On February 6, 2003, the U.S. Department of Justice (DOJ) Antitrust Division reached a consent order with Gemstar-TV Guide International, Inc. and TV Guide, Inc. to settle allegations that the companies violated the antitrust laws by engaging in gun jumping activities during the pendency of their 1999 merger. Gemstar and TV Guide agreed to pay a record civil penalty of $5.67 million for alleged gun jumping violations and to refrain from similar future conduct. This case illustrates the U.S. antitrust agencies’ increased concerns with coordination among merging parties prior to the completion of their transaction. This article outlines conduct that will be considered impermissible gun jumping, describes conduct that is permissible, and recommends actions to reduce the risks of improper gun jumping.
The DOJ and U.S. Federal Trade Commission (FTC) have brought several recent actions involving premature coordination, or gun jumping, among merging parties. Gun jumping is analyzed both under the Hart Scott Rodino (HSR) Act and Section 1 of the Sherman Act. The HSR Act generally requires parties to file notifications, and observe mandatory waiting periods, prior to consummating transactions valued in excess of $50 million. Gun jumping can occur when the parties begin to coordinate prior to the expiration of the HSR Act waiting period. HSR Act violations can occur even if the parties to the transaction do not compete in the same markets. In transactions involving competitors, Section 1 of the Sherman Act imposes a separate basis for liability. Parties to a transaction are viewed by the antitrust agencies as independent competitors until their transaction is actually completed. Coordination of competitive activities, or detailed information exchanges, between parties that are competitors can lead to a Sherman Act Section 1 challenge. Significantly, this liability can arise for activities that occur following the expiration of any applicable HSR Act waiting period. The Gemstar/TV Guide matter demonstrates how the antitrust agencies will use both statutes to challenge what they view as inappropriate premerger coordination.
Gemstar's and TV Guide's Alleged Conduct
According to the DOJ's complaint, Gemstar and TV Guide competed to supply interactive program guides to companies that provide packaged subscription television services to customers (such as cable television and satellite television service providers). The companies explored forming a joint venture that would market their products. Eventually the joint venture concept was abandoned and, in June 1999, Gemstar and TV Guide began negotiating a merger agreement. The parties reached a merger agreement in October 1999. The DOJ initiated an investigation during the HSR waiting period and ultimately informed the parties that it would not seek a preliminary injunction. The merger was completed in July 2000.
The complaint details alleged unlawful coordination of the parties’ businesses prior to the completion of the transaction. The complaint alleged violations of Section 1 of the Sherman Act by allocating markets, fixing prices, coordinating terms and conditions of sale and sharing sensitive commercial information among Gemstar and TV Guide. The complaint also alleged violations of the HSR Act by effectively merging the businesses prior to the expiration of the waiting periods imposed by the HSR Act. Under the HSR Act and the Sherman Act, the parties "were required to remain separate and independent economic actors prior to expiration of the [HSR Act] waiting period and prior to consummation of the merger, respectively." The complaint focused on many specific agreements reached by Gemstar and TV Guide that allegedly were violations of the antitrust laws.
Alleged Unlawful Agreements in Violation of Sherman Act Section 1
The DOJ alleged that Gemstar and TV Guide reached numerous anticompetitive agreements beginning in June 1999, when they began negotiating the merger agreement. According to the DOJ, the parties allegedly agreed to delay independent negotiations with certain key customers until the companies completed their merger so the companies could reach a more favorable sales agreement with these customers. The parties also allegedly agreed to allocate markets, customers and other responsibilities among one another. Gemstar allegedly prepared a chart that summarized which company "would approach and negotiate with particular customers" during the period of time prior to closing. As a result of the agreement, Gemstar allegedly phased out its marketing functions prior to completion of the transaction. The parties allegedly agreed to fix prices. Gemstar officials had access to TV Guide’s price lists and reviewed and approved specific prices TV Guide offered to customers. TV Guide also solicited comments from Gemstar on its proposed customer contracts. TV Guide allegedly accepted Gemstar’s comments and included contract provisions that would only serve to benefit Gemstar upon completion of the transaction.
