidelines provide: “[T]he Agency will use prevailing prices of the
products of the merging firms and possible substitutes for such products, unless premerger
circumstances are strongly suggestive of coordinated interaction, in which case the Agency
will use a price more reflective of the competitive price.” 1992 GUIDELINES § 1.11
(footnote omitted); see also id. § 1.21 (for geographic market definition, base price will be
determined in the same way as for product market definition).
3.
The Guidelines are asymmetrical in that they do not appear to recognize other
circumstances in which prevailing price is below competitive price. In particular, in
declining industries that are undergoing a shakeout, prevailing prices will often fall below
long-term competitive price (that is, the price that will prevail when the industry reaches
equilibrium). The Guidelines, of course, do not specify the meaning of “competitive
price,” and the agencies are likely to take the position that the term refers to the short-term
competitive price. In an appropriate failing company or declining industry case, however,
counsel may wish to invoke the Guidelines to support the proposition that the market
should be defined by reference to post-shakeout price and should therefore be broadened.
(The Guidelines’ provision discussed infra part II.G may also provide a basis for such an
argument.)
-9-
G.
Threshold Levels: Base Price (II)
1.
For reasons already stated, the price selected for assessing the degree of substitution
materially affects the resulting market definition. That price, in turn, depends on two
components: the base price from which the hypothetical price increase is taken, and the
magnitude of the price increase. We have already discussed the magnitude of the price
increase, see supra part II.C, and we have discussed one basis for selecting a base price that
differs from prevailing price, namely coordinated basis for selecting a base price that
differs from prevailing price: since Section 7 is forward-looking, see supra part I.E.1, the
market definition exercise arguably should be performed by reference to the price that will
prevail in the future in the absence of the transaction under investigation. This concept was
reflected in the 1982 and 1984 Guidelines and was carried over in revised form to the 1992
Guidelines.
2.
The 1992 Guidelines provide: “[T]he agency may use likely future prices, absent the
merger, when changes in the prevailing prices can be predicted with reasonable reliability.
Changes in price may be predicted on the basis of, for example, changes in regulation
which affect price either directly or indirectly by affecting costs or demand.” 1992
GUIDELINES § 1.11; see also id. § 1.21 (for geographic market definition, base price will be
determined in the same way as for product market definition).
H.
Price Discrimination as a Basis for Market Definition
1.
The 1982 Guidelines identified price discrimination as a basis for market definition
where certain conditions were satisfied. The practice was continued in the 1984 Guidelines
and the 1992 Guidelines.
2.
The 1992 Guidelines provide: “The Agency will consider additional relevant product
markets consisting of a particular use or uses by groups of buyers of the product for which
a hypothetical monopolist would profitably and separately impose at least a ‘small but
significant and nontransitory’ increase in price.” 1992 GUIDELINES § 1.12; see also id. §
1.22 (similar standard with respect to geographic markets).
3.
In light of its history, this provision is now standard in merger analysis. The
significance of the provision depends largely on its application, which remains highly
discretionary. Even though the language of the 1992 Guidelines on price discrimination
was substantially similar to the 1982 Guidelines and 1984 Guidelines, the FTC staff, at
least, discerned a shift: “The 1992 Guidelines embrace a greater acceptance of product
markets based on price discrimination. (Where price discrimination is possible, markets
can be as small as sales to a single buyer.)” FTC Pocket Guide, supra part I.D.3.a, at 2.
4.
The price discrimination provisions in the Guidelines are often viewed as creating an
analogue to the submarkets found in older cases. See ABA Merger Monograph, supra part
I.D.1, at 128 (discussion relationship to criteria identified in Brown Shoe Co. v. United
States, 370 U.S. 294, 325 (1962)).
- 10 -
a.
One objective of the 1982 Guidelines was to drive a stake through the heart of
the Brown Shoe approach to submarkets. See Panel Discussion: The New Merger
Guidelines, 51 ANTITRUST L.J. 317, 321 (1982) (remarks of William F. Baxter,
Assistant Att’y Gen., that the submarket concept “has been terribly abused” and “the
sooner we see the end to that kind of chatter the better”).
b.
Explicit adoption of submarkets, sometimes by reference to the Brown Shoe
criteria without regard to the principles described in the Guidelines, has begun to
reappear in recent cases. See FTC v. Cardinal Health, Inc., 12 F. Supp. 2d 34, 47-49
(D.D.C. 1998) (finding “distinct submarket” of wholesale prescription drug
distribution to customers that did not self-warehouse drugs and could not use other
methods of distribution as reasonable substitutes for defendants’ services); FTC v.
Staples, 970 F. Supp. 1066, 1073-81 (D.D.C. 1997) (finding submarket for the sale of
consumable office supplies through office supply superstores, despite high degree of
functional interchangeability between consumable office supplies sold by office
superstores and other retailers of office supplies, because certain customers did not go
elsewhere for supplies). For a detailed discussion of the market definition
methodologiesw in these cases, see William Blumenthal & David A. Cohen,
Channels of Distribution as Merger “Markets”: Interpreting Staples and Cardinal,
ANTITRUST REP. (MB), Nov. 1998, at 2.
III. MARKET PARTICIPATION AND MEASUREMENT
Once the market has been defined, market participants must be identified and market shares must
be assigned before HHI concentration levels can be calculated. Under the 1992 Guidelines, this
is not a mechanical exercise, but rather is highly judgmental.
A.
“Firms that Currently Produce or Sell”
1.
The identification and measurement of market participants normally begin with
suppliers that currently sell in the merchant market (that is, between firms that lack
corporate affiliation). The 1982 Guidelines and 1984 Guidelines stated that the “evaluation
of a merger will focus primarily, on firms that currently produce and sell the relevant
product.” 1982 GUIDELINES § II.B (emphasis added); 1984 GUIDELINES § 2.2 (emphasis
added). Other firms would be included based on probable supply responses.
2.
The 1992 Guidelines provide: “The Agency’s identification of firms that participate
in the relevant market begins with all firms that currently produce or sell in the relevant
market.” 1992 GUIDELINES § 1.31 (emphasis added).
a.
The Guidelines include, at least initially, both participants in the merchant
market and vertically integrated firms. The inclusion of vertically integrated firms in
- 11 -
the relevant market is, however, limited by the captive use provisions of the
Guidelines. See infra part III.B.
b.
The provision is clear in indicating that current suppliers are only the beginning
of the analysis of market participation, rather than the primary focus. The substantive
significance of this shift appears to be slight, though. Captive use is treated as part of
the beginning, 1992 GUIDELINES § 1.31, and the treatment of the only other classes
expressly recognized in the Guidelines -- durable products and production
substitution, see id. §§ 1.31, 1.32 -- is not markedly more inviting than in the 1982
Guidelines and 1984 Guidelines.
B.
Captive Use
1.
Authority is mixed on whether production for captive use should be considered when
identifying market participants and measuring market shares. The 1982 Guidelines and
1984 Guidelines provided that producers for captive use would be included in the market if
they would respond to a “small but significant and nontransitory” price increase by
beginning to sell the relevant product in the merchant market or by increasing production
of both the relevant product and the downstream product in which the relevant product is
embodied. See 1982 GUIDELINES § II.B.3; 1984 GUIDELINES § 2.23.
2.
The 1992 Guidelines provide that market participants “include[] vertically integrated
firms to the extent that such inclusion accurately reflects their competitive significance in
the relevant market prior to the merger.” 1992 GUIDELINES § 1.31.
3.
The Guidelines provision is cryptic, and its significance is not yet clear. From
interpretations issued shortly after the release of the Guidelines, however, the enforcement
agencies appear to disagree on the treatment of vertically integrated firms.
a.
The Antitrust Division evidently includes vertically integrated firms even if
production is solely for captive use. See J. Rill, Assistant Att’y Gen., 60 Minutes
with the Honorable James F. Rill, Before the ABA 40th Annual Antitrust Spring
Meeting, at 8 (Apr. 3, 1992) [hereinafter Rill Speech] (“the Guidelines now include
all current producers or sellers of the relevant product, even if the firm is vertically
integrated and produces only for its own internal consumption”); C. James, Deputy
Assistant Att’y Gen., Remarks before the Manufacturer’s Alliance on Productivity
and Innovation, at 12 (Apr. 10, 1992) [hereinafter James Speech] (“[i]nternal
production by vertically integrated firms is given full credit in market measurement
under the new Guidelines”).
b.
At least as of 1992, the FTC evidently included vertically integrated firms only
to the extent specified in the 1984 Guidelines. See K. Arquit, Director, FTC Bureau
of Competition, Further Thoughts on the 1992 U.S. Government Horizontal Merger
Guidelines, before the State Bar of Texas, at 7-8 (Apr. 24, 1992) [hereinafter Arquit
Speech] (little or no substantive change from 1984 Guidelines intended, so standard is
- 12 -
“whether, and to what extent, captive producers are likely to exert a competitive
impact on the relevant market, either by selling the relevant product or by increasing
production of both the relevant product and downstream products”). The agency’s
current practice is not clear.
4.
The practical difficulty of measuring the market participation of vertically integrated
firms depends largely on which of the preview interpretations is adopted. If inclusion of
vertically integrated firms depends on a matter-specific assessment of their competitive
impact, market measurement is highly judgmental -- how will they respond to a price
increase? -- and provides substantial room for argument. If production by vertically
integrated firms is counted fully, market measurement is eased considerably. (There will
still be some difficulties, though -- the merger parties often lack data estimating vertically
integrated competitors’ production for captive use.)
C.
Durable Products
1.
In United States v. Aluminum Co. of America, 146 F.2d 416 (2d Cir. 1945), the court
excluded scrap aluminum from the relevant aluminum market. Since then, authority has
been split on the treatment of recycled or durable products when measuring markets. See
ABA MERGER MONOGRAPH, supra part I.D.1, at 131-33. Rejecting the Alcoa
methodology, the 1982 Guidelines and 1984 Guidelines include in the market firms that
recycle or recondition products that “represent good substitutes for new products.” 1982
GUIDELINES § II.B.2; 1984 GUIDELINES § 2.22.
2.
The 1992 Guidelines provide: “To the extent that the analysis [in the product market
definition provisions] under Section 1.1 indicates that used, reconditioned or recycled
goods are included in the relevant market, market participants will include firms that
produce or sell such goods and that likely would offer those goods in competition with
other relevant products.” 1992 GUIDELINES § 1.31.
D.
Supply Substitution
1.
As discussed supra part II.B, authority is split as to the appropriate treatment of
supply substitution. Under the 1984 Guidelines, the standard governing the treatment of
supply substitution was essentially this: “If a firm has existing productive and distributive
facilities that could easily and economically be used to produce and sell the relevant
product within one year in response to a ‘small but significant and nontransitory’ increase
in price, the Department will include that firm in the market.” 1984 GUIDELINES § 2.21;
see also 1982 GUIDELINES § II.B.1 (same standard, except that period for shifting was six
months). While retaining this concept, the 1992 Guidelines elaborate upon the elements of
the standard and expand it to include supply responses through rapid construction or
acquisition of new facilities.
