Recent antitrust law developments relating to the Hart-Scott-Rodino Act are worth close attention by business executives and their counsel involved in mergers, acquisitions and joint ventures. First, HSR filing thresholds will increase in February 2008. Second, several recent civil penalty actions under the HSR Act serve as important reminders of the traps for the unwary and the associated cost of even inadvertent violations. And finally, a recent District Court decision highlights the potential cost of “gun jumping” from including covenants in merger agreements limiting a competitor’s ability to enter into agreements while a proposed transaction is pending.
The HSR Act requires companies to notify the Department of Justice and Federal Trade Commission of proposed acquisitions of assets or voting securities exceeding the filing thresholds. The statute allows the government to investigate whether transactions may lessen competition and violate antitrust law, before they are consummated. The Act applies, however, whether or not transactions may present substantive antitrust concerns; and the government takes its mandate seriously, as demonstrated by the recent enforcement actions.
HSR Thresholds Increase
Increases in the HSR notification thresholds, which have been indexed to changes in GNP since 2000, will take effect on February 28, 2008. The revised thresholds will apply to transactions that close on or after the effective date, unless an HSR filing has been previously submitted.
Perhaps most importantly, the “size of transaction” threshold above which deals must be reported will increase to $63.1 million. No HSR Act notification will be required if the value of voting securities and assets held as a result of a proposed transaction is below this threshold.
In addition, the “size of parties” thresholds triggering HSR Act notifications will increase, so that generally one party must have at least $126.2 million in total assets or annual net sales and the other party must have $12.6 million in total assets or annual net sales (when the acquired person is not engaged in manufacturing, its total assets must exceed $12.6 million unless its sales exceed $126.2 million). Transactions valued at more than $252.3 million will be reportable, however, regardless of the size of the parties, unless an HSR exemption applies.
The thresholds for incremental acquisitions of voting securities which must be reported have also been adjusted, to $126.2 million, $630.8 million, 25% if valued greater than $1,261.5 million, and 50% if valued greater than $63.1 million. The 50% threshold is the highest regardless of dollar value because it indicates the acquisition of control. The new thresholds also apply to certain exemption thresholds, such as whether sales into the U.S. from foreign assets or foreign subsidiaries may trigger a filing.
These new thresholds can be summarized as follows:
To view table click here.
Finally, thresholds determining what filing fee is owed will increase so that fees will be owed (the fees themselves are not indexed) as follows:
To view table click here.
The HSR filing rules are complex; HSR counsel should therefore be consulted to determine whether a filing will be required.
Firms contemplating non-reportable transactions should be aware that mergers and acquisitions that may “substantially lessen competition” are illegal whether or not an HSR filing is required. In recent years, the government has challenged several non-reportable transactions, particularly where they have resulted in monopolies or near monopolies. Of course, the government focuses most of its enforcement resources on reportable transactions.
DOJ and FTC Bring Civil Penalty Actions to Enforce HSR Rules
Three recent civil penalty actions under the HSR Act are instructive.
Failure to File Incremental Acquisitions; Acquisitions “Solely for the Purpose of Investment” Over 10%
In December 2007, an investment fund paid $1.1 million to settle charges that it violated reporting requirements. ValueAct Capital Partners, a San Francisco-based fund, allegedly failed to comply with the HSR Act three times during 2005 through a Master Fund:
- in acquiring Gartner, Inc. voting securities that resulted in ValueAct holding stock valued at approximately $248 million, surpassing the $100 million threshold (as adjusted);
- in acquiring Catalina Marketing Corporation stock that resulted in ValueAct holding more than 10% of Catalina voting securities valued at approximately $148 million; and
- in acquiring Acxiom Corporation voting securities that resulted in ValueAct holding more than 10% of Acxiom stock valued at approximately $178 million.
ValueAct was the ultimate parent entity of the Master Fund, according to the FTC, since it was entitled to 50% or more of its profits and/or 50% or more of its assets upon dissolution.
ValueAct had earlier made corrective filings relating to previous failures to file, taking advantage of the FTC’s “one free bite of the apple” policy for inadvertent omissions. In order to get that free pass, ValueAct outlined steps it would take to prevent future violations. Those policies apparently did not do the trick, and this time the FTC made ValueAct pay for its failure to follow the rules.
The action should remind firms that make incremental investments over time that even if they filed under HSR when initially acquiring stock, they will need to file if a higher notification threshold will be exceeded by a subsequent investment.
