Corporate Antitrust: More of the Same or a Changing Face of Government Enforcement? November 2, 2006
Topics 1. An Increasing spotlight on minority shareholder investment what are the limits? Current regulatory views on passive investor exemptions to Hart- Scott-Rodino Act, and switching majorities situations in the EC. Rules regarding interlocking directors (Clayton Act 8) Implications under antitrust conspiracy law (Sherman Act 1) and merger law (Clayton Act 7) of holding minority interests. 2. Do s and don ts of information exchanges. Gun jumping and pre-merger information exchanges Scrutiny of benchmarking activities 3. Merger enforcement. Enforcement activity, post Maytag/Whirlpool Fall Congressional elections potential repercussions 2
Acquisitions Solely For Purpose of Investment Hart-Scott-Rodino ( HSR ) Act requires U.S. antitrust approval before purchasing more than $56.7 million of voting securities of an issuer One exemption to HSR allows the purchase of 10% or less of an issuer s voting securities regardless of dollar value if the acquisition of voting securities is made solely for the purpose of investment Solely for purposes of investment if no intention by acquirer to participate in the formulation, determination, or direction of the basic business decisions of the issuer 3
Acquisitions Solely For Purpose of Investment FTC has construed the investment exemption narrowly Merely voting stock is consistent with investment intent But the following is not: nominating a candidate for the board of directors proposing corporate action requiring shareholder approval soliciting proxies having controlling shareholder, director, officer or employee simultaneously serve as director of the issuer being a competitor of the issuer 4
Acquisitions Solely For Purpose of Investment Government challenges to reliance on investment exemption: U.S. v. Smithfield Foods: challenged because Smithfield was actively considering merging with [Target] at the time. U.S. v. Farley: challenged because Farley found to be considering the possibility of seeking to acquire control of West Point at the time 5
Acquisitions Solely For Purpose of Investment United States v. The Coastal Corp.: challenged because Coastal s intent included the possibility of acquiring control of [Target]. U.S. v. Pennzoil: challenged because Pennzoil considered and anticipated participating in the management of Chevron... Pennzoil and Chevron were competitors in a number of markets... Pennzoil Board members and senior management personnel discussed, both internally and with third parties, obtaining a seat on Chevron s Board of Directors. 6
Acquisitions Solely For Purpose of Investment Informal FTC Staff Opinions Regarding Investment Exemption permitted an observer of acquirer on issuer s board permitted to engage in private communications with management of issuer in its capacity as shareholder permitted input into the selection of directors to fill two vacancies on target s board by selecting jointly an executive search firm who developed list of qualified candidates and could make suggestions so long as search firm had sole determination of which individuals were on the list 7
Acquisitions Solely For Purpose of Investment not permitted where acquirer stated it might seek control of Target, had demanded Target s shareholder list, and had retained a proxy solicitation firm not permitted where acquirer intended to engage in greenmail transaction not permitted where acquirer intended to make strong suggestions to management or the board 8
Acquisitions Solely For Purpose of Investment Current Issue: Can a shareholder meet with management and still rely on investment exemption? Yes, so long as solely receiving information No, if proposing action requiring shareholder approval Open issue: making suggestions without coercion and not requiring shareholder approval - Precedent would suggest you can - But FTC staff has indicated that such communications could be inconsistent with investment intent 9
Switching Majorities under the EC Merger Regulation When an acquisition of 100% of a company does not constitute an acquisition of control under EC law? Company A and B each acquire 49.8% of the equity. Management retains 0.4%. No voting agreements. Neither company A, B, nor management can veto (i) hire/fire of CEO, (ii) budget or (iii) business plan. Because the EC takes the position that you could theoretically have Switching Majorities, such an acquisition would not constitute an acquisition of control on a lasting basis, and the EC has no jurisdiction to review the acquisition. 10
Minority Investments and Antitrust Three Basic Issues Minority investments can create three types of substantive antitrust issues: 2 merger issues - Interlocking Directorates Section 8 of Clayton Act - Substantive Merger Review Section 7 of Clayton Act Conspiracy type Issues - Section 1 of Sherman Act 11
Minority Investments and Antitrust Conspiracies - Copperweld A parent company and its wholly owned subsidiary cannot conspire under Section 1 of the Sherman Act. Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752 (1984) Section 1 does not apply because a corporation and its subsidiary are not two independent sources of economic power previously pursuing separate interests. The facts in Copperweld presented an easy case for what seemed like a straightforward holding. The Supreme Court s specific holding was limited to wholly owned subsidiaries but the logic of the decision extends beyond wholly-owned subsidiaries. 12