- 13 -
2.
In particular, the 1992 Guidelines provide:
a.
“If a firm has existing assets that likely would be shifted or extended into
production and sale of the relevant product within one year, and without incurring
significant sunk costs of entry and exit, in response to a ‘small but significant and
nontransitory’ increase in price for only the relevant product, the Agency will treat
that firm as a market participant.” 1992 GUIDELINES § 1.321.
b.
“If new firms, or existing firms without closely related products or productive
assets, likely would enter into production or sale in the relevant market within one
year without the expenditure of significant sunk costs of entry and exit, the Agency
will treat those firms as market participants.” Id. § 1.322.
c.
[Defining one of the important terms in these standards:] “Sunk costs are the
acquisition costs of tangible and intangible assets that cannot be recovered through
the redeployment of these assets outside the relevant market, i.e., costs uniquely
incurred to supply the relevant product and geographic market.” Id. § 1.32.
3.
The provisions of the 1984 Guidelines relating to supply substitution and to the
related issue of entry, see 1992 GUIDELINES § 1.32; infra part V, resulted in substantial
differences in judgment between agency staffs and counsel for merger parties. While the
1992 Guidelines specify the agencies’ standard in greater detail, differences in judgment
are likely still to occur with some regularity.
a.
The 1984 Guidelines asked whether supply substitution could occur; the 1992
Guidelines ask whether supply substitution would occur. Whether the appropriate
legal standard is “could” or “would” remains open to dispute. A “would” standard
imposes greater burdens on the merger parties. It is also highly sensitive to the
manner in which facts are gathered -- for example, if agency staff seek to determine
whether supply substitution would occur by calling possible market participants, the
order and phrasing of questions can affect the answers received. This raises a further
issue: insofar as a “would” standard is deemed appropriate, is the determination of
whether firms would shift to be made through a subjective test (what do they say?) or
an objective test (what would you do if you were they?)?
b.
The “sunk cost” analysis is new to the private bar, and its practicalities have yet
to be explored. After further experience, it may not prove to be so difficult as initially
feared by many practitioners. And if it is difficult to apply, its practical significance
may be limited -- if sunk costs are low, supply responses are treated under this section
of the Guidelines; and if sunk costs are high, supply responses are treated under the
Guidelines’ entry provisions, see 1992 GUIDELINES § 3; infra part V. (What is “high”
in the world of sunk costs? See Rill Speech, supra part III.B.3.a, at 11 (“sunk costs in
excess of five percent of total annual costs will be regarded as significant”).)
Therefore, supply responses are credited, but sunk costs are material as to the specific
- 14 -
manner in which credit is given. Selection of the specific manner will matter in some
cases. More generally, though, counsel might consider these rules of thumb:
i.
If large supply responses are likely to occur, the transaction is likely to be
deemed lawful by virtue of either the supply response provisions or the entry
provisions of the Guidelines.
ii. If very limited supply responses are likely to occur, neither the supply
response provisions nor the entry provisions are likely to be of much assistance,
so move on to another issue.
iii. If some intermediate level of supply response is likely to occur and the
issue may be dispositive, invest the resources to learn the theory of sunk costs,
as well as the facts pertinent to the cost structure of the industry under review.
c.
If firms are to be included in the market based upon the Guidelines’ supply
response provisions, they must be assigned market shares for purposes of market
measurement. The determination of their market share is highly judgmental, and
agency staff and counsel for the merger parties may have different views.
E.
Selection of Statistical Proxy
1.
In some instances the analysis of a transaction will depend on the statistical proxy
used to measure the market -- capacity, revenues, unit sales, reserves, or something else
(such as branches and deposits in banking, for example.) Where market shares fluctuate,
the time period over which activity is measured can also be important. Considering the
potential importance of the issue, surprisingly little authority addresses the methodology of
measurement. See ABA MERGER MONOGRAPH, supra part I.D.1, at 153 n.749 (making
similar observation and summarizing available authority).
2.
The 1992 Guidelines provide:
market shares can be expressed either in dollar terms through measurement of sales,
shipments, or production, or in physical terms through measurement of sales,
shipments, production, capacity, or reserves.
Market shares will be calculated using the best indicator of firms’ future
competitive significance. Dollar sales or shipments generally will be used if firms are
distinguished primarily by differentiation of their products. Unit sales generally will
be used if firms are distinguished primarily on the basis of their relative advantages in
serving different buyers or groups of buyers. Physical capacity or reserves generally
will be used if it is these measures that most effectively distinguish firms. Typically,
annual data are used, but where individual sales are large and infrequent so that
annual data may be unrepresentative, the Agency may measure market shares over a
longer period of time.
- 15 -
1992 GUIDELINES § 1.41 (footnote omitted).
3.
When market shares differ materially depending on the proxy or time frame selected,
counsel should learn why. The explanation will often be significant in understanding the
workings of the market and therefore the competitive effects of the transaction, cf. infra
part IV (discussing Guidelines’ provisions on competitive effects). The explanation may
also provide a basis for arguing that the transaction should be evaluated by reference to a
particular proxy resulting in relatively low concentration levels.
4.
Certain technology and consumer products industries are characterized by
“generational competition,” in which firms compete to develop the product” that will have
substantial share until the next product cycle. Market shares in such industries often vary
sharply from year to year, depending on which particular firm is offering the hot product
for that generation. In evaluating transactions involving such industries, counsel should
consider a footnote in the Guidelines: “Where all firms have, on a forward-looking basis,
an equal likelihood of securing sales, the Agency will assign firms equal shares.” 1992
GUIDELINES § 1.41 n.15; see also ABA MERGER MONOGRAPH, supra part I.D.1, at 158-59
(discussing “bidding models”). (The footnote applies to other industries as well, such as
certain professional services.) Adjustments to market shares in light of generational
competition may also be appropriate under the Guidelines’ provisions for “Changing
Market Conditions,” see infra part III.H.
F.
Adjustments for Committed Capacity
1.
“Limited authority suggests that production undertaken pursuant to a supply contract
might appropriately be attributed in some circumstances to a purchaser/reseller, rather than
to the producer.” ABA MERGER MONOGRAPH, supra part I.D.1, at 136 (collecting cases).
The line of authority traces to United States v. General Dynamics Corp., 415 U.S. 486
(1974), in which a merger in the coal industry was held lawful because the acquired firm,
the reserves of which were either depleted or committed under long-term contract, was “in
a position to offer for sale neither its past production nor the bulk of the coal it is presently
capable of producing,” id. at 502.
2.
The 1992 Guidelines provide: “In measuring a firm’s market share, the Agency wil1
not include its sales or capacity to the extent that the firm’s capacity is committed or so
profitably employed outside the relevant market that it would not be available to respond to
an increase in price in the market.” 1992 GUIDELINES § 1.41.
3.
The Guidelines’ provision presents at least two issues:
a.
For how long a period must the capacity be committed before the provision may
be invoked? The standard is not clear. Presumably we would not slash the measured
share by half because the firm was sold out for the next six months. But what if the
firm is committed for a year? For five years? Does the Guidelines’ time frame for
- 16 -
assessing entry (two years), see 1992 GUIDELINES § 3.2, provide a beeline? And does
it matter whether the firm is committed to a single purchaser or to multiple
purchasers?
b.
While the Guidelines provide for reduction in the producer’s share based on
committed capacity, they do not address whether that capacity is simply dropped
from the market or, instead, whether the share may be attributed to the purchaser.
Where a purchaser has a long-term call on output, attribution may be appropriate in
certain circumstances. See ABA MERGER MONOGRAPH, supra part I.D.1, at 136-38.
G.
Adjustments for Foreign Firms
1.
“[T]here is a broad recognition that some accommodations in the treatment of foreign
competitors must be made to reflect jurisdictional, economic, and other considerations. . . .”
Id. at 141. The particular accommodations have been the subject of wide debate. Id. at
141-52. Many of the revisions from the 1982 Guidelines to the 1984 Guidelines related to
foreign firms, which were treated by the 1984 Guidelines in three different sections, see
1984 GUIDELINES §§ 2.34, 2.4, 3.23. Those three sections were combined and revised in a
single section in the 1992 Guidelines.
2.
The 1992 Guidelines provide that “market shares will be assigned to foreign
competitors in the same way in which they are assigned to domestic competitors[,]” but
that adjustments will be made in certain circumstances to reflect exchange rate fluctuations,
quotas and other trade restraints, and foreign coordination. 1992 GUIDELINES § 1.43.
3.
The adjustments specified in the 1992 Guidelines require judgments, as to which
counsel for the merger parties may disagree with agency staff. In view of the divergent
authority on the treatment of foreign competition, see supra part III.G.1, counsel might also
ask whether standards other than those reflected in the Guidelines should be applied; such
an argument is unlikely to be favorably received at the enforcement agencies, but might
have persuasive value before a court.
H.
Adjustments for Changing Market Conditions
1.
Because Section 7 is a forward-looking statute, see supra part I.E.1, historical market
share data have significance only to the extent that they have predictive value. When
market conditions are changing such that historical data lack predictive value, those data
must be disregarded or adjusted, or their interpretation must be modified. The 1984
Guidelines provided that the government’s interpretation of market concentration and
market share data take account of reasonably predictable effects of changing market
conditions. See 1984 GUIDELINES § 3.21; see also W. Baxter, The Definition and
Measurement of Market Power in Industries Characterized by Rapidly Developing and
Changing Technology, 53 ANTITRUST L.J. 717 (1984). The provision was carried over into
the 1992 Guidelines.
- 17 -
2.
The 1992 Guidelines provide: “[R]ecent or ongoing changes in the market may
indicate that the current market share of a particular firm either understates or overstates
the firm’s future competitive significance. . . . The Agency will consider reasonably
predictable effects of recent or ongoing changes in market conditions in interpreting market
concentration and market share data.” 1992 GUIDELINES § 1.521.
3.
The Guidelines’ approach involves interpretation of market concentration and market
share data, rather than adjustment of the data for purposes of the market concentration
calculation. (This compares with the treatment of committed capacity and foreign firms,
see supra parts III.F-G, as to which the Guidelines adjust the data.) The distinction is of
limited significance, but the adjustment approach pressures the advocate of adjustment
(whether the agency staff or counsel for the parties) to specify numbers with an arithmetic
precision that can be sidestepped under the reinterpretation approach.
4.
Of greater significance is the substantial discretion afforded by this provision of the
Guidelines. Unless invoked sparingly, the provision is an imitation to blue-sky conjectures
as to the future of the market. Counsel should note that the provision allows for data to be
reinterpreted downward or upwards. In at least one matter in which the author was
involved, agency staff contended that the transaction should be enjoined because the
acquiring firm was well poised to have a great future, so that its meager market share
therefore understated its competitive significance.
I.
Adjustments for Financial Weakness
1.