The action is also a reminder that under the HSR rules, acquisitions “solely for the purpose of investment” are exempt only if the securities held or acquired do not exceed 10% of the voting securities of the issuer. If the shares held or acquired will exceed 10% of the issuer’s outstanding voting securities, then the acquiring entity may have to file and observe the premerger waiting period regardless of the passive intent of the acquisition.
In its statement announcing the action, the FTC made clear that “while we are flexible and may forgive an inadvertent error, we are less so in cases where multiple errors have been made despite earlier promises of diligent oversight.”
Failure to Submit Required Documents with HSR Filing
As firms that have been through the HSR process know, often the most difficult part of preparing a filing is collecting so-called “4(c) documents,” responsive to Item 4(c) of the Notification and Report Form. Item 4(c) requires submission of:
- all studies, surveys, analyses and reports which were prepared by or for any officer(s) or director(s) (or, in the case of unincorporated entities, individuals exercising similar functions) for the purpose of evaluating or analyzing the acquisition with respect to market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets.
This requires collection of all documents that (1) relate to the transaction, (2) were prepared by or for officers or directors, and (3) discuss competition, competitors, market share, potential for sales growth, or expansion into product or geographic markets. The government has long held that firms must submit informal materials, such as handwritten notes and e-mails, as well as formal “studies, surveys, analyses and reports.”
In October 2007, the DOJ obtained a $550,000 civil penalty from a firm for failing to submit required 4(c) documents with its HSR filing.
Iconix Brand Group, a New York-based owner of fashion brands, agreed to settle charges that the company failed to produce a formal presentation made to its Board of Directors regarding its acquisition of Rocawear, another apparel brand, as well as e-mail among officers and directors regarding the transaction. The DOJ investigated the failure of Iconix to submit documents with its filing, even though it had concluded that the transaction did not raise substantive antitrust concerns and granted early termination of the HSR waiting period.
Failure to submit required documents with an HSR filing can delay government review, as the FTC or DOJ may restart the HSR clock with a late submission, as well as result in civil penalties. This enforcement action is a reminder that firms making HSR filings must take the obligation to submit such documents seriously, even when a transaction does not raise substantive antitrust concern.
Failure to Notify Exercise of Options
Earlier in 2007, a Texas hedge fund manager agreed to a $250,000 civil penalty to settle charges he violated premerger reporting requirements.
In May, the FTC and DOJ announced a suit against James Dondero of Dallas, the ultimate parent of Highland Capital Management, L.P., for failure to file under HSR before exercising options to acquire the stock of Motient Corp., based in Reston, Virginia. Like ValueAct, Dondero had, only a year before, made a corrective filing relating to another acquisition, using his one “get-out-of-jail free” card.
Highland, in a fairly typical transaction, bought some shares of Motient, and later exercised an option to acquire additional shares. The original acquisition was not large enough to trigger an HSR filing, and Dondero did not make one before Highland exercised its option to acquire the additional shares. The stock, however, had appreciated substantially since it was acquired, so that after exercising the option Dondero controlled Motient voting securities worth more than $90 million.
This enforcement action is a good reminder that the exercise of an option or other convertible security may require an HSR filing. Further, for voting securities it is the current value of all shares to be held after the acquisition that matters, and even a small “add-on” acquisition may trigger a filing. HSR counsel should be consulted before exercising options or otherwise acquiring voting securities if there is any doubt about whether an HSR filing may be required.
Penalties under the HSR Act can be significant. Any entity (or individual) that fails to comply with the Act may be subject to a civil penalty of up to $11,000 for each day the violation continues. Penalties can therefore quickly add up.
Anyone who may have violated the Act should consult with counsel immediately, and, where necessary, make a corrective filing as soon as possible, rather than allow potential penalties to continue to accumulate.
Court Refuses to Dismiss “Gun Jumping” Allegations; Case Highlights Potential Treble Damages in Private Antitrust Litigation
The final recent development worth noting relates to so-called “gun jumping” – arguably illegal coordination between firms proposing to merge.
The U.S. District Court for the Northern District of Illinois recently denied a motion to dismiss allegations that UnitedHealth Group and PacifiCare violated U.S. antitrust law by coordinating pricing decisions after agreeing to merge, but before consummating their proposed merger in 2005.
The September 28, 2007, decision in Omnicare v. UnitedHealth Group allows Omnicare to pursue treble damages claims based upon the fact that the United/PacifiCare merger agreement required United’s prior written consent for “any Contract … that involves [PacifiCare] or any of its Subsidiaries incurring a liability in excess of three million dollars ($3,000,000) individually or seven million five hundred thousand dollars ($7,500,000) in the aggregate.”
