On July 7, 2011, the FTC announced changes to the Notification and Report Form, which parties to certain transactions are required to file pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (HSR). These amendments become effective 30 days after notice is published in the Federal Register, so the likely effective date is mid-August 2011.
For the majority of mergers and acquisitions, the FTC expects that the amendments will reduce the burdens and costs of filing HSR. For example, the amendments eliminate base-year revenue reporting, which can prove difficult for firms that have had multiple acquisitions or sales of businesses since the defined base year (currently 2002). Offsetting that time savings is the need to collect documents responsive to the new Item 4(d) categories. The FTC estimates that the net effect of the various changes will reduce the average time required to complete HSR by about five percent.
For private equity firms, master limited partnerships (MLPs), and other complex management organizations, however, the announced changes will substantially increase the burdens of filing HSR. For these organizations, the new rules will require acquiring parties to produce detailed information about “associates” — entities under common management with the acquiring person, but not controlled by the acquiring person. Private equity firms and MLPs should begin preparing now to minimize the additional costs and preparation time needed for these new requirements by ensuring that the entities they manage keep regular quarterly financial statements that identify each entities' investments by industry and/or NAICS code.
Elimination of Base-Year Reporting
The most welcome aspect of the new changes is the elimination of the so-called “base-year” reporting in Item 5. Currently, HSR filers are required to report their revenues, classified according to the 2002 North American Industry Classification System (NAICS), for the most recent completed year and for the year 2002. The rationale for requiring a base year was to provide context and show the company's recent growth.1 The FTC originally assumed that such data would be kept in the ordinary course of business and, thus, would impose a minimal burden on HSR filers. In practice, however, such data is very rarely kept in the ordinary course of business; in some cases the base-year requirement has forced parties to undertake highly complicated analyses of their 2002 revenues.2
Fortunately, the new amendments eliminate the base-year requirement. This simple change can save many hours of work and significantly reduce the burdens on corporate accounting departments. Instead, under the new amendments, filers will simply report their previous year's non-manufacturing revenues by six-digit NAICS codes based on the most recent North American Industry Classification System – United States manual and their previous year's manufacturing revenues by 10-digit NAICS codes based on the most recent Numerical List of Manufactured and Mineral Products manual.
New Revenue and Document Submission Requirements
Although the new amendments eliminate the base-year burden, they impose two new burdens on all filers. First, the amendments create three new categories of documents that parties must submit to the government (Item 4(d)). Second, they now require parties to report and classify revenues from foreign manufacturing that result in U.S. sales (amended Item 5).
Typically, one of the most complex and labor-intensive components of the HSR form is compliance with Item 4(c), which requires the submission of certain categories of documents used to evaluate or analyze the proposed transaction.3 The amendments add three categories of documents to be collected and filed, under the heading “Item 4(d)”:
- Item 4(d)(i): All confidential information memoranda (or equivalent document(s)) that specifically relate to the sale of the acquired entity or assets.
- Item 4(d)(ii): All studies, surveys, analyses, and reports prepared by investment bankers, consultants, or other third-party advisors for the purpose of analyzing market shares, competition, competitors, markets, or potential for sales growth or expansion into product or geographic markets, that specifically relate to the sale of the acquired entity or assets.
- Item 4(d)(iii): All studies, surveys, analyses, and reports evaluating or analyzing synergies or efficiencies from the acquisition.
Like Item 4(c), only documents prepared by or for any officers or directors (or, in the case of unincorporated entities, individuals exercising similar functions) will need to be collected for Item 4(d).4 Documents responsive to Items 4(d)(i) and 4(d)(ii) are limited to those created within one year of the date of filing.
In many cases, the impact of Item 4(d) may be minimal. Item 4(d)(i) will require parties to submit confidential information memoranda. However, such documents (along with offering memoranda and “teasers”) are already routinely provided in response to Item 4(c). As the FTC's Notice of Proposed Rulemaking explained, “Most parties already submit these along with their HSR Filings and proposed Item 4(d)(i), which would require filing parties to do so, should not create any additional burden for them or substantial additional burden for others.”5 Likewise, Item 4(d)(ii) will require parties to submit relevant “pitch books” and other analyses that investment bankers and consultants have prepared in connection with the transaction; again, these documents are usually collected and, when appropriate, submitted with the HSR form in response to Item 4(c).
However, in many cases, Item 4(d)(iii) will require substantial effort. When a buyer expects to realize synergies from an acquisition, there often are large numbers of spreadsheets and other documents prepared to evaluate or analyze these synergies. Although parties sometimes submit such documents “voluntarily”6 in the hope of demonstrating the transaction's potential to lower costs and enhance competition, such practice is hardly universal. To the contrary, practical and even strategic considerations often counsel against submitting such documents. For example, in transactions that pose antitrust risk, documents showing only marginal efficiencies might suggest that the transaction lacks redeeming competitive value. On the other hand, in transactions that pose no antitrust risk whatsoever, there often are hundreds of pages of commercially sensitive documents that evaluate potential synergies, for example, in assessing whether the purchase price gives one party or the other a large enough slice of the pie.7 In such cases, identifying and submitting documents about synergies creates costs without serving any functional purpose.