Authority is split as to whether market share data may be adjusted to account for
financial weakness of a merging firm when the elements of the failing company doctrine,
see infra part VII, are not satisfied. See generally ABA MERGER MONOGRAPH, supra part
I.D.1, at 238-39. Over the years the enforcement agencies have taken inconsistent
positions. In Pillsbury Co., 93 F.T.C. 966, 1033-39 (1979), the Commission rejected
financial weakness as a decision factor except as a tiebreaker. In the 1982 FTC Statement
on Horizontal Mergers, at § III.A.2, however, the Commission wrote that “evidence of
individual firm performance can be of use in evaluating the probable effects of a merger.”
The 1982 Guidelines took no position on the issue, but the 1984 Guidelines provided that a
firm’s market share may overstate its significance if the firm faces financial difficulties that
clearly reflect an underlying weakness, see 1984 GUIDELINES § 3.22.
2.
The 1992 Guidelines do not include an express discussion of financial condition as a
factor affecting the significance of market shares and concentration.
3.
The significance of the deletion of the discussion of financial condition from the
Guidelines is not clear, and the enforcement agencies have expressed differing views.
a.
Discussing the change, the then-Chairman of the FTC said that the provision of
the 1984 Guidelines had been misapplied in efforts to create a “flailing firm” defense.
See Remarks of J. Steiger before the ABA 40th Annual Antitrust Spring Meeting, at 6
- 18 -
(Apr. 3, 1992); see also Arquit Speech, supra part III.B.3.b, at 15-16 (elimination of
provision from 1984 Guidelines “should dispel any notion . . . that a firm’s financial
weakness, standing alone and short of imminent failure, is likely to be a “changing
market condition”).
b.
The Antitrust Division, however, indicated that the “changing market
conditions” provision of the 1992 Guidelines, see supra part III.H, should be read to
include the deleted provision on financial condition. See James Speech, supra part
III.B.3.a, at 12.
J.
Adjustments for Other Factors
1.
The scope of other factors that might merit adjustment or reinterpretation of market
share and concentration data is open to dispute. At least one scholarly article has
advocated routine adjustment of data, see L. Kaplow, The Accuracy of Traditional Market
Power Analysis and a Direct Adjustment Alternative, 95 HARV. L. REV. 1817 (1982). In
several cases of the late 1970s, the FTC discounted market shares to reflect the conclusion
that the merging firms, while in the same market, were not head-to-head competitors. See
Heublein, Inc., 96 F.T.C. 385, 575-76 (1980); SKF Industries, 94 F.T.C. 6 (1979); CocaCola Bottling Co., 93 F.T.C. 110 (1979). The 1984 Guidelines identified changing market
conditions, financial condition, and foreign firms as examples of situations that might
warrant the conclusion that market share data understate or overstate the future competitive
significance of market participants. 1984 GUIDELINES § 3.2.
2.
The 1992 Guidelines also treat changing market conditions, see supra part III.H, as
illustrative. More generally, the Guidelines provide: “in some situations, market share and
market concentration data may either understate or overstate the likely future competitive
significance of a firm or firms in the market or the impact of a merger.” 1992 GUIDELINES
§ 1.52. In addition to changing market conditions, the “degree of difference between the
products and locations in the market and substitutes outside the market,” id. § 1.522, is
identified as an example of a situation that might warrant reinterpretation.
3.
In general, however, counsel should be reluctant to argue for adjustment or
reinterpretation of data based on considerations not expressly treated in the Guidelines. If
the facts that would support such an argument have merit, they ordinarily can be weaved
into an alternative argument based upon some consideration treated expressly in the
Guidelines. Often that consideration will be the Guidelines’ competitive effects section, a
catch-all to which we turn next.
K.
Herfindahl-Hirschman Index
1.
After the market participants and shares have been determined, the HHI is used to
calculate market concentration. The market share of each participant is squared and the
results are summed to produce the HHI level. Thus, a market with only one participant (a
- 19 -
true monopoly) will have an HHI level of 10,000 while a market with ten equal participants
will have an HHI level of 1,000.
2.
Under the 1992 Guidelines, a market with post-merger HHI of less than 1,000 is
considered unconcentrated and requires no analysis of competitive effects. 1992
GUIDELINES § 1.51. Markets with post-merger HHI levels between 1,000 and 1,800 are
considered moderately concentrated and an increase of 100 or more raises “significant
competitive concerns,” requiring further investigation. A market with an HHI level of
1,800 or greater is considered highly concentrated and increases of 50 or more require
further investigation. Increases in HHI levels of 100 or more for highly concentrated
markets are presumed to create or enhance market power.
IV. COMPETITIVE EFFECTS OF HORIZONTAL MERGERS
If a transaction falls within HHI-based safe harbors set forth in the Guidelines’ “General
Standards,” see 1992 GUIDELINES §1.51, it ordinarily will be cleared without further analysis, id.
Otherwise, the enforcement agencies undertake to assess the transaction’s competitive effects
before determining whether a challenge is warranted, see id. § 2. The requirements of a
competitive effects analysis, at least in its current form, is new to the Guidelines. Its inclusion
poses numerous issues, several of which are addressed here.
A.
Coordinated Interaction
1.
Mergers may facilitate tacit collusion in certain circumstances. Courts and
enforcement officials have known that for a long time, and the 1982 Guidelines and 1984
Guidelines were based largely on that premise. From the perspective of framing guidelines
or legal rules, the practical problem has been to identify the circumstances in which
facilitation of tacit collusion is a valid concern. For many years courts tried to identify the
circumstances through a summary statistic -- concentration. See, e.g., United States v.
Philadelphia National Bank, 374 U.S. 321, 363 (1963). The analysis now extends to
considerably more factors.
2.
The 1992 Guidelines provide a general framework for thinking about coordinated
interaction, and they identify many factors that warrant consideration. Market conditions
that are considered conducive to reaching terms of coordination include: homogeneous
products, standardized pricing, standardized marketing practices, and the availability of key
market information. 1992 GUIDELINES § 2.11. Conditions that are conducive to detecting
or punishing deviations from the terms of coordination include: regular availability of
information on actual prices and output level of competitors, small and frequent individual
transactions which reduce the incentive to “cheat” on the terms of coordination and allow
other firms to monitor “cheaters,” and the absence of maverick firms which have a greater
economic incentive to “cheat.” 1992 GUIDELINES § 2.12.
- 20 -
3.
Of course, these factors vary greatly in importance according to the particular
characteristics of each market and the prediction of future coordination is often akin to
speculation. See 1992 GUIDELINES § 2.1 (“In analyzing the effect of a particular merger on
coordinated interaction, the Agency is mindful of the difficulties of predicting likely future
behavior based on the types of incomplete and sometimes contradictory information
typically generated in merger investigations”).
4.
This section of the Guidelines is based largely on the field of economics known as
game theory. The Guidelines do not specify the various game-theoretic models upon
which the enforcement agencies’ analysis of coordinated interaction will rest. The basic
models are widely available in standard texts, although the field is evolving and new
variations on the models are continually being offered in the literature. For some
nonmathematical introductions, see D. KREPS, GAME THEORY AND ECONOMIC MODELING
(1990), or A. DIXIT & B. NALEBUFF, THINKING STRATEGICALLY: THE COMPETITIVE EDGE
IN BUSINESS, POLITICS, AND EVERYDAY LIFE (1991). For a more formal, but still accessible
survey, see Fudenberg & Tirole, Noncooperative Game Theory for Industrial
Organization: An Introduction and Overview, in I HANDBOOK OF INDUSTRIAL
ORGANIZATION (1989). Several textbooks in the field have appeared over the last few
years and should be available in local university bookstores. See, e.g., D. FUDENBERG & J.
TIROLE, GAME THEORY (1991).
B.
Unilateral Effects
Unilateral effects occur when the merged firm alone is able profitably to charge higher prices or
to reduce output, even without parallel action by other market participants. The 1992 Guidelines
provide two theories as to why mergers may reduce competition through unilateral effects. More
recent activity by the enforcement agencies appears to depart from the Guidelines’ formulations,
and consideration of unilateral effects appears increasingly to be the basis for the agencies’
analysis of specific mergers. See J. Baker, Director, FTC Bureau of Competition, Contemporary
Empirical Merger Analysis, before the George Mason University Law Review Symposium on
Antitrust in the Information Revolution (Oct. 11, 1996).
1.
Under the Guidelines’ first theory, when products in the market are differentiated and
substitution between the products is imperfect, competition is “non-uniform,” and
individual sellers compete more directly with rivals selling closer substitutes. The 1992
Guidelines provide in pertinent part: “Substantial unilateral price elevation . . . requires
that there be a significant share of sales in the market accounted for by consumers who
regard the products of the merging firms as their first and second choices, and that
repositioning of the non-parties’ product lines to replace the localized competition lost
through the merger will be unlikely.” 1992 GUIDELINES § 2.21. Under the Guidelines, the
enforcement agencies will presume the first prong to be satisfied where “each product’s
market share is reflective not only of its relative appeal as a first choice to consumers of the
merging firms’ products but also its relative appeal as a second choice, . . . market
concentration data fall outside the safeharbor regions. . ., and the merging firms have a
combined market share of at least thirty-five percent. . . .” Id. § 2.211.
- 21 -
a.
The relationship between the theory and market definition is far from clear. If
the theory is correct, market definition would seem to be irrelevant -- the merging
firms would be sufficiently close competitors, and sufficiently unconstrained by other
competitors, that the scope of the market or the precise share of the merging firms
would not matter.
b.
The difficulty of obtaining reliable evidence on consumers’ first and second
product choices will be substantial. The enforcement agencies probably should have
taken a lesson from the FTC’s consumer protection side on the infirmities in most
consumer research. The information identified in the Guidelines as probative -“marketing surveys, information from bidding structures, or normal course of
business documents from industry participants,” see 1992 GUIDELINES § 2.211 n.22 -may be the best available, but is almost certain to provide a skewed depiction of
competitive reality.
c.
Insofar as the theory stands for the proposition that a market may contain
narrower groupings that themselves merit antitrust scrutiny, it may be having the
ironic effect of rehabilitating submarket analysis. See part II.H.4 supra (discussing
Staples and Cardinal Health). Whether submarkets should be used remains a
legitimate policy issue. See ABA MERGER MONOGRAPH, supra part I.D.1, at 128-31.
d.
In New York v. Kraft General Foods, Inc., 926 F. Supp 321 (S.D.N.Y. 1995),
the court analyzed the potential unilateral effects of the merger of two cereal makers
focusing on one cereal brand from each of the merging firms (Grape-Nuts and
Nabisco Shredded Wheat). The court found that the government failed to show that
these two cereal brands were the first and second choices of a significant number of
consumers. Id. at 366. The court concluded that it would be not profitable for the
merged firm to raise prices of Grape Nuts and capture a substantial percentage of lost
sales through the sale of Nabisco Shredded Wheat “because it is likely that the lost
sales would be dispersed among a wide variety of products.” Id.
