Obama FTC, DOJ Lay Foundation for Change in Merger Enforcement
By Stephen Y. Wu
As a candidate for president, then Senator Barack Obama promised to “reinvigorate antitrust enforcement” and criticized the Bush administration for “what may be the weakest record of antitrust enforcement of any administration in the last half century.” Obama was especially critical of the Bush administration’s record of enforcement against what he saw as anticompetitive mergers.
Since being sworn into office, President Obama has appointed a new Chairman of the U.S. Federal Trade Commission (FTC), Jon Leibowitz, and a new Assistant Attorney General for the Antitrust Division of the U.S. Department of Justice (DOJ), Christine Varney, to carry out his antitrust enforcement agenda. Together, Chairman Leibowitz and Assistant Attorney General Varney have begun laying the foundation for President Obama’s promised “reinvigorated” antitrust enforcement. Specifically, the FTC and DOJ recently released for public comment revisions to the Horizontal Merger Guidelines, which state the enforcement policies of the FTC and the DOJ with respect to mergers and acquisitions. (Federal Trade Commission Seeks Views on Proposed Update of the Horizontal Merger Guidelines, Apr. 20, 2010.) The FTC and DOJ published the current merger guidelines in 1992 and have only slightly revised them once since then, in 1997. The revisions follow a series of public workshops involving federal, state and international enforcement officials; members of the antitrust bar; economists; and academics.
The FTC and the DOJ stated that their goals for revisions to the guidelines were to reflect actual practice at the agencies and new economic thinking that has developed in the 18 years since the guidelines’ original publication. (See Introduction of Philip Lowe and Announcement of Joint FTC/DOJ Project to Modernize the Horizontal Merger Guidelines, Jon Leibowitz, Chairman, Fed. Trade Comm’n, Sept. 22, 2009; Merger Guidelines Workshops, Christine A. Varney, Assist. Att’y Gen., Antitrust Division, Dep’t of Justice, Sept. 22, 2009.) While this effort has the potential to bring greater transparency to the merger review process by making more clear when the agencies will and will not seek enforcement, the effort will also reflect President Obama’s desire to make it easier for the FTC and DOJ to prevail in blocking mergers and acquisitions they believe will result in anticompetitive effects.
Changes to the Merger Guidelines
The largest change in the revised merger guidelines consists of their shift from defining the relevant market in which to analyze the merger or acquisition to focusing on the likely effects of particular merger or acquisition. The FTC and DOJ are de-emphasizing the proper market in part because they have lost challenges in court during the recent past when they defined the markets at issue too narrowly. For example, the DOJ lost its challenge to the Oracle-PeopleSoft transaction because it failed to convince the district court judge that the proper market in which to analyze that transaction was limited to “high function” enterprise application software. (See United States v. Oracle Corp., 331 F. Supp. 2d 1098 (N.D. Cal. 2004).)
By de-emphasizing market definition and focusing on effects, the agencies claim that they will refocus enforcement efforts on preventing those transactions which are likely to harm competition, regardless of the exact scope of the market. This means that the FTC and DOJ want to emphasize how a merger of competitors may result in higher prices as opposed to litigating over whether more differentiated or distant competitors are “in” or “out” of the market. Thus, the FTC and DOJ want to make it easier to challenge transactions they view as competitively problematic.
At the conclusion of the workshops, Assistant Attorney General Varney also announced that the DOJ and FTC would revise the merger guidelines’ Herfendahl-Hershman Index (HHI) thresholds that describe at what levels of market concentration the agencies will consider a particular merger or acquisition potentially anticompetitive. (See An Update on the Review of the Horizontal Merger Guidelines, Christine A. Varney, Assist. Att’y Gen., Antitrust Division, Dep’t of Justice, Jan. 26, 2010.) The HHI represents the sum of the squares of the market shares of firms that compete in the relevant product or service market of concern. For example, a market consisting of five firms with equal shares would have an HHI of 2000 (20%2 + 20%2 + 20%2 + 20%2 + 20%2 = 2000). In contrast, a monopolist would have an HHI of 10,000 (100%2 = 10,000).