Minority Investments and Antitrust Conspiracies - Copperweld s Progeny The trend in lower courts has been toward broadening the application of this doctrine to cases where the parent has legal control over its subsidiary. Legal control is largely determined by the ownership percentage of voting stock. Some courts have been reluctant to extend Copperweld beyond the de-minimis variances from 100% ownership. But, to a large extent, a 51% share ownership has been held sufficient to apply Copperweld. No bright-line test has emerged and, apart from share ownership, further facts may affect the determination. Fact issues may preclude dismissal of an intra-conspiracy claim on a motion to dismiss or, possibly, a summary judgment motion. 13
Interlocking Directorates Section 8 of the Clayton Act 14 Section 8 of the Clayton Act prohibits a person from serving as a director or board-elected officer of two or more corporations if each corporation has capital, surplus, and undivided profits of more than $22,761,000, if the corporations are by virtue of their business and location of operation, competitors, so that the elimination of competition by agreements between them would constitute a violation of any of the antitrust laws. Exceptions - interlocks are permitted when: The competitive sales of either company are less than $2,276,100 or 2% of the company s total sales; or The competitive sales of each company are less than 4% of total sales; or The competing entities are not corporations, or the corporations are banks, banking associations, or trust companies. Remedies Embarrassment. One individual must resign from the board. Not a DOJ enforcement priority, but this can come up in private litigation.
Interlocking Directorates Reading International, Inc. v. Oaktree Facts An asset management company, Oaktree, held a minority equity position in both Loews (40%) and Regal (17%). Oaktree had a board seat on both the Loews and Regal boards. Oaktree had assigned one principal, its president, to serve on Loews Board, and another principal to serve on Regal s board. Oaktree moved to dismiss on the theory that Section 8 only prohibits direct interlocks in which the same natural person serves on both boards. The Court (SDNY, Lynch J.) rejected the Oaktree arguments. The Court held that the entity having the authority to designate a director is a Person under Section 8. Oaktree would violate Section 8 if plaintiffs can demonstrate that the two individuals served on the board not in their individual capacities, but as the deputies of Oaktree. DOJ filed an Amicus Curia brief supporting the position that Section 8 applies to corporations as well as individuals. 15
Interlocking Directorates Implications of Oaktree 1. Following the Oaktree decision, to solve Section 8 concerns, it may no longer be sufficient to have different individuals on different boards. 2. Other approaches may be viable The DOJ (and the Oaktree Court) see the delegation as: We do not suggest that business entities are automatically liable whenever individuals having any arguable association with them serve as directors or officers of two or more competing corporations. Whether the officers or directors are acting as representatives of another business entity is necessarily a question of fact. But if it can be demonstrated that they are acting for that business entity, there is no justification for exempting the business entity from the strictures of Section 8. (DOJ Amicus Curia Brief) 3. Can independent outside board directors be an appropriate, and acceptable, solution? 4. The devil is in the details: is an individual a deputy of the corporation? 16
Minority Acquisitions Conspiracy Issues (Sherman Act 1) Apart from the issue of interlocking directors under 8 Clayton Act, simultaneously holding board seats on competing companies may present difficult conspiring or agreement issues. Simultaneous board representations can be the means for an impermissible exchange of competitively sensitive information. Competitively sensitive information includes: - information about future pricing - information about future margins - information about future pipeline products - strategic plans - customer specific information 17
Minority Acquisitions Conspiracy Issues (Sherman Act 1) Firewalls can solve the problem. Issue: How can we conclusively rebut the inference that competitively sensitive information has not been shared? Example: PE Fund 1 acquires, through teams A and B, 30% of competitors A and B. PE Fund should ensure that team A does not share competitive sensitive information with team B and PE Fund should wall off the individuals who get access to competitively sensitive information from teams A and B. The devil is in the details. 18