2.
Under the Guidelines’ second theory, where products are relatively undifferentiated
and capacity primarily distinguishes firms, a merger provides a larger sales base on which
to enjoy a price increase and eliminates a competitor to which sales otherwise would be
diverted. 1992 GUIDELINES § 2.22. Under the Guidelines, such an effect may be profitable
when the merging firms have a combined market share of at least 35%. The effect is
unlikely if nonparties could expand to provide alterative sources of supply to the merged
firm’s customers; nonparty expansion is deemed unlikely “if those firms face binding
capacity constraints that could not be economically relaxed within two years or if existing
excess capacity is significantly more costly to operate than capacity currently in use.” Id.
a.
The relationship between this theory, too, and market definition is potentially
problematic, although for reasons that are not so superficially obvious as under the
first theory.
- 22 -
b.
Determining the feasibility of nonparty expansion is likely to be difficult in
many cases. Note that the Guidelines test is whether capacity constraints could be
removed, not whether they would be removed. In this respect the provision differs
from the Guidelines’ treatment of supply responses through production substitution,
see supra part III.D, or entry, see infra part V.
3.
Other recent challenges under unilateral effects theories include United States v. SBC
Communications, Inc., 1999 WL 1211458 (D.D.C.) *12; United States v. Chancellor
Media Corp., 1999 WL 816689 *9 (D.D.C.); United States v. Chancellor Media Corp.,
1999 WL 631210 *8 (D.D.C.); United States v. Chancellor Media Co., Inc., 63 Fed. Reg.
17,446 (Apr. 9, 1998) (proposed final judgment and competitive impact statement); CVS
Corp., 62 Fed. Reg. 31,103, 31104 (June 6, 1997) (analysis to aid public comment); United
States v. Signature Flight Support Corp., 62 Fed. Reg. 7,041, 7047 (Feb. 14, 1997)
(proposed final judgment and competitive impact statement); United States v. Vail Resorts,
Inc., 62 Fed. Reg. 5037 (Feb. 3, 1997) (proposed consent order and competitive impact
statement); United States v. Interstate Bakeries Corp., 1996-1 Trade Cas. (CCH) ¶ 71,271
(N.D. Ill. 1996); United States v. Kimberly-Clark Corp., 1996-1 Trade Cas. (CCH) ¶
71,405 (N.D. Tex. 1996). For a useful article explaining the concepts, see C. Shapiro,
Mergers with Differentiated Products, 10 ANTITRUST 23 (1996). The competitive impact
statement in Vail Resorts is especially instructive in laying out the government’s current
thinking:
Economists have developed an analytical framework to explain how a merger
can allow a firm to charge higher prices after acquiring a competitor, even if firms do
not coordinate their behavior (such as by explicitly colluding with one another). . . .
This framework has been called a “unilateral effects” mode. It is particularly useful
in markets that have differentiated products, that is, where products of different firms
are not identical. Each ski resort, for example, has characteristics, such as terrain and
amenities, that different consumers value differently. This unilateral effects model is
an additional tool to examine the accepted, common-sense notion that a merger is
more likely to have a harmful effect if the merging firms are close competitors.
Before a merger, increases in price by two independent resorts are deterred by
the loss of customers that would result from a price increase. If resorts are put under
common ownership by a merger, however, they will no longer constrain each other’s
prices in the same way. A merger can make a price increase profitable. In particular,
before a merge[r], if two resorts are significant competitors to each other and one of
these resorts increases its prices, a significant proportion of this resort’s customers
would be “lost” to the other resort. After the merger between the two resorts,
however, some customers who would switch away from the resort that raises its price
would no longer be lost, but “recaptured” at the newly-acquired resort. Price
increases that would have been unprofitable to either firm alone, therefore, would
become profitable to the merged entity.
- 23 -
As a result of this recapture phenomenon, a merged firm, acting independently
to earn the most profits it can, will choose higher prices than its two component firms
did before the merger, if those firms were significant competitors to each other before
the merger. The loss of competition that arises as a result of this effect is what is
meant by a “unilateral” anticompetitive effect, that is, an effect that does not depend
on the firms in the market acting interdependently. This unilateral effect will be
larger as the recapture rate (which is sometimes called the “diversion ratio” . . .) is
larger, as the margin earned on recaptured customers is higher, and as the customers
who leave the merging firms in response to a price increase are fewer (in technical
terms, the lower the “own price elasticity”).
62 Fed. Reg. at 5044 (footnote omitted).
C.
Power Buyers
1.
In numerous cases, courts have declined to enjoin transactions that involve substantial
concentration levels, but in markets characterized by buyers that are large or otherwise
enjoy power to counteract the market power of the merged firm. See, e.g., FTC v. Elders
Grain Inc., 868 F.2d 901, 905 (7th Cir. 1989); United States v. Archer-Daniels-Midland
Co., 1991-2 Trade Cas. (CCH) ¶ 69,647, at 69,918-22 (S.D. Iowa 1991); United States v.
Country Lake Foods, Inc., 754 F. Supp. 669, 679-80 (D. Minn. 1990); United States v.
Baker Hughes Inc., 731 F. Supp. 3, 11 (D.D.C.), aff’d, 908 F.2d 981 (D.C. Cir. 1990); FTC
v. R.R. Donnelly & Sons Co., 1990-2 Trade Cas. (CCH) ¶ 69,239, at 64,852-55 (D.D.C.
1990); FTC v. Owens-Illinois, Inc., 681 F. Supp. 27, 48 (D.D.C.), vacated as moot, 850
F.2d 694 (D.C Cir. 1988); cf. United States v. Syufy Enterprises, 903 F.2d 659, 663 (9th
Cir. 1990) (similar point in monopolization matter). But see Eastman Kodak Co. v. Image
Technical Servs. Inc., 504 U.S. 451, 475 (1992) (doubting “that sophisticated purchasers
will ensure that competitive prices are charged to unsophisticated purchasers, too”); FTC
v. Cardinal Health, Inc., 12 F. Supp. 2d 34, 61 (D.D.C. 1998) (power buyers insufficient to
rebut prima facie case); United States v. United Tote, Inc., 768 F. Supp. 1064, 1085 (D.
Del. 1991) (rejecting large buyer defense).
2.
The 1992 Guidelines do not specifically recognize a defense based on large, powerful
or sophisticated buyers. The 1992 Guidelines do state: “In certain circumstances, buyer
characteristics and the nature of the procurement process may affect the incentives to
deviate from terms of coordination. Buyer size alone is not the determining characteristic.
Where large buyers likely would engage in long-term contracting, so that the sales covered
by such contracts can be large relative to the total output of a firm in the market, firms may
have the incentive to deviate. However, this only can be accomplished where the duration,
volume and profitability of the business covered by such contracts are sufficiently large as
to make deviation more profitable in the long term than honoring the terms of coordination,
and buyers likely would switch suppliers.” 1992 GUIDELINES § 2.12.
3.
The omission of an explicit large buyer defense from the Guidelines clearly was not
an oversight; the enforcement agencies are familiar with the issue. In many instances, large
- 24 -
buyers can be effective in destabilizing coordinated interaction among suppliers, inducing
new suppliers to enter, or otherwise assuring that competitive supply will remain available;
these considerations are recognized under the Guidelines. See H. Hovenkamp, Mergers
and Buyers, 77 VA. L. REV. 1369 (1991).
D.
Burden of Proof
1.
Allocation of the burden of proof with respect to the competitive effects issues raised
by the Guidelines will be important in determining the outcome of many litigated matters.
The Guidelines’ provisions addressing competitive effects contain many subjective
elements and are vague as to how those elements should be weighed; the game-theoretic
concepts underlying the provisions are not fully developed; and the facts that must be
assembled and presented are relatively intractable. Thus, the party that bears the burden of
proof with respect to the competitive effects analysis will be at a disadvantage.
2.
The Guidelines provide: “The Guidelines do not attempt to assign the burden of
proof, or the burden of coming forward with evidence, on any particular issue. Nor do the
Guidelines attempt to adjust or reapportion burdens of proof or burdens of coming forward
as those standards have been established by the courts.” 1992 GUIDELINES § 0.1.
Interpreting the last sentence, the Guidelines state in a footnote: “For example, the burden
with respect to efficiency and failure continues to reside with the proponents of the
merger.” Id. § 0.1 n.5.
3.
The prevailing view is that the burden of proof remains with the plaintiff. “Despite
the shifting burdens of production in an anti-trust case, the ultimate burden of persuasion
always rests with the Government.” FTC v. Cardinal Health, Inc., 12 F. Supp. 2d 34, 63
(D.D.C. 1998).
E.
Sliding Scale Rebuttal of Prima Facie Case
1.
Many of the factors considered during the competitive effects analysis were reflected
in the 1982 Guidelines and 1984 Guidelines, but principally as tiebreakers for use in close
cases. The 1984 Guidelines, for example, specified factors that would be considered “as
they relate to the ease and profitability of collusion. Where relevant, the factors are most
likely to be important where the Department’s decision to challenge a merger is otherwise
close.” 1984 GUIDELINES § 3.4. Comparable language was not included in the 1992
Guidelines, thus creating some ambiguity as to the relationship between the “General
Standards” and the competitive effects analysis. Is the showing required under the
competitive effects section intended to be a sliding scale dependent upon the level of
concentration? Or are the nature and significance of the competitive effects analysis
intended to be unrelated to the closeness of earlier phases of the case?
2.
The 1992 Guidelines provide: “The Agency assesses whether the merger, in light of
market concentration and other factors that characterize the market, raises concern about
potential adverse competitive effects.” 1992 GUIDELINES § 0.2.
- 25 -
3.
The proper interpretation of the Guidelines on this point is not clear, and the
enforcement agencies have expressed differing views. Compare Rill Speech, supra part
III.B.3.a, at 13 (no sliding scale), and James Speech, supra part III.B.3.a, at 4-5 (same),
with Arquit Speech, supra part III.B.3.b, at 5 (“high concentration is cause for more
concern than low concentration,” and “the level of these concerns and the evidence needed
to rebut them does not artificially plateau at 1800”), and B.F. Goodrich Co., 110 F.T.C.
207, 305, 338-39 (1988) (strength of evidence required to overcome presumption of
anticompetitive effect increases with concentration).
4.
If a prima facie violation can still be made out based on concentration levels alone,
the case law appears to favor a sliding scale. See, e.g., United States v. Baker Hughes, Inc.,
908 F.2d 981, 991 (D.C Cir. 1990) (“the more compelling the prima facie case, the more
evidence the defendant must present to rebut it successfully”).
V. ENTRY
A.
Appropriate Standard: In General
1.
There is little question that entry can defeat the exercise of market power in certain
circumstances. There is sharp disagreement, however, in identifying those circumstances
and in fashioning the legal standard that will govern entry analysis.
a.