Before they merged, UnitedHealth was a major managed care and health insurance company, and PacifiCare was an independent managed care company, also providing health insurance. The two firms agreed in July 2005 to merge, in a deal valued at $8.15 billion. At the time, both firms competed to provide prescription drug services to Medicare beneficiaries and contracted with pharmacies, including Omnicare. The DOJ cleared the deal in December 2005, after the parties agreed to divest certain commercial health insurance contracts in Arizona and Colorado.
In its complaint, Omnicare alleged that, after United and PacifiCare agreed to merge but before the transaction closed, the two firms conspired to fix prices in violation of the Sherman Act. The court rejected United’s argument that parties to a merger agreement have a unity of interest that makes them incapable of conspiring, distinguishing the case from a 1993 Eighth Circuit decision, in International Travel Arrangers v. NWA, which had accepted a jury finding that parties to a merger agreement had not conspired because of the unity of interest between the parties.
The DOJ and FTC have made “gun jumping” an issue through speeches and consent decrees with a number of companies over the last 10 years. The government has asserted that firms have violated both the HSR Act and the Sherman Act by coordinating activities before merging.
Notably, the Omnicare court is the first to conclude that coordination by firms that have agreed to merge may violate the antitrust laws. It suggests corporate lawyers exercise caution in drafting covenants in merger and acquisition agreements imposing restrictions on premerger conduct to ensure that ordinary course competition is not restricted. It also provides a warning to business executives that their premerger actions can lead to lawsuits by customers as well as trigger government enforcement actions.
It may be possible to read the decision as condemning the PacifiCare covenants because the dollar threshold for requiring UnitedHealth’s consent was set so low as to intrude on ordinary course competition, although there is no language in the decision that focuses on the size of the dollar threshold. It certainly would make more sense only to condemn covenants that restrict ordinary course competition, and allow covenants that restrict actions outside the ordinary course of business. But caution is warranted when drafting such contractual provisions, regardless of the dollar threshold.
DOJ Approves “Ordinary Course” Covenants
The DOJ has, in fact, advised that provisions commonly found in merger agreements requiring firms merely to carry on their business “in the ordinary course in substantially the same manner as heretofore conducted” are appropriate and lawful. The DOJ has also suggested that other “standard provisions … to prevent a to-be-acquired person from taking actions that could seriously impair the value of what the acquiring firm had agreed to buy,” will be allowed. While these provisions may limit a firm’s ability to make certain business decisions without consent of the buyer, they are also reasonable and necessary to protect the value of the transaction and are lawful, according to the DOJ.
The DOJ has, however, said that agreements that “impose extraordinary conduct of business limitations” enabling a firm to exercise operational control over significant aspects of the seller’s business, and that go beyond ordinary and reasonable pre-consummation covenants, violate the HSR Act by allowing “operational control of the to-be-acquired person’s business.” The DOJ has also condemned price coordination among competitors before consummation of mergers in its enforcement actions.
The last U.S. government challenge to “gun jumping” was in 2006 in connection with a Qualcomm acquisition. There, the DOJ identified covenants that, among other things, prohibited Flarion, without first obtaining Qualcomm’s written consent, from entering into any agreement involving the obligation to pay, or the right to receive, $75,000 or more per year or $200,000 or more in the aggregate. The DOJ, however, focused on the parties’ actual conduct, applying the covenants in a restrictive manner. The government alleged, for example, that Flarion had sought Qualcomm’s consent before it marketed products and services to customers and potential customers. The government alleged that Flarion sought Qualcomm’s consent even before providing pricing information to a potential customer, and Qualcomm discouraged Flarion from certain business opportunities. At the time, the DOJ Assistant Attorney General for Antitrust emphasized that “merging parties must continue to operate independently until the end of the premerger waiting period” under the HSR Act.
European Concerns With “Gun Jumping”
“Gun jumping” has also become an issue in Europe. In December, the European Commission announced that it had conducted “dawn raids” at two PVC manufacturers in the U.K. proposing to merge to investigate whether they may have implemented their proposed transaction before receiving antitrust clearance and exchanged information in violation of the EC rules on cartels and restrictive business practices.
Premerger coordination remains an area where companies must be cautious to avoid government scrutiny as well as, now, private damages actions by customers. Merging parties must be particularly careful not to coordinate competitive decisions before transactions are consummated.