Alleged Premature Combinations of Operations in Violation of the HSR Act
The DOJ alleged that the companies "effectively merged most of their… operations prior to the expiration of the" HSR waiting period. The complaint alleged that Gemstar acquired effective control over TV Guide prior to the closing. The complaint detailed various alleged conduct by which TV Guide sought the approval of Gemstar before entering into agreements with TV Guide’s own customers. In addition, the complaint claimed that TV Guide acted as Gemstar’s agent in transactions with Gemstar customers and even undertook to negotiate a settlement of litigation between Gemstar and one of Gemstar’s customers. Gemstar and TV Guide also allegedly shared sensitive confidential business information and began integration of their operations that "substantially scrambled their assets at a time when they were required by law to remain independent economic actors." Gemstar and TV Guide allegedly engaged in all of these activities despite having been advised about the perils of gun jumping by their respective counsel.
Gemstar/TV Guide Consent Order Provides Guidance on Permissible Conduct
Gemstar and TV Guide settled the DOJ litigation by paying a record $5.67 million in civil penalties for HSR Act violations and by agreeing not to engage in certain conduct in the future. The $5.67 million penalty represents the maximum allowable fine under the HSR Act, which permits civil penalties of up to $11,000 per day. The DOJ obtained the maximum statutory penalty from each defendant, resulting in the record-breaking total. The proposed injunctive relief prohibits Gemstar and TV Guide, when negotiating or completing potential acquisitions, from entering into any agreement in the context of a contemplated transaction that would: combine the firms’ operations prior to the expiration of any waiting period required under the HSR Act; fix, raise, set, stabilize or otherwise establish price or output of any competitive product; suspend the sales efforts of any party or allocate markets while a potential transaction was being negotiated. In addition, the parties may not disclose information about current or future prices, information or projections of future prices or contract offers on competing products except under highly controlled circumstances. Such exchanges are permissible only if “(1) the information is reasonably related to a party’s understanding of future earnings and prospects; (2) and the disclosure occurs pursuant to a non-disclosure agreement that (a) limits use of the information to conducting due diligence and (b) prohibits disclosure of any such information to any employee of the person receiving the information who is directly responsible for the marketing, pricing or sales” of a competing product. The order also requires Gemstar and TV Guide to allow customers who had negotiated contracts prior to the closing of the Gemstar/TV Guide transaction to rescind their contracts.
Gun Jumping Remains an Enforcement Priority
Acting Assistant Attorney General R. Hewitt Pate has stated publicly that the DOJ will seek to prosecute more gun jumping cases, which is consistent with the agencies’ recent enforcement actions. The Gemstar/TV Guide settlement follows significant settlements reached by the DOJ and FTC involving Computer Associates (2002) and Input/Output Inc. (1999) for alleged gun jumping violations. The antitrust agencies are aggressively investigating activities that appear to be excessive premerger coordination, even when the underlying transaction does not raise competitive concerns. The antitrust agencies appear to be focusing on two broad types of gun jumping activities: parties to a transaction placing pre-closing restrictions on the target that prevent it from operating in the ordinary course of business and companies moving too early in combining their businesses and/or assets or exchanging highly sensitive information on pricing or customers.
Pre-closing Contractual Restrictions on a Target
The DOJ’s 2002 Computer Associates case was based primarily on Computer Associates’ enforcement of provisions in a purchase agreement that allegedly prevented the acquiring firm from continuing to compete with Computer Associates prior to closing. The Computer Associates consent order, as well as the Gemstar/TV Guide case, makes clear that most customary covenants in merger agreements will not be deemed inconsistent with the HSR Act. Acceptable restrictions include covenants in which a seller limits its ability to declare or pay dividends or distributions of its stock; issue, sell, pledge or encumber its securities; amend its organizational documents; acquire or agree to acquire other businesses; mortgage or encumber its intellectual property or other material assets outside the ordinary course; make or agree to make large new capital expenditures; make material tax elections or compromise material tax liability; pay, discharge or satisfy any claims or liabilities outside the ordinary course; and commence lawsuits other than the routine collection of bills. The purpose of these provisions is to prevent the to-be-acquired business from taking actions that could seriously impair the value of the business the acquiring firm has agreed to buy.