The 1982 Guidelines stated that “the Department is unlikely to challenge
mergers” in markets in which entry “is so easy that existing competitors could not
succeed in raising prices for any significant period of time.” In assessing the degree
of entry, the Guidelines evaluated the response within two years of a “small but
significant and nontransitory” price increase of five percent. Where significant entry
was unlikely, the Department generally “will not attempt to differentiate further the
degrees of difficulty of entry.” 1982 GUIDELINES § III.B.
b.
The 1984 Guidelines applied essentially the same test, except for shifting to a
sliding scale: “The more difficult entry into a market is, the more likely the
Department is to challenge the merger.” 1984 GUIDELINES § 3.3.
c.
Often citing to the Guidelines’ entry provisions, numerous courts have relied
upon entry considerations in holding transactions lawful under Section 7,
notwithstanding high levels of concentration. See, e.g., United States v. Baker
Hughes Inc., 908 F.2d 981 (D.C. Cir. 1990); United States v. Waste Management,
Inc., 743 F.2d 976 (2d Cir. 1984); United States v. Country Lake Foods, Inc., 754 F.
Supp. 669 (D. Minn. 1990); United States v. Calmar Inc., 612 F. Supp. 1298 (D.N.J.
1985). In several recent decisions, courts have found transactions unlawful under
Section 7, but only after considering and rejecting entry arguments. E.g., FTC v.
- 26 -
Cardinal Health, Inc., 12 F. Supp. 2d 34, 58 (D.D.C. 1998); FTC v. Staples, 970 F.
Supp. 1066, 1086-88 (D.D.C. 1997).
d.
By the late 1980s, the enforcement agencies had moved away from reliance on
structural conditions of entry and had begun also to consider the incentives to enter
and the likely sufficiency of entry. The focus shifted from whether entry could occur
to whether it would occur. See, e.g., Statement of J. Whalley, Deputy Assistant Att’y
Gen., before the 29th Annual Antitrust Seminar, Practicing Law Inst. (Dec. 1, 1989)
[hereinafter Whalley Speech], reprinted in 7 Trade Reg Rep. (CCH) ¶ 50,029, at
48,625 (test “is not whether entry can occur, but whether timely, sufficient entry is
likely to occur in response to noncompetitive performance”).
e.
In the Baker Hughes litigation the Antitrust Division argued that entry had to be
“quick and effective” in order to rebut a prima facie case based upon high
concentration. The D.C. Circuit rejected this argument as “novel and unduly
onerous.” 908 F.2d at 987. For a particularly useful discussion of the issues in Baker
Hughes, see Jonathan B. Baker, The Problem with Baker Hughes and Syufy: On the
Role of Entry in Merger Analysis, 65 ANTITRUST L.J. 353 (1997).
2.
The 1992 Guidelines establish the following general standard on entry considerations:
“A merger is not likely to create or enhance market power or to facilitate its exercise, if
entry into the market is so easy that market participants, after the merger, either collectively
or unilaterally could not profitably maintain a price increase above premerger levels. . . .
Entry is that easy if entry would be timely, likely, and sufficient in its magnitude, character
and scope to deter or counteract the competitive effects of concern.” 1992 GUIDELINES §
3.0.
3.
One open issue is the appropriate treatment of entry that is scheduled to occur
independent of the suspect merger, rather than as a competitive response. Arguably the
Guidelines treat the entrant by reference to the standard provisions governing identification
of market participants, measurement of market share, and assessment of competitive
effects, rather than by reference to the entry provisions. Courts have not always agreed. In
Long Island Jewish Medical Center, the court addressed the government’s post-trial brief
that asserted new anchor hospitals were not likely to enter the market by pointing out that
there was already a new and emerging “entry” in the form of another hospital near the
LIJMC that fulfilled the likelihood, timeliness, and sufficiency requirements of entry under
the 1992 Guidelines and that other medical care facilities were entering the relevant
geographic market as Manhattan hospitals moved to Long Island. United States v. Long
Island Jewish Medical Center, 983 F. Supp. 121, 149 (E.D.N.Y. 1997).
B.
Timeliness
1.
The speed with which entry must occur in order to rebut concern over a transaction’s
competitive effects has been the subject of dispute. See generally ABA MERGER
MONOGRAPH, supra part I.D.1, at 213-15.
- 27 -
2.
Following the pattern of the 1982 and 1984 Guidelines, the 1992 Guidelines provide:
“The Agency generally will consider timely only those committed entry alternatives that
can be achieved within two years from initial planing to significant market impact.” 1992
GUIDELINES § 3.2. Exception is made for durable goods in certain circumstances. Id.
3.
An illustration of the government’s approach may be seen in the FTC’s challenge to
the merger of two drug companies that developed gene therapy technologies, Ciba-Geigy
and Sandoz. Ciba-Geigy Ltd., 62 Fed. Reg. 409 (Jan. 3, 1997) (analysis to aid public
comment). Timely entry into the gene therapy market was deemed unlikely in light of the
length clinical trials, data collection and analysis, and significant resource expenditures
required for entry. Id. at 410. The FTC also concluded that one company would hold so
many patents and patent applications that the barriers to entry would be heightened, thus
impeding others firms in the development of their own products. Id. at 410-11.
4.
The Guidelines’ standard is open to attack on numerous bases:
a.
The two-year standard is entirely arbitrary. It has a history in prior government
practice, but the use of any bright line (whether two years or something more or less)
can be called into question. In some markets two years is a long time; in others, not
so. The exception for durable goods recognizes that longer time frames may be
appropriate for some types of markets. Suppose that substantial inventory is in the
hands of distributors and is overhanging the market, thus limiting the competitive
damage that could occur in two years. Or suppose consumers have substantial
discretion to postpone purchase decisions.
b.
In some instances the mere threat of entry is sufficient to deter anticompetitive
conduct. “[A] firm that never enters a given market can nonetheless exert
competitive pressure on that market. If barriers to entry are insignificant, the threat
of entry can stimulate competition in a concentrated market, regardless of whether
entry ever occurs.” Baker Hughes, 908 F.2d at 988.
c.
The Guidelines’ treatment of fringe expansion is not entirely clear, but appears
to be viewed principally in assessing concentration and competitive effect. Fringe
expansion is certainly important to those assessments, but fringe expansion could also
be viewed from an entry perspective as well. The effects of expansion by a fringe
competitor are often more rapid and competitively significant than the effects of entry
by a de novo competitor.
- 28 -
VI. EFFICIENCIES
A.
In General
1.
Historically, courts have been skeptical of the argument that the efficiencies produced
by a merger could offset potential anti-competitive effects. See, e.g., United States v.
Philadelphia Nat’l Bank, 374 U.S. 321, 370-71 (1963) (A merger which substantially
lessens competition “is not saved because, on some ultimate reckoning of social or
economic debits and credits, it may be deemed beneficial.”); Brown Shoe, 370 U.S. at 344
(“Congress appreciated that occasional higher costs and prices might result from the
maintenance of fragmented industries and markets.”).
2.
More recently, courts have taken efficiencies into account when analyzing mergers.
See FTC v. University Health, Inc., 938 F.2d 1206, 1222 (11th Cir. 1991) (“an efficiency
defense to the government’s prima facie case in section 7 challenges is appropriate in
certain circumstances”); FTC v. Butterworth Health Corp., 946 F. Supp. 1285, 1301 (W.D.
Mich. 1996) (denying preliminary injunction where merger would “result in significant
efficiencies, in the form of capital expenditures and operating efficiencies”), aff’d, 121 F.3d
708 (6th Cir. 1997). The efficiencies defense, however, can raise difficult evidentiary
problems for merging companies. University Health, 938 F.2d at 1223 (“it is difficult to
measure the efficiencies a proposed transaction would yield”); FTC v. Cardinal Health,
Inc., 12 F. Supp. 2d 34, 63 (D.D.C. 1998) (rejecting efficiencies defense where the
defendants had not shown that the projected savings from the mergers would be sufficient
to overcome possibly greater benefits from continued competition); United States v. Mercy
Health Services, 902 F. Supp. 968, 988-89 (N.D. Iowa 1995) (rejecting efficiencies defense
where the defendants did not have the “actual ability to implement the proposed
efficiencies”).
3.
The 1992 Guidelines recognize the efficiencies defense providing that “[s]ome
mergers that the Agency might challenge may be reasonably necessary to achieve
significant net efficiencies.” 1992 GUIDELINES § 4. Cognizable efficiencies which are
listed in the Guidelines include economies of scale, integration efficiencies, lower
transportation costs, more efficient manufacturing, service, or distribution operations, and
administrative savings.
4.
The Antitrust Division and FTC have announced plans to give greater weight to
efficiency considerations in merger enforcement and to issue policy statements explaining
their views in greater detail. The statements are likely to appear in mid-1997.
B.
Passing On
1.
Suppose a transaction yields substantial efficiencies, but increases market power, so
that many of the benefits are retained by the merging firms. Are those efficiencies to be
credited in assessing the net benefits of the transaction? The 1982 Guidelines and 1984
Guidelines were silent on the subject, but in a 1989 speech the Antitrust Division indicated
- 29 -
that efficiencies would be considered only to the extent that their benefits were passed on to
consumers over time. See Whalley Speech, supra part V.A.1.d.
2.
Like the prior Guidelines, the 1992 Guidelines are silent on the issue. See 1992
GUIDELINES § 4.
3.
The interpretation of the Guidelines on this issue is not clear, and the enforcement
agencies have expressed differing views. Compare Rill Speech, supra part III.B.3.a, at 27
(efficiencies recognized “even though they may not in every case inure to the benefit of
consumers in the short term”) with Arquit Speech, supra part III.B.3.b, at 11, 14 (FTC may
challenge mergers that allow supracompetitive pricing if the benefits of efficiencies will
not be passed on to consumers, but may tolerate short-term price increase as necessary to
attain efficiencies if price reductions will result in the future).
4.
The differing perspectives on the issue may reflect the agencies’ differing
perspectives on the purpose of Section 7. See supra part I.D.3. Under a wealth transfer
test, efficiencies would be credited only to the extent that they were passed on. Under an
efficiencies test, the incidence of the efficiencies would not matter.
5.
In University Health, the court addressed the passing on requirement directly: “[W]e
hold that a defendant who seeks to overcome a presumption that a proposed acquisition
would substantially lessen competition must demonstrate that the intended acquisition
would result in significant economies and that these economies would ultimately benefit
competition and, hence, consumers.” 938 F.2d at 1223 (footnote omitted). Similarly, the
Butterworth court based its acceptance of the merging hospitals’ efficiencies defense on its
finding that the efficiencies “would . . . invariably be passed on to the consumers.” 946 F.
Supp. at 1301. See also United States v. Long Island Jewish Medical Center, 983 F. Supp.
121, 148-49 (E.D.N.Y. 1997) (recognizing significant efficiencies). By contrast, the court
in Staples found that the defendants did not successfully rebut the government’s case with
efficiency arguments because, among other factors, the projected pass-through rates were
unrealistic. FTC v. Staples, 970 F. Supp. 1066, 1088-90 (D.D.C. 1997).