To reflect actual practice, the revised guidelines have revised upward the HHI thresholds above which the agencies will typically express a competitive concern and conduct a more thorough investigation. (Horizontal Merger Guidelines for Public Comment, Apr. 20, 2010.) In the past, the agencies rarely challenged mergers and acquisitions that resulted in HHIs less than 1,000, despite language in the merger guidelines stating that such transactions “potentially raise significant competitive concerns.” (Dep’t of Justice and Fed. Trade Comm’n, Horizontal Merger Guidelines, § 1.51 (1992) (rev. 1997).) The proposed change to a threshold HHI of 1,500 before considering that a transaction will “potentially raise significant competitive concerns” means that firms engaged in mergers and acquisitions in industries with several competitors will have greater certainty that the FTC and DOJ will likely not investigate their transaction.
The FTC and DOJ also clarified their theories as to how a merged firm can unilaterally harm competition following a merger or acquisition. Specifically, the FTC and DOJ revised the merger guidelines to include explicit consideration of how a merger or acquisition can cause upward pricing pressure (UPP) by eliminating a particularly close rival. (Horizontal Merger Guidelines for Public Comment, Apr. 20, 2010.) To predict whether a transaction will lead to UPP, the agencies will focus on the companies’ diversion ratios, which refer to how many sales are diverted from one product to others when prices increase, and price-cost margins. The FTC and DOJ are incorporating the concept of UPP because of a desire to focus on how a merger of close competitors may result in higher prices.
Besides these significant changes to the merger guidelines, the FTC and DOJ have revised the guidelines to clarify the following:
- The types of evidence the agencies will consider when investigating a merger or acquisition for anticompetitive effects
- The agencies’ views on the presence of price discrimination between customers and suppliers
- That a transaction can raise the agencies’ concerns that it will result in an increased likelihood of coordination among competitors without them reaching an actual agreement
- The measures the agencies will take to account for market dynamics and innovation
- How the agencies will treat powerful buyers, mergers and acquisitions between competing buyers, and partial acquisitions
(Federal Trade Commission Seeks Views on Proposed Update of the Horizontal Merger Guidelines, Apr. 20, 2010.)
Impact on Clients
Taken together, the FTC’s and DOJ’s revisions to the merger guidelines are a timely update to their existing statements of enforcement policy with regards to mergers and acquisitions. The revised guidelines are not a significant departure from current FTC and DOJ practice, but, at the same time, they may also lead to greater antitrust scrutiny of certain mergers and acquisitions, particularly for those involving close competitors in highly concentrated industries. Nevertheless, it is an open question how the courts will react to the new guidelines and their shift away from defining markets, in particular.
On a more practical level, the revisions to the merger guidelines increase the importance of certain types of evidence in the agencies’ reviews of mergers and acquisitions, particularly those involving differentiated products. Diversion ratios, price-cost margins, win-loss reports and customer-switching patterns, in addition to the views of competitors, customers and industry observers, will likely take on even more pronounced roles in FTC or DOJ investigations. Clients should proceed with caution and take stock of these kinds of documents and data prior to entering into mergers and acquisitions with competitors in concentrated industries.
Cross-Border M&A in the Commodities Sector: Asset Purchases
By Hugh Nineham, Prajakt Samant and Rashpaul Bahia
Mergers and acquisitions (M&A) activity in the commodities trading sector has been buoyant over the past 18 months, affecting the trading operations of both financial institutions and energy companies. There have been a number of factors at play, including the collapse of significant market players, changes of ownership where new owners have a different market appetite for the particular market risk, and the desire by some market participants to rebalance asset portfolios (either by upsizing or downsizing) in response to the crisis in the financial markets.