The agencies will, however, challenge "ordinary course" provisions if they are being used by the acquirer to prevent the seller from engaging in activities that really are within its ordinary course of business. The substance of any conduct restrictions, and the manner in which they are enforced and monitored, will take precedence over the language of the contractual commitments themselves. Counsel drafting contractual provisions placing limits on the seller’s independent activities must be sensitive to overreaching that may create gun jumping problems.
Pre-closing Integration and Exchanges of Competitively Sensitive Information
The antitrust agencies have become increasingly concerned about pre-closing coordination and information exchanges that may violate the HSR Act or the Sherman Act (if the parties are competitors). The antitrust agencies understand the importance of parties being able to conduct effective due diligence, but they will be wary of due diligence that exceeds the proper scope of what parties need in order to evaluate the transaction or due diligence that may affect the competitive decisonmaking of rival firms.
The recent actions, and statements by agency staff members, indicate that several types of conduct raise red flags for premerger coordination because they may curtail a firm’s ability to compete, either while the transaction is under review or in the event the transaction is not completed for any reason. Problematic pre-closing activities include the following, among others: agreeing to allocate customers between the parties; agreeing on pricing; making joint calls to customers to discuss details of future business relationships; wholesale moves of staff from the seller to the buyer during the pendency of the HSR waiting period; exercise by the acquiring company of decisionmaking authority over the seller’s investments, research and development activities, new product launches and other types of competitive strategic decisions; negotiating contracts for the other party, or advising on such contracts; and placing representatives of the acquiring firm in the facilities of the acquired company to review or evaluate any business activities of the acquired firm. Antitrust agency staffers have also made clear that they will view joint operating agreements or joint marketing agreements entered into by parties to a merger or acquisition agreement as premature transfers of control in violation of the HSR Act. These activities can give rise to violations of the HSR Act (by transferring control during the waiting period) or the Sherman Act if the parties are competitors (so that such activities could constitute a conspiracy in restraint of trade between two independent competitors).
The Gemstar/TV Guide case is only the most recent example of aggressive agency challenges to parties’ conduct during the HSR waiting period. Agency staffers understand the rationale for detailed information exchanges as part of the due diligence process and the need for reasonable restrictions on a selling party during the pendency of the transaction. Nevertheless, agency staff members have shown that they will react aggressively when they believe that information exchanges or "conduct of business" limitations cross the line from serving legitimate business needs to illegal gun jumping. The agencies will challenge alleged gun jumping activity even if the conduct does not have an immediate effect on competition between the merging parties. If the agency does not ultimately challenge questionable activity as gun jumping, it likely will divert staff resources to investigate that activity. That diversion of resources will almost invariably slow the pace of the underlying merger investigation, which is undesirable for merging parties.
Implementing Effective Pre-closing Procedures Is Critical To Managing Gun Jumping Risk
Parties can often meet their legitimate business objectives, while managing the antitrust risk, by tightly controlling the processes by which they interact prior to closing their transaction. For instance, parties may employ third parties, or an internal "clean team," to evaluate contracts or other highly sensitive business information. Detailed due diligence that might be inappropriate for line employees (whose day-to-day competitive decisions could be affected by reviewing a seller’s information) can instead be reviewed by other less problematic employees operating under special, restrictive non-disclosure agreements. This type of arrangement was allowed in both the Gemstar/TV Guide and Computer Associates consent orders. In some cases, a dedicated clean team can be assigned to post-merger integration planning on the transaction if individuals are not engaged in daily competitive activities for their respective firms. The third party or internal clean team may report information in an aggregated format that would substantially reduce the antitrust risk. The foregoing examples are typical of conduct that is likely permissible so long as parties implement appropriate procedural safeguards. Counsel should be closely involved in developing, implementing and monitoring appropriate procedures to manage the risk that the antitrust regulators will investigate parties’ pre-closing activities as impermissible gun jumping.
McDermott, Will & Emery's Antitrust Group regularly defends transactions before the U.S. and international competition authorities, providing guidance to clients regarding premerger reporting and the scope of permissible premerger activities.