On May 9, 2016, District Judge John E. Jones III of the Middle District of Pennsylvania denied the Federal Trade Commission’s (FTC) and the Commonwealth of Pennsylvania’s motion for a preliminary injunction against Penn State Hershey Medical Center and PinnacleHealth System. The FTC was seeking to halt any moves by the hospitals toward consummation of their proposed merger pending the completion of the FTC’s full administrative trial on the merits of the transaction, which was previously slated to begin on May 17. Judge Jones rejected the FTC’s request based on a finding that the proffered geographic market definition was “unrealistically narrow and does not assume the commercial realities faced by consumers in the region.” While the decision on the geographic market was dispositive of the motion, Judge Jones’ opinion goes on to criticize the FTC in unusually pointed language, expressing the view that the litigation brought by the FTC could be considered “no small irony [when] the same federal government under which the FTC operates has created a climate that virtually compels institutions to seek alliances such as the Hospitals intend here.”
There are a number of other aspects of the opinion likely to raise concerns within the FTC and thus it is not entirely surprising that the FTC is taking the relatively unusual route of appealing the decision to the Third Circuit, and focusing the appeal on alleged defects in Judge Jones’ geographic market analysis. In light of the district court’s ruling, and in order to give the parties time to determine how to proceed, the Commission has granted a continuance of the administrative trial until June 1. The district court, in response to the FTC’s request for a stay, has extended the existing temporary restraining order until May 27.
Penn State Hershey Medical Center (Hershey) is a 551-bed hospital located in Hershey, Pennsylvania, which offers a wide range of medical services, including tertiary and quaternary care. PinnacleHealth System (Pinnacle) operates three hospitals in central Pennsylvania totaling 646 licensed beds. Pinnacle’s facilities are all community hospitals focused on general acute care services, though they also offer some higher-acuity services.
Hershey and Pinnacle signed a letter of intent for a proposed merger in June 2014 and received final board approval for the transaction in March 2015. Following a nine-month investigation, the FTC filed administrative and civil complaints to block the transaction in December 2015.
The FTC’s complaint alleged that the transaction would “create a dominant provider of general acute care inpatient hospital services in the Harrisburg [Pennsylvania] area” and was likely to lead to “increased healthcare costs and reduced quality of care for over 500,000 local residents and patients.” The FTC alleged that the relevant geographic market in which to assess the transaction was four counties described as the “Harrisburg Area,” an area “roughly equivalent to the Harrisburg Metropolitan Statistical Area.” In defining the alleged geographic market, the FTC noted that “patients choose to seek care close to their homes or workplaces” and that hospitals outside the Harrisburg Area were not meaningful competitors because they “draw very few patients from the Harrisburg Area.” Further, the FTC argued that patient preferences for local care meant that insurers would have difficulty marketing a health plan network in the Harrisburg Area consisting of hospitals from outside the Harrisburg Area.
The FTC further alleged that Hershey held a 36% share and Pinnacle a 40% share in the purported “Harrisburg Area” geographic market, meaning the combined entity would control approximately 76% of the market post-transaction. If one accepts the proposed market and shares, the transaction would result in increases in market concentration well in excess of Horizontal Merger Guidelines thresholds, creating a presumption the merger was likely to create or enhance market power.
Following briefing on the FTC’s preliminary injunction motion and a five-day evidentiary hearing in April, the court issued its ruling.
Under Section 13(b) of the FTC Act, a court may issue a preliminary injunction to enjoin a transaction “[u]pon a proper showing that, weighing the equities and considering the Commission’s likelihood of ultimate success, such action would be in the public interest.” In assessing the likelihood of the FTC succeeding on its claim under Section 7 of the Clayton Act, the court noted it was “essential that the FTC identify a credible relevant market before a preliminary injunction may properly issue.”
The parties both agreed the relevant product market was general acuity services sold to commercial health insurers and thus the dispute, as is typically the case in hospital mergers, focused on the relevant geographic market. The court noted that the “end goal in this analysis is to delineate a geographic area where, in the medical setting, few patients leave…and few patients enter”, i.e., an area from which the defendant hospitals draw the bulk of their patients, with few patients entering from outside that area to seek medical care and few patients within that area leaving to seek care from other hospitals. The court found of key importance the “uncontroverted fact” that, in 2014, 43.5% of Hershey’s patients traveled to Hershey from outside the FTC’s proposed Harrisburg Area geographic market, while “several thousand” of Pinnacle’s patients lived outside of the Harrisburg Area. With little in the way of further analysis, Judge Jones therefore found that, instead of the “starkly narrow” market alleged by the FTC, any of 19 hospitals within a 65 minute drive of Harrisburg provided a “realistic alternative” patients could use, “given the realities of living in Central Pennsylvania, which is largely rural and requires driving distances for specific goods or services.”