C.
Alternative Means
1.
The Guidelines provide: “the Agency will reject claims of efficiencies if equivalent
or comparable savings can reasonably be achieved by the parties through other means.”
1992 GUIDELINES §4.
2.
While this position is reasonable on its face, it can be detrimental unless it is invoked
with care.
a.
Whether other means are realistically attainable is often unclear. Many merger
lawyers (including within the enforcement agencies) like to play investment banker
by conjuring up alternative deals. Implementing the alternatives is much tougher.
- 30 -
b.
Determining the comparability of savings from the alternatives is also difficult.
Accurate efficiencies assessments require extensive, transaction-specific analysis; and
the limited time, data, and resources available for merger reviews often will not
permit a proper examination of comparability.
c.
Because the enforcement agencies are not required to publish decisions setting
forth the bases for their enforcement actions, there is often confusion -- even with the
agencies themselves -- as to the reasoning upon which a particular enforcement action
rested. This can give rise to uncertainty as to whether a challenge was based upon the
belief that (i) efficiencies were insubstantial, (ii) efficiencies were substantial, but
could be realized through alternative means, or (iii) efficiencies were substantial, but
did not outweigh adverse effects of the transaction. Knowing the basis is often
critical to decisions on whether to seek a consent settlement. A real-life example:
Several years ago one of the enforcement agencies challenged a joint venture based in
part on the staff economists’ assessment that the parties could restructure the venture
in a way that would pose less competitive risk, but would yield comparable
efficiencies. Evidently, word was not fully communicated to the staff lawyers, who
took the position that the agency had challenged the venture and that the parties could
not be permitted to circumvent that decision by restructuring the venture. The effort
to cut through the confusion, coupled with certain commercial pressures on the
transaction, proved so frustrating that the business executives simply abandoned the
transaction. No efficiencies were realized, and one of the parties eventually exited
from the market that had provoked the competitive concern.
VII. FAILING FIRMS
A.
Requirement of Exit, Absent the Transaction
1.
The failing firm doctrine has a lengthy history, which has created considerable
ambiguity as to the doctrine’s basis and purpose. See generally ABA MERGER
MONOGRAPH, supra part I.D.1, at 233-37. In Citizen Publishing Co v. United States, 394
U.S. 131 (1969), the Supreme Court reiterated prior law requiring that the acquired firm
“face the grave probability of a business failure” and that the acquiring firm be the only
available purchaser, id. at 137. The Court also stated that the failing firm must show that
its prospects for bankruptcy reorganization must be dim or nonexistent, id. at 137-38;
accord, United States v. Greater Buffalo Press, Inc., 402 U.S. 549, 555 (1971), but this
element was later omitted when the Court stated the failing company standards in dictum in
United States v. General Dynamics Corp., 415 U.S. 486, 507 (1974). The 1982 Guidelines
and 1984 Guidelines recognized a failing firm defense, based upon all three Citizen
Publishing elements. 1982 GUIDELINES § V.B; 1984 GUIDELINES § 5.1.
2.
The 1992 Guidelines identify the elements of the failing firm defense as the following
“1) the allegedly failing firm would be unable to meet its financial obligations in the near
future; 2) it would not be able to reorganize successfully under Chapter 11 of the
- 31 -
Bankruptcy Act; 3) it has made unsuccessful good-faith efforts to elicit reasonable
alternative offers of acquisition of the assets of the failing firm that would both keep its
tangible and intangible assets in the relevant market and pose a less severe danger to
competition than does the proposed merger, and 4) absent the acquisition, the assets of the
failing firm would exit the relevant market.” 1992 GUIDELINES § 5.1 (footnotes omitted).
3.
The fourth element is new to the 1992 Guidelines and appears to go beyond the
elements of the failing firm defense as stated in the case law. It is also inconsistent with the
common view that one of Congress’s purposes in recognizing the failing firm defense was
to protect the interests of shareholders, creditors, employees, and communities. See ABA
MERGER MONOGRAPH, supra part I.D.1, at 236 nn.1203-08.
4.
The second element of the Guidelines is also open to attack as inconsistent with
Congressional intent, see id. at 234 n.1195 (citing POSNER, supra part II.C.1, at 21), but at
least it finds strong support in the case law.
B.
Value of Alternative Offers
1.
“How great a sacrifice in price the failing firm’s shareholders must be willing to
accept in order to be sold to a ‘less anticompetitive’ purchaser remains unresolved.” ABA
MERGER MONOGRAPH, supra part I.D.1, at 237-38. The issue turns in part on construction
of the Citizen Publishing requirement that the acquiring firm be the “only available
purchaser,” 394 U.S. at 137. Does that mean only available purchaser at the suspect
transaction’s price, at a “reasonable” price, at any price, or something else? (The issue also
turns on interpretation of legislative intent with respect to protection of shareholders and
creditors, see supra part VII.A.3.) The case law has not addressed the issue. The 1984
Guidelines did not specify a minimum alternative price, but noted that “[t]he fact that an
offer is less than the proposed transaction does not make it unreasonable.” 1984
GUIDELINES § 5.1 n.38.
2.
The 1992 Guidelines provide: “Any offer to purchase the assets of the failing firm
for a price above the liquidation value of those assets -- the highest valued use outside the
relevant market . . . -- will be regarded as a reasonable alternative offer.” 1992 GUIDELINES
§ 5.1 n.36.
3.
The position reflected in the Guidelines is certainly hard nosed. It may or may not be
correct as a matter of law; the issue is ripe for litigation. Use of a “liquidation value” test
has a few problems, including the following:
a.
From the perspective of social welfare, it may lead to a suboptimal result. The
competitively objectionable offer may be the highest-valued due to a market power
premium, an efficiency premium, or both. We shouldn’t credit the market power
premium, but we should credit the efficiency premium. If we permit an alternative
purchaser to scoop up the assets at any price exceeding liquidation, the efficiencies
from the objectionable transaction will go unrealized. A different standard -- 32 -
requiring that alternative offers be no lower than the competitively objectionable offer
minus the included market power premium -- might warrant consideration.
b.
Liquidation value is highly subjective. Five liquidation value studies are likely
to yield five different conclusions. The only way to determine liquidation value
conclusively is to liquidate.
c.
Liquidation value also changes over time, a reality that opens the bid process to
manipulation. If a company is failing, its liquidation value tends to decline over time,
and antitrust reviews take time. Thus, an alternative offer that was below liquidation
value when the competitively objectionable offer was accepted, if left on the table,
may exceed liquidation value if the antitrust review is sufficiently prolonged.
Delaying tactics may prevent the assets from reaching their best use, but can benefit
persons hoping to scuttle the winning bid.
C.
Manner of Search for Alternative Offers
The Guidelines do not specify the manner in which the search for alternative offers is to be
conducted, and the case law on the issue is limited. For an illustration of what can happen when
the search process goes awry, see FTC v. Harbour Group Investments, L.P., 1990-2 Trade Cas.
(CCH) ¶ 69,247 (D.D.C. 1990). Harbour Group includes some dubious propositions, but it is
worth reading.
1.
As one dubious proposition, the court reacted negatively to “the fact that the
[challenged] deal . . . had already been struck at the time any serious efforts to find
alternatives . . . began,” id. at 64,915. Does this mean that the failing company defense is
waived unless the search is performed early, even if legitimate defenses on the competitive
merits can be asserted? That would be wasteful, since searches are costly and timeconsuming. If the search is conducted in good faith and the competitively suspect buyer
agrees not to assert a tortious interference claim against new bidders, the timing of the
search should be irrelevant.
2.
Similarly, the court reacted negatively to the appearance that the “efforts to find
alternative purchasers were motivated by advice of legal counsel, after most of the deal
with [the suspect purchaser] had been completed,” id. at 64,915 n.9. Does that mean the
defense is waived if its elements are followed on advice of counsel? Businessmen
sometimes do things, after all, because their lawyers identify legal requirements.
VIII. COMPETITIVE EFFECTS OF VERTICAL MERGERS
During the 1950s and 1960s numerous mergers between firms in a customer/supplier relationship
were challenged on the theory that vertical effects, typically the foreclosure of competing
customers or suppliers, would substantially reduce competition. The theory fell into disrepute,
and few vertical challenges were brought during the 1970s and 1980s. The 1982 and 1984
- 33 -
Guidelines addressed “non-horizontal mergers” only insofar as the mergers caused horizontal
effects, and the 1992 Guidelines were limited to horizontal mergers. Beginning in 1994,
however, the federal enforcement agencies began to show renewed interest in theories of
challenge to vertical mergers. This Part VIII begins by summarizing the older court cases. It
then briefly reviews the vertical merger provisions of the 1984 Guidelines, which remain the
most recent formal government statement of enforcement policy towards vertical mergers.
Finally, it summarizes the government’s recent enforcement actions, which have been
implemented solely through consent order.
A.
Older Court Cases
1
Historically, vertical merger cases have been based primarily on two traditional
theories of challenge: foreclosing competitors from access to customers, and foreclosing
competitors from access to inputs.
2.
United States v. E.I. du Pont de Nemours & Co., 353 U.S. 586 (1957), the first
Supreme Court case to address vertical mergers, relied on a foreclosure theory to bar du
Pont’s acquisition of General Motor’s stock. The court established a two-prong for
assessing the legality of a vertical merger: (1) the affected market must be substantial, and
(2) foreclosure of competition in a substantial share of the market must be likely. The court
held that the test was met in the markets for automobile finishes and fabrics. Du Pont sold
automobile finishes and fabrics to GM, the world’s largest automobile producer at the time.
3.
In Brown Shoe Co. v. United States, 370 U.S. 294, 323-324 (1962), the court echoed
its previous ruling in du Pont stating, “[t]he primary vice of a vertical merger” is that the
foreclosure of competitors of either party “may act as a clog on competition, which
deprive[s] . . . rivals of a fair opportunity to compete.” The Supreme Court upheld the
district court finding the merger of Brown Shoe, primarily a shoe manufacturer, and
Kinney, the largest U.S. shoe retailer at the time, violated Section 7. The court held that in
vertical cases, market share is important but seldom determinative, so long as it is above de
minimis proportions. The most important factor to the court was “the very nature and
purpose of the arrangement.” Id. at 329.
4.
Ford Motor Co. v. United States, 405 U.S. 562 (1972), aff’g, 286 F. Supp. 407 (E.D.
Mich. 1968) and 315 F. Supp. 372 (E.D. Mich 1970), is another example of the court
applying a foreclosure theory. The Supreme Court upheld the district court finding that
Ford’s internalization of spark plug production through the purchase of Autolite
manufacturing facilities was a blatant violation of Section 7. The district court also
identified raised barriers to entry into spark plug production as a competitive concern.
B.
1984 Merger Guidelines
The 1984 Merger Guidelines are the most recent formal statement of agency policy for the
evaluation of vertical mergers. They do not expressly address vertical competitive effects.
