This summer, the Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking (“NPRM”) proposing extensive revisions to the rules that implement the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (“HSR Act”). The NPRM represents what the FTC has described as a “comprehensive redesign of the premerger notification process.” The public comment period ended about a month ago. If ultimately finalized and implemented, the new rules would substantially increase the time and expense of preparing a premerger Notification and Report Form under the HSR Act. This Client Alert will discuss a few of the proposed changes that are particularly relevant to private equity firms and to “middle market” deals (i.e., deals with transaction values under $1.0 billion).
The purpose of the HSR Act is “to amend the federal anti-merger law, Section 7 of the Clayton Antitrust Act (15 U.S.C. §18) by establishing premerger notification and waiting requirements for corporations planning to consummate very large mergers and acquisitions.” The HSR Act is procedural and does not substantively expand the antitrust laws.
When originally enacted in 1976, all transactions with an “acquisition price” in excess of $15 million were reportable. Over time, the acquisition price threshold has been increased and today mergers and acquisitions above $111.4 million are reportable to the federal antitrust agencies (unless certain exceptions apply) for antitrust review prior to closing. The HSR Act charges the FTC and the Antitrust Division of the United States Department of Justice (collectively the “Agencies”) with conducting this review. Premerger notification is intended to trigger a relatively brief period (generally 30 days) for the Agencies to assess whether a transaction presents any competitive concerns. In a typical year, about 97% of reportable transactions sail through the HSR process with little or no further inquiry from the Agencies. In the roughly 2%–3% of reportable deals that present competitive concerns, the Agencies proceed to a much more in-depth investigation via a “Second Request” and, if necessary, take enforcement action.
Presently, parties to a transaction reportable under the HSR Act are required to disclose information regarding the deal, the parties’ individual holdings, their owners and how they derive revenue, as well as documents analyzing the deal as it relates to markets, market shares and competition. The current disclosure obligation for preparing a Notification and Report Form is significant, but manageable from a timing and expense perspective.
If enacted, the proposed changes would dramatically change the magnitude of documents and information parties to a merger or acquisition would be required to provide as part of their Notification and Report Form. Examples of documents and information that would need to be included if the proposed rules go into effect include: drafts of deal documents (currently limited to execution version); drafts of so-called “Item 4(c)” documents (i.e., documents analyzing the deal as it relates to competition-related issues); strategic plans and other documents prepared in the ordinary course of business (not currently required); information about board members, customers, suppliers and employees (not currently required); narrative descriptions of the rationale for the transaction and the relevant product and geographic markets (not currently required); and, in certain cases, information about prior transactions going back 10 years (much broader than currently required).
In practice, these changes would impose significant additional time and costs on all reportable deals, including those in which there are no competitive concerns. The FTC estimates the current form takes an average of about 37 hours to complete and the new form will take an average of 144 hours to complete. The U.S. Chamber of Commerce, based on a survey of HSR practitioners, sharply disagrees, and estimates the new form will take an average of about 327 hours to complete. Under the current rules, an uncomplicated HSR can be put together within a week or two. That obviously will no longer be true if the new rules go into effect.
Comments were submitted by business groups including the Business Roundtable, industry associations including the American Investment Council (on behalf of private equity firms), law firms including Wachtell, Lipton, Rosen & Katz, consumer organizations including Public Knowledge, and labor organizations including the Service Employees International Union (SEIU). A number of comments note that the HSR Act only permits the agencies to collect documents and information “necessary and appropriate” to determine if an acquisition would violate the antitrust laws; these commenters suggest that the proposed rules exceed the authority granted by Congress. Commenters also point to legislative history. For example, when Congress initially passed the HSR Act, Rep. Peter Rodino said that the Act was meant to apply only to “the very largest corporate mergers—about the 150 largest out of the thousands that take place every year ... . If these premerger reporting requirements were imposed on every merger, the resulting added reporting burdens might more than offset the decrease in burdensome divestiture trials.”
IMPACT ON PRIVATE EQUITY AND “MIDDLE MARKET” DEALS
Private Equity: Current Department of Justice (“DOJ”) and Federal Trade Commission (“FTC”) leadership have been advocating increased antitrust enforcement aimed at private equity firms. The recent DOJ and FTC draft Merger Guidelines target serial acquisitions or “roll-ups,” stating that “[i]f an individual transaction is part of a firm’s pattern or strategy of multiple acquisitions, the Agencies [may] consider the cumulative effect of the pattern or strategy.” In September, the FTC alleged that a private equity firm undertook a “multi-year anticompetitive scheme” to dominate Texas anesthesiology practices through, inter alia, such “serial” acquisitions. The Agencies have also been focused recently on so called “interlocking directorates.” Section 8 of the Clayton Act prohibits directors and officers of one corporation from serving simultaneously as directors or officers of a competing corporation, subject to certain exceptions. Private equity firms often have executives sitting on the boards of multiple portfolio companies, raising the risk of Section 8 enforcement if any of the portfolio companies are competitors. Several recent Section 8 cases have involved private equity firms.