The court analyzed whether, post-transaction, the combined hospital would be able to impose a price increase (a “Small but Significant and Non-transitory Increase in Price,” known as a SSNIP) in the alleged geographic market and found it highly significant that the hospitals had recently entered into rate agreements with their two largest insurers (representing 75-80% of the hospitals’ commercial patients) that “maintain existing rate structures for fee-for-service contracts and preserve the existing rate differential between the hospitals” for the duration of the contracts (five years for one insurer, ten years for the other). The court noted it could not be “blind to this reality” that rates “cannot increase for at least 5 years” and found that it would therefore be “imprudent” to enjoin the merger based on what amounted to a “prediction” of what might happen five years from now, in the “rapidly-changing arena of healthcare.”
Judge Jones thus held that the FTC failed to set forth a relevant geographic market, meaning that it could not make a prima facie case and did not therefore demonstrate a likelihood of success on the merits under Section 13(b), and he denied the preliminary injunction. While the court’s decision on the geographic market disposed of the case, Judge Jones provided further discussion of what he viewed as “several important equitable considerations.”
The court found that the hospitals presented a “compelling efficiencies argument” in defense of the proposed merger.
Specifically, the court found that the transaction would help alleviate capacity constraints and overcrowding at Hershey, allowing the hospitals to better allocate higher-acuity and lower-acuity patients between Hershey and Pinnacle, thus allowing Hershey to avoid spending the money to build a new patient bed tower as an alternative. The court dismissed what it described as a “series of arguments…the FTC assembled” to rebut the parties’ position regarding this efficiency. The court also discussed the transition of the healthcare system toward “risk-based contracting,” which was described as a process that aims to “transfer the risk for the cost of care for the individual to the provider.” The court credited the testimony of Hershey’s CEO when he said the merger would help the combined hospital adapt to risk-based contracting by providing “size of scale” and allowing the “spread of costs…of population health over a larger health care system.”
Judge Jones concluded that the equities weighed in favor of allowing the merger and ended his opinion with an unusually harsh assessment of the FTC case and, more broadly, a critique of its merger policies in the era of the Affordable Care Act. He indicated that his decision “reflects the healthcare world as it is, and not as the FTC wishes it to be” and recognizes the “growing need for all those involved to adapt to an evolving landscape of healthcare” including the Affordable Care Act, changes in Medicare and Medicaid reimbursement, and the transition to risk-based contracting.
The decision concludes with an endorsement of hospital consolidation as the perhaps inevitable response to the regulatory environment, noting that “[l]ike the corner store, the community medical center is a charming but increasingly antiquated concept. It is better for the people they treat that such hospitals unite and survive rather than remain divided and wither.”
The FTC’s Appeal & Analysis
It has been the FTC’s long-standing practice to cease its administrative litigation if it fails in its effort to obtain a preliminary injunction in federal court. In this instance, however, the FTC is keeping its options open. As noted above, the Commission granted a two-week continuance of the administrative case until June 1, and the FTC is seeking an injunction while it appeals Judge Jones’ ruling to the Third Circuit. While the FTC might continue its administrative challenge during any appeal of the district court decision, it would be more in keeping with past practice for the FTC to maintain a stay of the administrative case during the pendency of the appeal.
The FTC’s brief seeking an injunction pending appeal claims the court “erred in several key respects” in analyzing the geographic market by focusing almost exclusively on one fact -- where Hershey’s patients live -- while “[i]gnoring, without any explanation, the testimony of industry and expert witnesses on how prices for hospital services are determined.” In particular, the FTC asserts that Judge Jones in essence applied what it refers to as “the discredited ‘Elzinga-Hogarty’ test,” an approach to market definition that focuses primarily on patient location. In recent years the FTC has advocated that courts move away from strict application of Elzinga-Hogarty and has had notable success in convincing courts of its view that “health care mergers must be analyzed through the lens of contract negotiations between health care providers and commercial health plans.”