In these circumstances, institutions and companies that take a favorable view of the sector have been able to take advantage of opportunities either to enter the market or to strengthen and diversify existing operations. Examples of transactions over this period are the acquisitions by JPMorgan of various business units of RBS Sempra Commodities; the sale by UBS AG of its commodities trading business, part of which was sold to Barclays Bank plc; and the sale of Constellation Energy’s coal, freight and international commodities business to J. Aron / Goldman Sachs.
Transactions such as these present interesting structuring options, particularly in the context of risk transfer where there is a sale and purchase of the assets and liabilities of a company, which this article focuses on, rather than the shares of the business itself. Cross-border regulatory issues are also a key consideration given the international nature of many businesses in this sector.
Structuring the Transaction
The first structural decision in M&A transactions in the commodities sector, as in any other, is whether the subject of the transaction will be the shares in the company conducting the target business and holding the assets and liabilities, or only some of its assets, liabilities and business activities.
An asset purchase, particularly in the commodities trading sector, will typically be more complicated procedurally than a share purchase due to the need to transfer each of the separate assets (transactions or trading relationships) that constitute the business. Because a commodities trading portfolio will, by its very nature, involve a multitude of trading relationships with counterparties, more consents and approvals are likely to be required than on a share purchase, in particular in respect of the assignment or novation of trading contracts.
However, depending on the commercial agreement between the parties, an asset purchase will confer a greater degree of flexibility, particularly in circumstances where the seller has liabilities that cannot be easily quantified or identified, or where it has infrastructure or other assets that the buyer does not want.
Options for Risk Transfer
If the parties decide to proceed by way of a share purchase, all the benefits and risks associated with the business will effectively transfer at closing. There may be a need for closing to be deferred depending, among other matters, on the regulatory position (for example, whether there will be a need to obtain merger control clearances). If there is a gap between signing and closing, there will need to be a purchase price adjustment mechanism for any value changes occurring during this period.
In the case of asset purchases, the position may be more complex and the following structures may be used to deal with the transfer of benefit and risk:
An asset purchase of the relevant commodities transactions is made for a fixed price set at the signing of the sale and purchase agreement (SPA) and paid at closing. The closing date will be the date on which the transfer of the portfolio is effective. There will be a purchase price adjustment mechanism for changes between signing and the closing date, and all assets will be transferred on the closing date.
An asset purchase of the relevant commodities transactions is made for a fixed price paid at signing, with a total return swap (TRS) being effective on signing to transfer specified risks of transactions from the seller to the buyer. Alternatively, the TRS may be effective on the closing date rather than at signing. There will be no price adjustment mechanism because the TRS will transfer the economic and other risks to the buyer, and once all underlying trades are transferred to the buyer, the TRS will terminate.
An asset purchase of the relevant commodities transactions is made for a fixed price paid at signing, with mirror transactions between the seller and buyer that transfer price (market) risk between signing and the closing date. No price adjustment mechanism is needed because mirror transactions (followed by the TRS) transfer the price risk to the buyer at signing. Once the underlying assets are transferred to the buyer, the TRS terminates.
Sale and Purchase Agreement
In the context of a share purchase, the main negotiation points on the SPA will be relatively consistent with transactions in other sectors, although the price adjustment mechanism, if there is one, will be very specific to valuation methods relating to the underlying assets. The representations and warranties will also be tailored to the particular characteristics of the market.
In an asset purchase, the SPA may look more different than the norm, principally because of the procedural aspects of the transfer of the underlying assets and liabilities, and the time the process is likely to take, which is often considerably longer than in other types of transactions. The following points may give rise to particular difficulty:
- Conditions Precedent to Closing: Apart from any required regulatory conditions, there may well be tension between the buyer and seller as to the required level of counterparty novations that are achieved before the transaction may be closed.
- Novation Process: There will need to be clear agreement over the conduct of the novation process. In addition, one of the critical components of a portfolio purchase will be the need to novate the transactions comprising the portfolio. Therefore, the parties may include in the SPA the process for transferring the underlying trades, and the SPA will need to cover issues such as the seller using commercially reasonable efforts to obtain counterparty consents to the novation of transactions and to agree on a form of novation agreement.