Even though Item 4(d)(iii) will require the submission of documents that often have no bearing on antitrust concerns, it will be important to ensure that all responsive documents have been collected and submitted. The notice of final rulemaking suggests that Item 4(d)(iii) documents might carry greater weight in persuading the government of a transaction's pro-competitive benefits than documents submitted at a later time during a merger investigation. Moreover, failures to comply will subject filers (and the persons who certify filings) to a penalty of up to $16,000 per day.8 The government has obtained significant civil penalties against companies in the past for failing to provide documents responsive to Item 4(c), and parties also should expect the government to take Item 4(d) seriously.
Amended Item 5
Another burden created by the amendments is that Item 5 will require filers to report and classify by NAICS code revenues derived from products they manufacture outside the United States and sell into the United States (even if the sales are not through an establishment in the United States controlled by the filing person). Until now, the scope of Item 5 has been limited to operations conducted within the United States.9 As amended, however, Item 5 will require parties to classify by the appropriate NAICS manufacturing codes the revenues they derive from U.S. sales of products produced in their foreign manufacturing operations. This change will impose an additional burden on corporations making sales in or into the United States of products they manufacture outside the United States, but it will eliminate the need for the complex rules and exceptions that had arisen under Item 5. For instance, companies selling through their establishments in the United States products they manufacture abroad are currently required to report such revenue under the appropriate wholesaling or retail code. Additionally, informal interpretations of Item 5 require parties to treat manufacturing operations based in foreign “maquiladoras” as though they were conducted within the United States. These two complexities are now obsolete.
Special Requirements for Complex Management Organizations
The amendments will substantially increase the burdens on private equity firms, MLPs, and similar complex management organizations. Until now, acquiring persons were only obligated to report information for entities within their “control.”10 The new amendments, however, create the concept of an “associate,” essentially defined as an entity under common “management” with the acquiring person, but not “controlled” by the acquiring person.11 In the private equity context, two funds might each be their own “ultimate parent” — because, for example, in the case of an unincorporated entity, no single person has the right to 50 percent of either fund's profits or assets upon dissolution — but the investment decisions of both funds might be managed by the same general partner. Similarly, in the MLP context, two MLPs might each be their own “ultimate parent” because no single person has the requisite 50-percent interest for HSR control purposes, but the operations of both MLPs might be managed by the same operating company. In these cases, both “sister” entities as well as the common managers are all deemed associates of one another. Similar associate relationships might also lie in a myriad of other complex management organizations, such as joint ventures where the minority owner has management rights.
The amendments will require acquiring persons to report certain information for their associates. Item 6(c)(ii) will require acquiring persons to identify any holdings of five percent (but less than 50 percent) of entities that derive revenue from the same NAICS codes as the acquired entity. Item 7(b) will require the identification of any such interests when associates hold 50 percent or more of entities that derive revenue from the same NAICS codes as the acquired entity. Finally, Item 7(d) will require information about the geographic scope of any interests identified in Item 7(b). Fortunately for acquiring persons, revenue reporting for associates will not be required.
To illustrate, imagine that private equity fund “A” acquires a reportable interest in a chain of toy stores X. Its sister fund “B,” which is separately controlled for HSR purposes but is under common management with A, owns 25 percent of another chain of toy stores “Y,” and 100 percent of a third chain of toy stores “Z.” With the new amendments, fund A will have to disclose fund B's 25-percent interest in toy store Y (under Item 6(c)(ii)), fund B's 100-percent interest in toy store Z (under Item 7(b)), and the address of each establishment toy store Z operates (under Item 7(d)). This is a relatively simple example; it is not at all unusual for private equity firms or MLPs to hold far more elaborate, commonly managed interests.
Because the new amendments will substantially increase the burdens required of private equity firms, MLPs, and similar organizations, these organizations may want to act in advance to identify possible associates and to minimize the burden when they are trying to quickly file an HSR notification. In a concession to these organizations, Item 6(c) will allow an acquiring person to rely on its “regularly prepared financials that list its investments and those of its associates . . . provided the financials are no more than three months old.” Additionally, where “NAICS codes are unavailable,” Item 6(c)(ii) will allow acquiring persons to identify those entities “that have operations in the same industry” as the acquired entity that are five-percent-owned (but less than 50-percent-owned) by associates. Finally, Item 6(c)(ii) also will allow the option of listing all of the acquiring person's associates' holdings of five percent (but less than 50 percent) of entities across the board, without any reference to NAICS codes or industry; however, the FTC warns that taking this option may delay the review process and increase the likelihood of follow-up requests.
In short, private equity firms and MLPs will minimize the costs of future HSR filings by ensuring that they keep regularly prepared, quarterly financial reports that list the investments of their associated entities. For HSR purposes, a “regularly prepared” financial is one that is routinely prepared in the normal course of business; it does not include pro forma financial statements prepared for unique or non-recurring events. Ideally, such reports will identify holdings by NAICS code or, at a minimum, by industry. Taking such steps now will not avoid all of the burdens of the new HSR amendments, but they will certainly minimize the time, effort, and costs of future HSR filings.
The new HSR amendments have reduced some of the burdensome aspects of the HSR process, but they also add new requirements that will impose additional burdens and costs. The FTC predicts that the majority of HSR filers can expect the amendments to yield small benefits and cost savings. For certain HSR filers, particularly those that have considerable sales in the United States from manufacturing they do outside of the United States, those on the acquiring side that have management arrangements that create associate relationships, and those parties undertaking substantial synergy and efficiency analyses, the amendments may impose significant new costs. Organizations such as private equity firms and MLPs can work to have ready the types of financial statements that will allow them to avoid some new HSR costs in the future.