In that regard, Judge Jones’ decision is notable for its lack of discussion of health insurer views on the Hershey-Pinnacle transaction. While referencing the rate commitment agreements signed with the two largest insurers in the area, the opinion is silent on what insurers actually thought about the transaction, even though the FTC alleged that “[n]umerous health plans have expressed concern that the proposed Merger will eliminate competition and result in price increases” and provided insurer testimony on the point. Indeed, the FTC argues that Judge Jones’ decision on the geographic market “disregarded  evidence from insurers,” and in particular failed to “address unrebutted testimony from insurers that they would pay more than a SSNIP to keep defendants in their networks.” Typically, customer testimony is a critical piece of any merger investigation and a key factor leading agencies to seek a merger challenge, and is routinely addressed by the reviewing court as well. This issue is likely to receive significant consideration on appeal.
The FTC also criticized the court for its analysis of the rate agreements. Judge Jones held that the agreements made it impossible for the merging parties to impose a SSNIP for at least five years. The FTC brief argues that this analysis is misguided and irrelevant to the geographic market inquiry, noting that the parties “did not even advance that claim, which mixes apples and oranges” because the SSNIP focuses on the behavior of a hypothetical monopolist and whether it would be able to impose a SSNIP on customers within a purported geographic market, not on what the merging parties may have agreed to do or not do by contract with two specific insurers. The FTC argued that this was a “grave error that undermines the integrity of the antitrust laws” because such an analysis would allow any defendant to shield itself from antitrust scrutiny in future cases by simply entering a rate-protection agreement with its customers and thus prevent a plaintiff from proving a geographic market.
Though the focus of the FTC’s brief is on the geographic market analysis, the agency also argues that the district court’s decision erroneously credited the hospitals’ claimed efficiencies “in the guise of ‘equities’” without “rigorously analyzing” whether those efficiencies are verifiable, achievable, or merger-specific as required by precedent and the Horizontal Merger Guidelines. In particular, the FTC contends that the specific action considered by Judge Jones to be an efficiency -- Hershey’s cancellation of a project to build additional patient facilities -- is actually a restriction in output. The FTC also criticized Judge Jones’ ruling for asserting “without citation that the merger [was] made necessary by the Affordable Care Act” when “[n]othing in the ACA compels anticompetitive consolidation among competing hospitals.”
It is not surprising the FTC took issue with Judge Jones’ closing critique of the FTC for seeking to block mergers that the court believes are undertaken in response to the regulatory climate. Such a view stands in direct opposition to the FTC’s long-held position on this issue. The FTC has stated numerous times that it believes that antitrust enforcement is a complement to the new health care environment: “The goals of the [Affordable Care Act] are in harmony [with antitrust enforcement] and not in conflict…. There are other practical ways of achieving coordinated care and alternative payment models beyond merging with a close competitor.” While Judge Jones’ criticism appears to be dicta, it also appears to have influenced other aspects of his decision, notably his readiness to accept the efficiencies rationales of the merging parties.
The FTC’s appellate brief also suggests that Judge Jones improperly applied the standard for review in ruling on the FTC’s preliminary injunction motion under Section 13(b) of the FTC Act. While Judge Jones’ opinion recognized that an application under Section 13(b) requires a different standard than the traditional preliminary injunction standard applied to civil parties and the DOJ, Judge Jones did not apply the more lenient test used by many courts to assess the FTC’s ”likelihood of success.” The FTC’s appellate brief notes that under Section 13(b) the FTC “need not definitively prove the merger is unlawful, but only that it likely is unlawful,” citing to FTC v. Cardinal Health, Inc., a case that applied the more lenient standard. As the Cardinal Health court wrote: “To prevail, the FTC needs to prove only that it is likely to succeed on the merits of its case in a full administrative proceeding. The Commission meets this burden if it can raise questions going to the merits so serious, substantial, difficult, and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination by the Commission in the first instance and ultimately by the Court of Appeals.” In contrast, Judge Jones’ decision seemed to require the FTC to meet a significantly higher standard.
The Penn Hershey decision interrupts the FTC’s winning streak in hospital merger cases. It remains to be seen whether the FTC can reverse that defeat on appeal, and if that appeal provides any additional guidance on geographic market definition in hospital mergers, preliminary injunction standards under Section 13(b) or, perhaps more important, the role of antitrust enforcement in a healthcare market increasingly moving in the direction of provider collaboration.