Minority Acquisitions Merger Enforcement Issues Section 7 applies to any acquisition by one corporation of all or any part of the stock of another corporation. United States v. E.I. du Pont de Nemours & Co., 353 U.S. 586, 592 (1957). DOJ and FTC have not expressed a bright line acquisition threshold as for when the acquisition of any stock triggers the application of 7. As a practical matter, passive investments of less than 15% are very unlikely to be challenged. But shareholdings sufficient to designate at least one director (or otherwise influence the management of the two competitors) have been subject to litigation. In US v. Northwest Airlines and Continental Airlines, DOJ challenged Northwest s acquisition of 14% of Continental s equity. - This was an unusual equity structure, as Northwest would have also acquired 50% of Continental s voting stock. 19
Minority Acquisitions Merger Enforcement Issues (cont d) In US v. Northwest Airlines and Continental Airlines, DOJ challenged the acquisition although Northwest had agreed to strict governance limitations: Deposit of the stock in a voting trust, nullifying Northwest s voting power for ten years (except in extraordinary circumstances, such as merger, reorganization or acquisition). Northwest ensured that independent directors nominated by Continental s board always constitute a majority of the board. Northwest committed not to influence Continental s board or management either directly or indirectly. DOJ argued that both carriers would be influenced by the equity interest to pull their competitive punches. Litigation was settled when Continental repurchased Northwest s stock interest. 20
What Is Gun-Jumping? Antitrust laws treat merging firms as competitors until consummation of the transaction and require the firms to continue to compete until the deal is lawfully closed. Gun-jumping concerns are raised by activities such as: Pre-closing exchanges of competitively sensitive information; Coordinated pre-closing market actions; and Deal terms that transfer operational control or provide highly favorable interim terms to the buyer. 21
Legal Implications Of Gun-Jumping Alleged gun-jumping activities can be pursued by antitrust authorities under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ( HSR Act ) and/or the Sherman Act. Violation of the HSR Act if an acquiring company obtains beneficial ownership (i.e., control) of a target company before the deal has lawfully closed. Pre-closing exchanges of information and/or certain joint activity between the merging parties likely to cause competitive effects may be considered an unlawful restraint of trade under Section 1 of the Sherman Act. The antitrust agencies have aggressively investigated activities that appeared to involve excessive pre-merger coordination. 22
Legal Implications Of Gun-Jumping GUN JUMPING CONSENT DECREES In April 2006, in Qualcomm Inc., the DOJ fined the parties $1.8 million for gun jumping in violation of the HSR Act. The primary issue was purchase agreement operating covenants which restricted the target s ability to enter into ordinary course license agreements or to present business propositions to prospective customers. Within days after the agreement was executed, target deferred to Qualcomm before entering transactions with third parties. 23
Legal Implications Of Gun-Jumping In 2003, in United States v. Gemstar-TV Guide International, Inc., the DOJ fined each of the parties the maximum civil penalty under the HSR Act ($11,000/day), for a combined total of $5.676 million, for activities that constituted price fixing and customer allocation during the pre-closing period. - The parties agreed that TV Guide would focus on marketing to cable service providers while Gemstar would focus on consumer electronics firms. - The parties agreed on prices to be charged to cable service providers. 24
Legal Implications Of Gun-Jumping In 2002, in Computer Associates / Platinum Technology, the DOJ fined the parties $638,000 in civil penalties for gun jumping. The DOJ alleged violations of Sherman Act Section 1 and the HSR Act. Prohibited buyer conduct included: Purchase agreement operating covenants establishing limits on discounts for any of seller s products. Operating covenants also granting buyer the right to approve or reject ordinary customer contracts for any product or service of the seller. 25
Legal Implications Of Gun-Jumping Computer Associates / Platinum Technology (cont d) Installing a senior executive at seller s headquarters to review contracts. Collecting from seller and disseminating competitively sensitive information, including prospective customers, and specific price, discount and contract term details. Making day to day decisions for seller including whether seller could participate in trade shows. 26
General Standards For Conduct During Pre-Closing Period Maintain Separate Organizations and Conduct Business as Usual. No Coordinated Decisions: Decisions concerning the parties respective businesses, unless otherwise appropriate in the context of integration planning (discussed below), should be made independently of each other. Hold Yourselves Out As Competitors: Before closing, the parties should not deal jointly with clients, suppliers, customers or any third persons. Joint meetings with clients to market the transaction may be appropriate. 27