- 34 -
Instead, under the caption “Horizontal Effects from Non-Horizontal Mergers,” the Guidelines
identify four competitive concerns, all of which differ from the traditional foreclosure theories:
1.
Vertical mergers may eliminate potential entrants in the market because firms are
often likely entrants into vertically related markets. In some circumstances, the elimination
of the one firm from the “edge” of the market that the other firm is already in, may
adversely affect competition. 1984 GUIDELINES § 4.11.
2.
Vertical mergers may increase barriers to entry under specified conditions by
requiring entry into both markets simultaneously. Id. § 4.21.
3.
Vertical mergers can facilitate collusion between firms in the same market by helping
to monitor retail prices or by eliminating a disruptive buyer. Id. § 4.22.
4.
Finally, in regulated industries, monopoly utilities may be able to circumvent rate
regulation by integrating with a supplier of inputs, internally pricing the inputs above
competitive levels, and increasing prices to consumers based on increased costs. Id. § 4.23.
C.
Recent Enforcement through Consent Agreements
In the past few years, the agencies have dramatically increased enforcement actions in
connection with vertical mergers. All of the recent actions have been settled through consent
agreements. These theories go well beyond those previously identified by the courts or
expressed in the 1984 Guidelines. For the most recent published statement of the agencies’
vertical enforcement theories, see 7 Trade Reg. Rep. (CCH) ¶ 50,147 (Apr. 5, 1995) (reprinting
text of speech by S. Sunshine, Deputy Assistant Att’y Gen., before ABA Antitrust Section
Spring Meeting).
1.
Product Complements
a.
Recent enforcement actions have been extended beyond mergers involving
customers and inputs to mergers of firms making complements. This extension from
inputs to complements is easy to explain and justify by realizing that market power in
one has similar effects as market power in the other. For example, competition in the
market for computer hardware can be affected by both power in chips (an input) and
power in software (a complement).
b.
In In re Martin Marietta Corp., 59 Fed. Reg. 37,045 (April 12, 1994) (proposed
consent agreement with analysis to aid public comment), the government challenged
the acquisition of General Dynamics’ Space Systems Division by Martin Marietta.
Martin Marietta manufactured satellites, and General Dynamics produced a
complementary product, satellite launch vehicles. The FTC alleged that in its role as
a satellite launch vehicle producer, the merged firm would receive confidential
proprietary information about its competitors in satellite manufacture. To resolve
these concerns, the parties entered into a consent decree that prohibits Martin
- 35 -
Marietta from disclosing to its satellite division any nonpublic information it receives
from satellite competitors through its newly-acquired launch vehicle division.
c. In In re Cadence Design Sys., Inc., 62 Fed. Reg. 26,790 (May 15, 1997) (analysis
to aid public comment), the FTC challenged the proposed merger of Cadence Design
System, Inc., a dominant supplier of complete software layout environments, and
Cooper & Chyan Technology, Inc., a company that sold a router that worked within a
layout environment. According to the Commission, new entrants would need to enter
into the integrated circuit layout environment and router markets at the same time. A
consent decree required Cadence to allow independent commercial router developers
to build interfaces between their design tools and the Cadence layout environment.
Id. at 26,792-93.
2.
Discrimination
a.
Even if competitors are not foreclosed, the vertically integrated firm’s
discrimination in one market might competitively disadvantage rivals in an adjacent
market. Merging firms have agreed to a variety of conditions in order to satisfy the
agencies’ concerns.
b.
In United States v. AT&T Corp., 59 Fed. Reg. 44,158 (Aug. 26, 1994) (proposed
final judgment and competitive impact statement), the government challenged
AT&T’s acquisition of McCaw Cellular Communications. AT&T was both the
dominant long-distance supplier and the largest supplier of cellular infrastructure
equipment in the U.S. and McCaw was the largest cellular service provider. The
government alleged that the merger would increase McCaw’s incentive to
discriminate against AT&T’s long distance competitors. The consent agreement
required McCaw to give other long distance companies equal access (in terms of
quality, type, and price) to its cellular services. See also United States v. Sprint
Corp., 1996-1 Trade Cas. (CCH) ¶ 71,300 (D.D.C. 1996) (consent settlement
imposing antidiscrimination safeguards and reporting requirements to address vertical
effects from investment in Sprint by France Telecom and Deutsche Telekom); United
States v. MCI Communications Corp., 1994-2 Trade Cas. (CCH) ¶ 70,730 (D.D.C.
1994) (similar consent settlement to address vertical effects from investment in MCI
by British Telecommunications).
c.
In re Eli Lilly and Company, Inc., 59 Fed. Reg. 60,815 (Nov. 28, 1994)
(proposed consent agreement with analysis to aid public comment), reopened and set
aside, Docket No. C-3594 (May 13, 1999), concerned the acquisition of a pharmacy
benefit management company, PCS Health Systems, by Lilly, a pharmaceutical
manufacturer. The consent agreement realized that discrimination will be necessary
to achieve procompetitive efficiencies, but regulated the manner of discrimination.
Specifically, PCS was required to keep an open drug formulary (to not exclude Lilly’s
competitors from its list of approved medications) and to accept all discounts offered
by Lilly’s competitors and reflect such discounts in the formulary rankings of
- 36 -
preference. See also In re Merck & Co., Inc., 63 Fed. Reg. 46,451 (Sept. 1, 1998)
(analysis to aid public comment).
d.
The consent agreement entered in In re Time Warner Inc., 61 Fed. Reg. 50,301
(Sept. 25, 1996) (proposed consent agreement with analysis to aid public comment),
addresses both vertical and horizontal concerns arising from the acquisition by Time
Warner of Turner Broadcasting System. The vertical provisions address
discrimination in two respects. First, the decree requires that Turner programming
must be offered to Time Warner’s competitors in consumer multi-channel television
services at the same relative rate that Turner provided before the merger. Second, the
decree requires Turner and a larger Time Warner shareholder, TCI, to cancel a
preferential long-term carriage agreement and to wait for a six-month “cooling off”
period before negotiating a new carriage agreement. Significantly, however, the
decree does not require that the new carriage agreement must be non-discriminatory.
e. The FTC entered into a consent agreement addressing discrimination concerns in
connection with a proposed joint venture between Texaco and Shell. Texaco owned
the only heated pipeline for the transport of undiluted heavy crude oil from the San
Joaquin Valley to San Francisco, and Shell was one of two asphalt manufacturers in
the San Francisco area. To alleviate concerns that the joint venture would charge
Huntway, Shell’s asphalt competitor, a higher price than it charged to Shell for the
crude oil used to make asphalt, the joint venture entered into an FTC-approved tenyear supply agreement with Huntway. In re Shell Oil Co., 62 Fed. Reg. 67,868-869
(Dec. 30, 1997) (analysis to aid public comment).
3.
Misuse of Information
a.
Both the complement and discrimination theories can be viewed as extensions
of previous theories of vertical merger regulation: complements are analogous to
inputs, and discrimination is a more subtle form of foreclosure. The misuse of
information theory, on the other hand, is not rooted in any of the traditional reasoning
concerning vertical mergers.
b.
In numerous recent cases, the government has challenged mergers because of
potential misuse of information obtained from customers or supplier in one market
who are competitors in an adjacent market. See, e.g., In re TRW, Inc., 63 Fed. Reg.
1866 (Jan. 12, 1998) (analysis to aid public comment); In re Raytheon Co., 61 Fed.
Reg. 31,526 (June 20, 1996) (proposed consent agreement with analysis to aid public
comment); In re Alliant Technologies, Inc., 59 Fed. Reg. 61,617 (Dec. 1, 1994)
(proposed consent agreement and analysis to public comment); United States v. MCI
Communications Corp., 1994-2 Trade Cas. (CCH) ¶ 70,730 (D.D.C. 1994).
c.
Most misuse of information cases are solved through an agreement by the
merged entity to erect informational firewalls to isolate proprietary information of
competitors from the competing division of the firm. In some cases, however,
- 37 -
divestiture of the potential conduit of confidential information is required. In re
Lockheed Martin Corp., 61 Fed. Reg. 18732 (Apr. 29, 1996) (proposed consent
agreement with analysis to aid public comment); In re Litton Industries, Inc., 61 Fed.
Reg. 7,105 (February 26, 1996) (consent agreement with analysis to aid public
comment).
d. The misuse of information theory has been criticized, even within the agencies,
because often the efficiencies created by the merger require complete and open
integration of the merged entities components. Further, government intervention may
be unnecessary because companies routinely enter into confidentiality agreements to
protect their proprietary information from competitors. See Dissenting Statement of
Deborah K. Owen on Proposed Consent Agreement with Martin Marietta Corp., 59
Fed. Reg. 37,045 (April 12, 1994) (proposed consent agreement with analysis to aid
public comment).
IX. PREMERGER NOTIFICATION REQUIREMENTS
The Hart-Scott-Rodino Antitrust Improvements Act of 1976, 15 U.S.C. § 18a, requires that
parties to certain mergers and acquisitions must notify the enforcement agencies of the
contemplated transaction and observe a waiting period prior to closing. Roughly 3000
transactions per year have been subject to HSR reporting over the recent period. This Part IX
summarizes the basic tests governing whether a transaction is subject to a reporting obligation
and identifies the principal exceptions. It then reviews the process by which reportable
transactions are reviewed.
A.
Basic Tests under HSR
Parties to a purchase and sale of assets or voting securities must file premerger notification under
HSR if each of three tests is satisfied. If the transaction fails to satisfy any one of the tests, it is
not subject to a reporting obligation. The tests are as follows:
1.
The “Commerce” Test
One of the parties must be engaged in interstate commerce or in any activity affecting
interstate commerce. Id. § 18a(a)(1). This test should be presumed to be invariably
satisfied.
2.
The “Size of Parties” Test
The parties must include one $100,000,000 person and one $10,000,000 person in
accordance with the following specifications:
- 38 -
a.
A “person” is defined as including the ultimate parent of the party to the
transaction and all other entities controlled by the same ultimate parent. 16 C.F.R. §
801.1(a). “Control” is a term of art under the HSR regulations. See id. § 801.1(b).
b.
The size of the person is measured by reference to “annual net sales” and “total
assets.”
i.
The “annual net sales of a person shall be as stated on the last regularly
prepared annual statement of income and expense of that person.” Id. §
801.11(c)(1).
ii. The “total assets of a person shall be as stated on the last regularly
prepared balance sheet of that person.” Id. § 801.11(c)(2).
iii. The preceding (i) and (ii) are subject to requirements that the financial
statements are consolidated, are prepared in accordance with normal accounting
principles, and are not more than fifteen months old. See id. § 801.11(b).
Where the financial statements are not consolidated, annual net sales and total
assets must be recomputed. Id.
c.
Using the preceding definitions, the “size of parties” test is satisfied under any
of the following circumstances, 15 U.S.C. § 18a(a)(2):
i.