- Conduct of the Business Between Signing and Closing: In view of the estimated time that the novation process is likely to take, there will be more than the usual focus on the provisions relating to the conduct of the target business between signing and closing.
- Termination Rights: A combination of all these factors is likely to lead to close discussion about the rights of either party to terminate before closing (including on the basis of material adverse change), particularly if the novation process is not proceeding as envisaged.
TRS / Mirror Transactions
Structures Two and Three described above contemplate the use of a TRS. Pending required consents or approvals to the transfer of the portfolio, the parties can use a TRS to transfer the benefits and burdens of trades from the seller to the buyer before the trades are legally transferred by novation. Risks that may be transferred include market, credit, legal and operational risks, and the buyer may agree to assume all or some of these risks. For example, in terms of credit risk, a TRS allows flexibility as to who is going to take the risk if a counterparty to a particular transaction does not pay.
The Regulatory Environment
As with any M&A transaction, the impact of competition law will need to be considered. Generally speaking, trading activity in the commodities markets is considered by competition authorities to be sufficiently fragmented that substantive competition issues are unlikely to arise, although the markets in each of the commodities that are the subject of an M&A transaction must be considered separately; the levels of competition differ in each of them. Therefore, substantive issues may arise.
The first question is whether the transaction satisfies the relevant tests that might bring it within the scope of merger control regulations, either on a national or supranational level. In the case of jurisdictions such as the European Union (EU) where the relevant tests are based on turnover of the acquirer and the target, the character of the parties and the nature of the target business make it more likely than in many other types of transactions that the tests will be met.
A further element of the analysis, at least for EU purposes, is whether, in the case of an asset purchase, the portfolio of contracts (along with any ancillary assets or personnel) comprises an “undertaking.” If it does not, the transaction will fall outside European Commission merger laws.
Other regulations must be considered on a jurisdiction-by-jurisdiction basis. As a general rule, there is no single regulatory regime that will apply to these types of transactions. However, in the United States, for example, energy sector regulatory approvals may need to be considered, as well as approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. In the United Kingdom, it is highly likely that certain activities undertaken by the target will be covered by financial services regulations.
Recent Developments Affecting M&A in Belgium: Money Laundering and Insider Dealing
By Patrice Corbiau & Jacques Pieters
Two recent legal developments significantly affect Belgian M&A practice. The first concerns legislative modifications to the law on money laundering, and the second relates to a recent decision of the European Court of Justice (ECJ) on insider dealing.
Modifications to the Money Laundering Act of January 11, 1993
The Belgian Law of January 18, 2010, modified the Belgian Law of January 11, 1993 (the Money Laundering Act). Stakeholders in the financial sector, including lawyers, notaries, accountants, real estate agents, casinos, trustees and similar company service providers, now must heed new anti-money-laundering due diligence requirements.
Existing legislation already required stakeholders to verify the identity of their clients and the effective “beneficiaries” of the transaction in question, and to inform the Belgian National Financial Intelligence (CTIF/CFI) before executing a transaction for a client (or its beneficiary) if the stakeholder knew or suspected that the requested transaction was linked to money laundering or terrorist financing.
The principal amendments to the Money Laundering Act made by the Law of January 18, 2010, are the following:
- Establishing certain objective criteria for identifying a beneficiary—notably, any person who holds more than 25 percent of the capital stock or equity of a company
- Identifying circumstances in which reduced diligence is allowed—notably, when the effective beneficiary of the transaction is a Belgian or EU public authority
- Requiring stakeholders to carry out enhanced due diligence in situations that, by their nature, present a high risk of money laundering and terrorist financing—notably regarding business relations with “politically exposed” persons (e.g., persons that have a reputation of having ties with terrorist groups) living abroad
- Exempting notaries, auditors, external accountants and tax advisers from the obligation to notify the CTIF/CFI referenced previously, unless they themselves take part in the money laundering activities or the financing of terrorism, or provide legal advice in furtherance of such activities, or they know that the client is requesting advice in furtherance of such activities
- Prohibiting stakeholders from creating or maintaining business relationships or carrying out occasional operations when such stakeholders are unable to perform their supervisory/control duties under the Money Laundering Act
In relation to the last point, it should be noted that lawyers, however, are not required to terminate their legal representation when assessing the legal situation for their clients or when performing their task of defending or representing clients in judicial proceedings, including advice in the context of such proceedings and, in particular, how to engage in or avoid such proceedings. In cases where stakeholders do notify the CTIF/CIF, lawyers are prohibited from informing their clients or the effective beneficiaries or third parties that such notification has taken place, except among professionals within the same organisation.