General Standards For Conduct During Pre-Closing Period GUN-JUMPING RISKS IN OPERATING COVENANTS Ordinary course covenants are typical in most agreements. Purpose -- protecting buyer s benefit of the bargain. Such provisions protect the buyer to receive at closing what it thought it was buying when it negotiated the price. The right balance must be struck between protecting the buyer s bargain and preventing the buyer from controlling sellers ordinary business activities pre-closing. 28
General Standards For Conduct During Pre-Closing Period SETTING OPERATION COVENANTS TO AVOID GUN JUMPING Generally, provisions designed to preserve value, such as restrictions on seller s rights to issue new voting securities, assume new debt, or sell assets are acceptable. Provisions that restrict a seller s ability to compete pre-closing such as restrictions on pricing and new customer contracts are not acceptable. Counsel should be involved in setting restrictions on investments in new capital or product technology. Such investments may materially impact deal value. However, restrictions on such investments may limit competition pre-closing and impact ability to compete if the deal is not consummated. 29
General Standards For Conduct During Pre-Closing Period GUIDELINES FOR INFORMATION EXCHANGE IN THE PRE-SIGNING DUE DILIGENCE PERIOD Information exchange is an essential part of evaluating a potential transaction and most due diligence activities raise no antitrust issues. Guidelines: The information exchanged should be necessary and relevant to the process of negotiating the contract. Competitively sensitive information necessary and relevant to the diligence process may be provided with certain safeguards. 30
General Standards For Conduct During Pre-Closing Period GUIDELINES FOR INFORMATION EXCHANGE IN THE PRE-SIGNING DUE DILIGENCE PERIOD (cont d) Safeguards for exchange of competitively sensitive information Limit distribution on a need to know basis. Exclude access to those involved in the daily commercial business. Do not exchange current customer pricing data and current strategic plans without checking with legal. 31
General Standards For Conduct During Pre-Closing Period GUIDELINES FOR INFORMATION EXCHANGE IN THE INTEGRATION PLANNING PROCESS Disclose or exchange only that confidential information reasonably necessary to plan integration. Limit disclosure to those with a need to know. The firms should not base business decisions -- other than integration planning -- on any sensitive information received from the other party during the negotiation and planning process. 32
General Standards For Conduct During Pre-Closing Period Information that generally can be exchanged for integration planning: Information concerning valuation of assets. Information concerning projected aggregated revenues and profitability (but not customer specific information). Information necessary to plan for potential cost reductions or to identify opportunities for rationalization. Other non-competitively sensitive information -- typically includes details of corporate and organizational structures, historical financial statements, historical labor costs and employee information, tax returns; and environmental, health and safety data. 33
General Standards For Conduct During Pre-Closing Period Information that should not be exchanged for integration planning: Do not share competitively sensitive material, including information relating to: Pricing and discounts for specific customers. The current and anticipated future cost of supplying particular services or products. Marketing plans and other strategic plans. Details on research and development projects or other proprietary technology and data. 34
General Standards For Conduct During Pre-Closing Period ADDITIONAL GUIDELINES FOR INTEGRATION PLANNING General Rule: Properly safeguarded integration planning is appropriate; actual preclosing integration is not. Inappropriate Integration Activities: Do not coordinate any bidding, pricing, promotions, or other competitive practices, decisions or strategies. Do not allocate customers. Seller should avoid directing customers or suppliers to buyer and vice versa. Do not jointly approach customers, potential customers, or suppliers. Joint sales calls are inappropriate. Do not share competitively sensitive information. 35
General Standards For Conduct During Pre-Closing Period Appropriate Integration Activities: Coordinate communications designed to inform employees and the public about the nature, objectives and consequences of the proposed transaction. Share human resources information to assist in developing integration plans. Individual hiring decisions should be made unilaterally. 36
General Standards For Conduct During Pre-Closing Period Appropriate Integration Activities (cont d): Exchange Information Technology and Systems Integration Information: buyer and seller may exchange information necessary to permit the integration of IT systems, financial reporting systems, pension and benefits payment systems and regulatory compliance systems and procedures. Integration planning activities related to the front end, such as product portfolio integration, new products, sales and marketing integration, and distribution integration should be delayed until closer to closing. 37