The dramatic rise in private equity and hedge fund transactions has led to closer scrutiny from US antitrust regulators.
Since 2005, US antitrust regulators have pursued enforcement action against private equity and hedge funds in two key areas: the filing of pre-merger notifications under the Hart-Scott-Rodino (HSR) Act, and the acquisition of minority equity interests in competing issuers.
Scrutiny of Filing Decisions
The HSR Act requires that transactions valued at more than US$59.8 million be reported to the US Federal Trade Commission (FTC) and US Department of Justice (DOJ). The HSR Act, however, also exempts certain types of transactions from the reporting requirements, including some transactions intended for investment purposes.
The “investment-only” exemption is frequently cited in so-called “financial” deals. This exemption applies only to passive investments of less than 10 per cent of an issuer’s securities where the buyer cannot influence the issuer’s activities.
Private equity and hedge funds may not qualify for the investment-only exemption because of the passivity requirement. Rather, private equity and hedge funds generally want some degree of influence over the issuer’s activities, and, therefore, may be considered “activist” shareholders, losing the exemption.
The FTC and DOJ have repeatedly warned that they will monitor this area. Moreover, since 2005, these agencies have opened at least two enforcement actions against private equity and hedge funds for failing to file an HSR notification, resulting in substantial penalties. As a result, private equity and hedge funds must exhibit caution when relying on the exemptions to the HSR Act. Increased Scrutiny of Interests In another significant shift, US antitrust regulators are looking more closely at acquisitions of minority equity interests by private equity or hedge funds. Private equity and hedge funds increasingly acquire sufficient equity interests in issuers with overlapping activities to have some influence over the companies’ respective activities. Antitrust regulators theorise that activist shareholders holding minority interests in competing companies may limit the incentives and ability of competing companies to compete with one another. The regulators worry that such conduct can adversely affect the competitive dynamic more generally and ultimately translate into harm to consumers.
Such a case arose in January 2007, when two private equity funds, The Carlyle Group and Riverstone Holdings, planned to purchase a 22.6 per cent interest in Kinder Morgan, Inc. (KMI). Carlyle and Riverstone already held an indirect 50 per cent interest in KMI’s direct competitor, Magellan Midstream Partners, L.P. As a result, Carlyle and Riverstone would have held seats on the boards of both KMI and Magellan, a veto right over certain Magellan actions, and access to both KMI’s and Magellan’s competitively sensitive information.
The FTC challenged the KMI transaction, arguing that it would give Carlyle and Riverstone sufficient control over both KMI and Magellan to permit them to exercise unilateral market power, which could have led to a reduction in output and increase in petroleum prices. Consequently, the FTC required Carlyle and Riverstone to relinquish their influence over certain of KMI’s and Magellan’s activities in order to proceed with the transaction.
These trends mean that private equity and hedge funds must pay particular attention to US antitrust laws where they acquire more than a passive, but less than a controlling, interest in a target.