In any event, these legislative changes will force M&A practitioners to adhere more diligently to the know-your-client principle and to withdraw more quickly from a transaction if the information received from a client proves unclear or unsatisfactory.
Insider Dealing – A Rebuttable Presumption of Illegality
The Spector Judgment
On December 23, 2009, the ECJ ruled that when a person trades in a security while in possession of “inside information” relating to that security, he or she is presumed to “use the information” and therefore commits the offense of insider trading as defined by European legislation (Directive 2006/6/EC). Thus, according to the ECJ, the prohibition on insider trading applies when an insider who possesses “inside information” takes unfair advantage of the benefit gained from that information by entering into a market transaction based on that information.
Nevertheless, the ECJ recognises that the individual concerned has the right to rebut the presumption by proving that he or she did not “use the information.” In a complicated discussion of how the individual might rebut the presumption, the ECJ concluded that the individual could exculpate himself or herself by proving that he or she did not use the information in a manner contrary to the purpose of Directive 2006/6/EC—namely, to protect the integrity of financial markets and to enhance investor confidence—which is based on the principle that everyone must be placed on equal footing and protected from the misuse of inside information.
This leaves traders and regulators with an important factual analysis and judgment call as to whether there has been insider trading or if a legitimate rebuttable presumption exists. Requiring a factual analysis and judgment call ultimately creates uncertainty.
Some comfort can be drawn, however, from examples mentioned in the recitals to Directive 2006/6/EC (and referred to by the ECJ):
- The mere fact that market makers, bodies authorised to act as counterparties, or persons authorised to execute orders on behalf of third parties with inside information confine themselves in the first two cases to pursuing their legitimate business of buying or selling financial instruments, or, in the last case, to carrying out an order dutifully, should not in itself be deemed to constitute use of such inside information.
- Having access to inside information relating to another company and using it in the context of a public takeover for the purpose of gaining control of that company or proposing a merger with that company should not in itself be deemed to constitute insider trading.
Consequences Under Belgian Law
Under Belgian law, insider dealing is punishable under Article 25 of the Law of August 2, 2002, with criminal penalties imposed by Article 40 of the same Law.
In its present form, Article 25 prohibits a person who possesses information that he or she knows, or ought to have known, to be inside information from acquiring or disposing of, or trying to acquire or dispose of, for his or her own account or for the account of a third party, either directly or indirectly, the financial instruments to which that information or connected financial information relates.
The insider dealing offence under the Law of August 2, 2002, appears to be defined more strictly than the ECJ’s interpretation of Directive 2003/6/EC, because Article 25 of that Law does not require, as an element of the offense, that the person concerned “used” the inside information.
Since the objective of Directive 2003/6/EC is maximal harmonization at EU level (i.e., to reach the highest degree of harmonization between the national laws of the EU Member States), it would appear that Article 25 of the Law of August 2, 2002, will be interpreted to include a requirement that the accused person actually “used” the inside information.
Court Rulings on Solvency and Fairness Opinions Help to Define Liability for Financial Advisors
Corporate Rescue and Insolvency
By Jeffrey Rothschild
Given the recent significant volatility of the financial markets and the economy, valuations have become difficult for buyers and sellers to agree upon, and thus are a focus of litigation.