On July 7, 2011, the Federal Trade Commission and the Antitrust Division of the Department of Justice (the “Agencies”), issued extensive changes to the Hart Scott Rodino (“HSR”) Premerger Notification form. The changes will go into effect 30 days after publication in the Federal Register, which is expected any day. By statute, parties to a transaction that meet certain thresholds cannot consummate the transaction until each side files an HSR form with the Agencies and observes the waiting period, which is generally 30 days. The speed and ease with which parties to a transaction can collect and submit the necessary documents and information, therefore, have a significant impact on a transaction’s timing.
This briefing will briefly describe the major changes being implemented, which include:
- Additional documents that must be submitted with the HSR form
- Revisions to the revenue information that must be supplied
- Disclosure of relationships with companies that are not controlled by the entity filing notification
Production of Additional Documents
The Agencies have added three categories of documents – Items 4(d)(i), (ii), and (iii) – that now must be submitted along with the HSR form. New Item 4(d)(i) requires the submission of all Confidential Information Memoranda (“CIM”) prepared by/for any officer or director that “specifically relate to the sale of the acquired entity(s) or assets” and that were prepared within one year of the filing. If no CIM exists, however, the rule requires the production of documents that serve the function of a CIM. Because of the ambiguous nature by which documents may effectively serve as the CIM, filing parties should pay even closer attention to the contents of the documents they share, before and during due diligence.
Item 4(d)(ii) requires the filer to submit all documents prepared by third party advisors (including consultants and investment bankers) for any officer/director during an engagement, or for the purpose of seeking an engagement, that specifically relate to the sale of the acquired entity or assets. This requirement only relates to documents that evaluate or analyze market shares, competition, competitors, markets, potential for sales growth, or expansion into product or geographic markets. Like with 4(d)(i), only documents prepared within one year of the filing must be produced. Because this item would capture “pitch books” and “bankers’ books”, investment bankers must be extremely careful in how they describe the nature of the industry and the competitive effects of the acquisition, lest something they wrote to obtain an engagement come back to haunt the client during the HSR waiting period.
The last category of new documents that must now be submitted relate to the synergies of the transaction. Item 4(d)(iii) requires the submission of all documents “evaluating or analyzing synergies and/or efficiencies prepared by or for any officer(s) or director(s) . . . for the purpose of evaluating or analyzing the acquisition.” Notably, such documents must be submitted even if they were not prepared for the transaction being filed. Previously, such documents were arguably not required and the parties only submitted such documents on a voluntary basis if they were claiming that the efficiencies of the transaction would outweigh any anticompetitive effect. Now such documents will be produced at the start of the Agencies’ analysis, requiring the parties to pay much closer attention at a much earlier stage in the transaction’s lifecycle to the synergy documents they create.
Additional Reporting Requirements for Foreign Manufactured Products
Item 5 currently requires the filer to categorize its U.S.-based revenue by North American Industry Classification System (NAICS) code for a base year – 2002 – and for the most recent fiscal year. The requirement that a filer categorize revenue going back to 2002 has become daunting and onerous for clients, and provided very little meaningful information to the Agencies. Recognizing this, the Agencies have now deleted this requirement.
The Agencies did, however, increase the amount of information filers must submit in Item 5 in another way. Item 5(a) now requires companies that manufacture products outside the U.S. to provide the 10-digit NAICS product codes for each product manufactured outside the U.S. but sold within the U.S. through direct sales, retail and wholesale. Revenue for products manufactured abroad and sold in the U.S., whether the manufacturer is foreign or domestic, will now be reported only under the 10-digit manufacturing NAICS and not also included in a NAICS wholesale code, to prevent double-counting. Sales of products manufactured abroad by others and sold in the U.S. by the parties will continue to be classified under the appropriate wholesale code. Because filers were not required to report revenue for products made abroad prior to these changes, many companies, especially foreign filers, may not have experience with the NAICS reporting process. Nevertheless, the Agencies believed this information was important to their analysis of the competitive consequences of a transaction.
Disclosure of Associated Entities
Due to the growth of private equity funds and master limited partnerships, the Agencies developed a new category of entity – “associate” – about whom they seek information should there be an overlap between the associate and the target business. Associates, by definition, are not “controlled” by the filing party under HSR rules. Under the final rules, an associate is broadly defined to include any entity that:
(A) has the right, directly or indirectly, to manage the operations or investment decisions of an acquiring entity (a “managing entity”); or (B) has its operations or investment decisions, directly or indirectly, managed by the acquiring person; or (C) directly or indirectly controls, is controlled by, or is under common control with a managing entity; or (D) directly or indirectly manages, is managed by, or is under common operational or investment management with a managing entity.
The form now requires information about overlaps between any entity controlled by an associate and the target, as well as overlaps between companies in whom the associate has a minority investment and the target. Specifically, Item 6(c)(ii) requires an acquiring party to report, based on its “knowledge and belief,” any of its associates’ holdings of voting securities and non-corporate interests of 5 percent or more, but less than 50 percent, in the target and in any entity having a 6-digit NAICS code overlap with the target. The rule only requires the acquiring party to provide the information based on its “knowledge and belief”, thereby leaving the possibility that some information may not be provided due to the party’s lack of knowledge. Despite this allowance, filing parties must make a good faith effort to acquire such information.
Similarly, Item 7 now includes not only entities controlled by the filing party, but also entities controlled by any associate. The new Item 7 requires an acquiring party to report (a) any 6-digit NAICS codes where both an entity controlled by the acquiring person or an associate of the acquiring party, on the one hand, and the acquired entity, on the other, derive dollar revenues; (b) the name of the entity that derived revenue in the overlapping 6-digit NAICS code; and (c) certain geographic information for the entity.
If an acquiring party is unable to provide a list of its associates’ minority holdings based on overlapping NAICS codes, the party may provide a list of its associates’ minority holdings that are within the same industry as the target. The party may also rely on regularly prepared financials that list its investments, or with information filed with the SEC, as long as they are no more than three months old. Although these allowances initially reduce the burden and cost of gathering the necessary information, they come at a price. First, such financial information may omit the information that is necessary to determine the industry of the associate and particularly of the entity in which the associate made a minority investment. Thus, reliance on such information may be of no practical help. Second, such short-cuts could result in the Agencies’ requesting additional information during the waiting period to understand more specifically the competitive overlaps between the target business and the associate, which could potentially delay expiration or termination of the initial waiting period. In contrast, if an acquiring party engages in the effort to determine the NAICS codes for its associate’s controlled entities and for their minority investments, it may determine there are no overlaps to report, or at least fewer overlaps than had it simply reported based on general industry classification.
The new NAICS overlap reporting requirement will undoubtedly be costly and time consuming, at least initially, for acquiring parties that have many “associates”. Nevertheless, for parties that file regularly, rather than take a filing-by-filing approach, it most likely makes sense to develop a database of the necessary information that is updated regularly so that the information can be accessed in a timely manner and the HSR filing does not become an issue that delays the timing of the transaction.
The new rules reduce the burden on filers in some respects, but increase the time and cost in many ways. All filers will now have to submit a broader range of documents and private equity funds (and similarly structured entities) face a far more significant burden in compiling information than they did previously. The substantive analysis undertaken by the Agencies, however, remains unchanged.