The proposed HSR rules directly target private equity transactions in a number of ways. Examples include:
- The proposed rules would require additional information on co-investors and minority investors, including limited partners in the private equity fund.
- The proposed rules would seek information about possible roll-ups: In any transaction where the buyer and the seller have a horizontal overlap, both sides would be required to report information about prior acquisitions over the past 10 years.
- Finally, the proposed rules would seek to identify interlocking directorates by requiring merging companies to identify: (1) all current officers, directors, and board observers for each entity within the acquiring person and the acquired entity, as well as those who have served in the applicable position within the prior two years, and (2) for each of these officers, directors, and board observers, all other entities for which the individual serves, or has served within the last two years, as an officer, director, or board observer.
Middle Market Deals: By definition, companies in the “middle market” fall between startups and large public corporations. They occupy the broad middle of the market. These companies are often described as having annual revenues between $10 million and $500 million (or $1 billion). Middle market deals range from about $25 million to about $1 billion in value, so these deals fall on both sides of the HSR size-of-transaction threshold.
Significantly, an overwhelming majority of private equity dealmaking, whether measured by aggregate deal value or deal count, involves the middle market. According to a recent article in TheWall Street Journal: “In a typical year, midmarket deals account for about 65% of all private-equity transactions [based on aggregate value] ... . This year, deals in the segment are on track to set an annual record, accounting for nearly 76% of transactions through June, according to PitchBook. That pace would surpass the record of almost 72% set in 2019.” This percentage gets even larger when measured by deal count. Specifically, as reported by PitchBook in its “2022 Annual US PE Breakdown,” of approximately 8,900 U.S. private equity transactions consummated in 2022, well in excess of 90% of such deals were sub $1 billion transactions, with, the median deal size for platform transactions in 2022 at $301 million and the median deal size for all 2022 transactions (inclusive of add-ons and growth investments) at $50 million.
The current rules provide flexibility as to when the parties are able to file HSRs. So long as both parties can attest to a good faith intention to complete the transaction, HSR notification can be filed on a nonbinding Letter of Intent (“LOI”). Parties do not need to wait until there is an executed definitive agreement to file. While the FTC permits a draft of a definitive agreement (if one exists) to be included when an HSR is filed on an LOI, doing so is not required.
The proposed new rules would change this state of affairs dramatically. First, it is not clear that parties will still be able to file on an LOI if and when the new rules go into effect. Rather, the rules contemplate “amending § 803.5(b) to eliminate the ability to submit an HSR Filing on any Preliminary Agreement [i.e. indication of interest, non-binding letter of intent, or agreement in principle] without providing a term sheet or draft agreement that reflects sufficient detail about the proposed transaction to allow the Agencies to understand the scope of the transaction and to confirm that the transaction is more than hypothetical.”
Second, the proposed rules would require all drafts of transaction documents as well as drafts of Item 4(c) material to be supplied with the initial HSR filing. Placing this requirement for production at the filing stage ultimately means that companies will be compelled to: (1) formulate procedures for collecting, organizing and storing such draft documents, and (2) conduct a review of such documents to determine if they qualify as “drafts” and if any are privileged.
Third, the proposed new rules contemplate amending the language of the certification to “require affirmation that the filing person has taken the necessary steps to prevent the destruction of documents and information related to the transaction.” In other words, something like a litigation hold would be required of all HSR filers. Finally, the proposed rules require companies to “identify and list all communications systems or messaging applications on any device” that “could be used to store or transmit information or documents related to its business operations.” Thus, in addition to preserving drafts, companies would need to provide details of their email and messaging applications.
It seems clear that these burdensome rule changes would be felt most acutely in middle market deals. Larger, public companies would be able to adjust to these changes as another cost of doing business. To companies in the middle market, however, the effective transaction “tax” rate would be much more significant. If these rules are enacted, it is fair for a buyer to expect to pay between $150,000–$250,000 in legal fees for a routine HSR filing and significantly more for a larger, involved transaction.
TIMING AND NEXT STEPS
It is unclear when the FTC will finalize the rules. Predictions range from the end of 2023 to sometime in 2024. In addition, we cannot rule out the possibility that the final rules will be challenged in court. As noted, the HSR Act uses the term “necessary and appropriate” when talking about the FTC’s authority to make rules for the HSR form and the documents and information to be collected. Several commenters question whether the proposed rules satisfy this “necessary and appropriate” limitation. We will continue to track developments as they occur.
This document is intended to provide you with general information regarding proposed changes to the Hart-Scott-Rodino Antitrust Improvements Act of 1976. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions. The information in this article is accurate as of the publication date. Because the law in this area is changing rapidly, and insights are not automatically updated, continued accuracy cannot be guaranteed.