Voting securities or assets of a person engaged in manufacturing which
has annual net sales or total assets of $10,000,000 or more are being acquired by
any person which has total assets or annual net sales of $100,000,000 or more;
ii. Voting securities or assets of a person not engaged in manufacturing
which has total assets of $10,000,000 or more are being acquired by any person
which has total assets or annual net sales or $100,000,000 or more; or
iii. Voting securities or assets of a person with annual net sales or total assets
of $100,000,000 or more are being acquired by any person with total assets or
annual net sales of $10,000,000 or more.
3.
The “Size of Transaction” Test
Following the transaction, the acquiring person must hold 15% or an aggregate of
$15,000,000 of voting securities or assets of the acquired person, in accordance with the
following specifications:
a.
The percentage of voting securities is measured by reference to the voting
power for directors of the issuer (not necessarily the person as defined above) whose
voting securities are being acquired. The test is specified at 16 C.F.R. § 801.12.
- 39 -
b.
The percentage of assets is measured by reference to book values. See id. §
801.12(d). In some circumstances acquisitions of assets by the acquiring person from
the acquired person within the prior 180 calendar days must be aggregated. See id. §
801.13(b). Note that “person” is defined as above to include the ultimate parent and
its controlled entities, so that the aggregation requirement may extend beyond the
subsidiaries that are parties to any particular transaction.
c.
The value of the assets or voting securities is measured by reference to
acquisition price, market price (in the case of publicly traded securities), and fair
market value (in the case of assets and private securities), under tests specified in 16
C.F.R. §§ 801.10 and 801.13.
i.
Acquisition price includes the value of all consideration. Id. §
801.10(c)(2). (As a practical matter, however, the definition of consideration,
particularly in the form of assumed liabilities, depends on whether the
transaction involves assets or voting securities. See ABA ANTITRUST SECTION,
PREMERGER NOTIFICATION PRACTICE MANUAL (rev. ed. 1992).)
ii. Fair market value must be determined in good faith by the directors of the
ultimate parent of the acquiring person, although the responsibility may be
delegated. 16 C.F.R. § 801.10(c)(3). The regulations do not specify the test by
which fair market value is to be measured. For one commentary’s suggestions,
see S. AXINN ET AL., ACQUISITIONS UNDER THE HART-SCOTT-RODINO
ANTITRUST IMPROVEMENT ACT § 5.04 (rev. ed. 1996).
d.
For purposes of the “size of transaction” test, cash is not considered an asset of
the person from whom it is acquired. 16 C.F.R. § 801.21.
B.
Exemptions from HSR Reporting Obligations
The statute exempts twelve classes of transactions from reporting obligations. 15 U.S.C. §
18a(c). All of the twelve, as well as other classes of exempt transaction, have been addressed in
the regulations. The most significant exemptions are the following:
1.
Certain acquisitions of goods or realty in the ordinary course of business. See 61 Fed.
Reg. 13666, 13684 (Mar. 28, 1996) (to be codified at 16 C.F.R. § 802.1).
2.
Certain acquisitions of real property assets, including office and residential property,
hotels and motels and related improvements (but not ski facilities or casinos), golf courses,
swim and tennis clubs, agricultural property, retail rental space, and warehouses. See id. at
13686 (to be codified at 16 C.F.R. § 802.2).
3.
Acquisitions of carbon-based mineral reserves below certain dollar thresholds. See
id. at 13688 (to be codified at 16 C.F.R. § 802.3).
- 40 -
4.
Acquisitions of investment rental property. See id. (to be codified at 16 C.F.R. §
802.5).
5.
Certain acquisitions involving federal agency approval or supervision. 16 C.F.R. §§
802.6, 802.8.
6.
Acquisitions solely for the purposes of investment, regardless of dollar value, if the
acquiring person will hold ten percent or less outstanding voting securities of the issuer. Id.
§ 802.9. The FTC interprets “solely for the purposes of investment” as precluding anything
other than a passive role for the acquiring person. If the acquiring person receives a board
seat, for example, the exemption is not available.
7.
Acquisitions involving less than $15,000,000 of assets and voting securities, so long
as the acquiring person will not hold assets with a value of more than $15,000,000 or
voting securities that confer control of an issuer which, together with the issuer’s controlled
entities, has annual net sales or total assets of $25 million or more. Id. § 802.20.
8.
Acquisitions in which the acquired and acquiring persons are commonly controlled
by reason of holdings of voting securities. Id. § 802.30.
9.
Acquisitions of convertible voting securities, id. § 802.31, which are defined as “a
voting security which presently does not entitle its owner or holder to vote for directors,”
id. § 801.1(f)(2). The act of converting the instrument into one with present voting power,
however, may be a reportable event. Id. § 801.32 (“conversion is an acquisition within the
meaning of the act”).
10.
Certain acquisitions by employee trusts. Id. § 802.35.
11. Certain acquisitions of foreign assets or voting securities by U.S. persons. Id. §
802.50.
12. Acquisitions by foreign persons of assets located outside the United States. Id. §
802.51(a). The “location” of certain assets, such as intangible assets and moveable assets,
may involve difficult characterization issues.
13. Certain acquisitions by foreign persons of foreign voting securities or of assets
located in the United States. Id. § 802.51(b,c).
14. Certain acquisitions by foreign government corporations. Id. § 802.52. Acquisitions
by foreign states and foreign governments, other than through their corporations engaged in
commerce, are generally exempt by virtue of the regulations’ definition of “entity,” see id.
§ 801.1(a)(2).
15. Certain acquisitions by creditors, insurers, and institutional investors. Id. §§ 801.63,
802.64.
- 41 -
16.
Acquisitions subject to divestiture order in a government antitrust case. Id. § 802.70.
17. Acquisitions resulting from gift, intestate succession, testamentary disposition, or
irrevocable trust. Id. § 802.71.
C.
HSR Procedure for Transactions Subject to a Reporting Obligation
1.
For most transactions, the HSR process is commenced by the filing of the requisite
forms and attachments by both parties to the transaction. The parties must then observe a
thirty-day waiting period, which may be terminated early or extended by the enforcement
agencies.
2.
For tender offers and acquisitions of voting securities from third parties not included
within the same person as the issuer, see id. § 801.30, the HSR process is commenced by
the acquiring person’s giving notice to the issuer whose voting securities are being acquired
and the filing of the requisite forms and attachments by the acquiring person. The
acquiring person must then observe a thirty-day waiting period, which may be terminated
early or extended by the enforcement agency; provided that the waiting period is shortened
to fifteen days in the case of a cash tender offer. Under the regulations, the acquired person
is required to file its HSR form and attachments by the fifteenth day (tenth day in the case
of a cash tender offer) following receipt of notice from the acquiring person.
3.
The HSR process is a clearance process, not an approval process, and inaction by the
enforcement agencies means the parties are free to close.
4.
Subject to the next paragraph, the fact of a person’s filing HSR notification and the
contents of the filing are confidential and exempt from the Freedom of Information Act. If
an enforcement agency elects to investigate the transaction, however, third parties can often
infer aspects of the transaction from the agency’s questions.
5.
If neither the FTC nor the Antitrust Division wishes to investigate the transaction, the
agencies may simply permit the waiting permit to expire or, if the parties have so
requested, may grant early termination of the waiting period. Grants of early termination
are publicly disclosed by the FTC on a recorded message on the date of the grant and are
reported in the Federal Register some time later. The disclosure contains only limited
information -- little more than the identities of the acquiring and acquired person.
6.
If either agency wishes to investigate the transaction formally, it must request
“clearance” from the other agency. Clearance is ordinarily resolved within the first ten
days of the HSR waiting period.
a.
Once clearance has been granted, the agency ordinarily contacts the parties with
“informal, voluntary” information requests. It also ordinarily contacts third parties,
such as customers, competitors, and trade associations. If the investigation is
- 42 -
sufficient to allay the agency’s competitive concerns, the waiting period is permitted
to expire.
b.
If the agency’s investigation is not sufficient to allay competitive concerns, the
agency will issue a “Request for Additional Information and Documentary Material,”
commonly known as a “Second Request.” The issuance of the Request extends the
waiting period within which the parties may not close until twenty days (ten in the
case of a cash tender offer) after both parties (or the acquiring party only in the case
of a tender offer) have “substantially complied” with the Request. See 15 U.S.C. §
18(e); 16 C.F.R. § 803.20. Generally, Second Requests are very broad. By their
terms, they call for virtually all documents in the recipient’s possession relating to the
definition of the relevant markets, market shares, competition, competitors,
competitive evaluations and assessments, pricing and marketing, and conditions for
entry. The scope of the Second Request is typically negotiated between the parties
and the agency’s staff, but the compliance burden common extends the closing for
three or four months and sometimes longer.
7.
The statute provides for civil penalties of up to $11,000 (after adjustment for
inflation) per day of violation, as well as other relief, for failing to file required notification
or for closing a transaction prior to expiration of the waiting period. The government has
been active since 1995 in imposing substantial penalties for noncompliance. See, e.g.,
FTC: WATCH No. 450 (Feb. 14, 1996) (penalty of $3,100,000 imposed on Sara Lee for
failure to report); United States v. Mahle GmbH, 1997-2 Trade Cas. (CCH) ¶ 71,868
(D.D.C.) (penalty of $5.6 million for failure of German piston manufacturer to make
requisite U.S. filing with respect to acquisition of controlling interest in Brazilian
competitor); United States v. Blackstone Capital Partners II Merchant Banking Fund, L.P.,
1999-1 Trade Cas. (CCH) ¶ 72,484 (D.D.C.) (penalty of $2,785,000 for failure of a
merchant banking fund and one of its general partners to produce all required documents).
D.
Merger Review Other Than Under HSR
The FTC and the Antitrust Division both have the statutory authority to investigate transactions
independent of the HSR Act.
1.
The FTC may open an investigation and issue compulsory process in the form of
annual or special reports, access orders, subpoenas and civil investigative demands. See 15
U.S.C. § 49 (subpoena power); 15 U.S.C. § 57b-1 (CID power).
2.
The Antitrust Division can issue CIDs requiring the production of documents, oral
testimony, or answers to interrogatories. 15 U.S.C. § 1312(a).
3.
The agencies face no time constraints on the issuance of CIDs. In some instances
they have issued CIDs in HSR-reportable transactions, either to develop information prior
to the issuance of a Second Request or to close gaps in the response to the Second Request.
Although there is an issue as to whether agencies may pursue both the CID process and the
- 43 -
Second Request process in connection with any particular transaction, the question has not
been addressed by the courts.
4.
Although the agencies rarely challenge transactions that are not subject to a reporting
obligation under the HSR Act, such challenges can be developed, even after closing,
through the use of CID tools. One such challenge resulted in a judgment against the
merged firm and a related divestiture order. See United States v. United Tote, Inc., 768 F.
Supp. 1064 (D. Del. 1991).
- 44 -
WDC-84031-1
January 18, 2001--17:50:48