Private equity’s (anti) trust issues

Top antitrust officials in the Biden administration have opened a yearslong project to remake American society, and they see private equity as a problem to be solved.

Under Lina Khan, chair of the Federal Trade Commission (FTC), and Jonathan Kanter, who heads the Department of Justice (DOJ) antitrust division, Biden administration enforcers have already adopted or proposed new guidelines making it easier for Washington to attack interlocking board memberships, industry roll-ups and non-compete agreements, and block pending mergers.

They’ve also filed suit against private equity managers or imposed strict conditions on the mergers they have approved. They’ve made it clear that they’re only getting started.

“Antitrust enforcers must be attentive to how private equity firms’ business models may in some instances distort incentives in ways that strip productive capacity, degrade the quality of goods and services, and hinder competition,” Khan and her fellow Democratic commissioners said in a joint statement in early 2022. “While private equity firms can support capacity expansion and upgrades, firms that seek to strip and flip assets over a relatively short period of time are focused on increasing margins over the short term, which can incentivize unfair or deceptive practices and the hollowing out of productive capacity.”

Industry is fighting back where it can, but Khan and her co-commissioners say they’re playing a long game. The guidance they’ve adopted and the suits they’ve filed have all been careful to hew to the kind of conservative, consumer price-oriented approach that has dominated American jurisprudence since the 1970s. Their ultimate goal, though, is to overturn that approach – sometimes known as “the consumer welfare standard” – because, according to their brief, it’s too narrow an answer for a society struggling with wealth inequality.

“It’s a much more egalitarian view of antitrust law, where citizens weren’t beholden to distant corporations,” says William Kovacic, who served as FTC chair under former president George W Bush and now teaches at George Washington University’s law school. “The interests at stake weren’t just citizens who were consumers, but citizens who were workers, citizens as residents of a community. In many respects, Khan and Kanter want to restore that egalitarian vision. I think they would say, ‘We’re not radicals, we’re conservatives. We’re trying to bring antitrust back to its roots.’ And it entails a significant expansion of enforcement in a variety of ways.”

Through an FTC spokeswoman, Khan declined Private Funds CFO’s request for an interview or to answer detailed questions we sent via e-mail. DOJ officials also have not responded to Private Funds CFO’s requests for an interview, nor have they answered detailed questions sent by e-mail.

It’s clear, though, that Khan and Kanter see themselves as the spear’s tip in a growing movement to restore antitrust law to its earliest principles. Some supporters have taken to calling themselves “neo-Brandeisians,” in honor of former Supreme Court justice Louis Brandeis, who, before he joined the high court, was the author of some of the nation’s founding antitrust laws in the early 20th century. “We must make our choice,” Brandeis famously said. “We may have democracy, or we may have wealth concentrated in the hands of a few, but we cannot have both.”

Whatever you think of the neo-Brandeisians or their arguments (some critics have dismissed them as “hipster antitrust law”), private equity managers should take them seriously, says James Keyte, director of the Fordham Competition Law Institute and a director at the Brattle Group, an economic consulting firm.

“The ideology,” Keyte says, “is that they don’t like consolidated industries and believe that antitrust should promote markets that are more structurally competitive as a prophylactic measure. Their mantra is bright-line structuralism: ‘We want markets with more suppliers.’ And you can see where private equity just walks right into this, where managers see an efficiency in rolling up companies into larger groups that, in their view, probably serve consumers better. But with these new antitrust guidelines, any significant industry consolidation is now a major concern at the FTC and DOJ.”

Lina Khan’s ‘improbable’ rise

How one essay made a law student one of the world’s foremost trustbusters

Lina Khan was still a law student when she became one of the world’s most famous trustbusters. Her essay, “Amazon’s Antitrust Paradox,” published in the Yale Law Journal in early 2017, was, by academic standards, a blockbuster. It has since become one of the seminal texts of the growing neo-Brandeisian movement.

Among other things, the essay brought Khan to the attention of Sen. Elizabeth Warren, D-Mass., a former free-market Republican who had come to Washington promising to solve some of capitalism’s “structural” problems. That would have fateful consequences in the 2020 presidential election.

Khan’s essay didn’t just take aim at Amazon, or even Big Tech. It called for overturning the “consumer welfare standard” that had come to dominate American antitrust jurisprudence since the 1970s. It had special scorn for the consumer welfare standard as practiced by “the Chicago School,” represented by thinkers such as former U.S. solicitor general Robert Bork and two generations of scholars, lawyers and judges trained at or influenced by the University of Chicago after the Second World War.

In Khan’s view, the Chicago School had led capitalism down a blind alley by convincing judges, law- and policymakers that the main worry of antitrust law ought to be a given merger’s impact on consumer prices.

“The current framework in antitrust fails to register certain forms of anticompetitive harm and therefore is unequipped to promote real competition – a shortcoming that is illuminated and amplified in the context of online platforms and data-driven markets,” she wrote. “This failure stems both from assumptions embedded in the Chicago School framework and from the way this framework assesses competition.”

Radical (and conservative)

Part of the power of Khan’s essay was its radicalism. It aimed at what had become conventional wisdom for both political parties in Washington, appealing especially to young professionals who had soured on unregulated markets after the Great Recession.

Part of its power was also its conservativism. Khan called for courts (and antitrust agencies) to return to an older, prewar version of antitrust law, where consumer prices are just one aspect of merger analysis, along with prevailing wages, worker benefits, community engagement and other, (admittedly) harder-to-measure questions about full citizenship.

Khan might have remained on the sidelines as a think tank or law school academic except for a deal Warren struck with then-presidential candidate Joe Biden in 2020, says former FTC chair William Kovacic. In exchange for ending her own campaign and agreeing to endorse Biden, Warren got a promise that she could serve as gatekeeper to a Biden administration’s financial regulators. Biden kept his word, Kovacic says, and in March 2021, he nominated a then-32-year-old Khan to run an agency with jurisdiction over wide swaths of the American economy.

The neo-Brandeisian movement had been growing for years, but with Khan’s appointment, Kovacic says, “lightning struck.”

“Now, suddenly, they’ve got power,” Kovacis says. “Much faster than they ever expected. I think they would’ve said, that was improbable.”

Pain in healthcare

Just ask Welsh, Carson, Anderson & Stowe: in September, the FTC sued the private equity manager and its portfolio company, US Anesthesia Partners (USAP), accusing them of building an illegal monopoly in Texas as part of a yearslong scheme to “exploit the fact that anesthesia services are critical to modern surgery; hospitals need to offer anesthesia services, and patients, their employers and insurers must pay for them, even if choices dwindle and prices go up.”

The suit involves not just one acquisition, but nearly a decades’ worth of acquisitions as part of Welsh, Carson’s roll-up strategy.

Welsh, Carson is fighting back. It has promised to defend itself in court. “We are proud of our investment in USAP, which has allowed independent anesthesiologists to deliver superior clinical outcomes to underserved populations,” the firm said in September.

Similar lawsuits may be on the way. In a Valentine’s Day speech to the American Medical Association (AMA), Khan said she was proud of the Welsh, Carson suit, and her agency’s broader efforts to wrestle with “how the business of healthcare today forces many of you to subordinate your own medical judgment to corporate decision-makers at the expense of patient health.” Khan said she saw healthcare as “the key” battleground to test her antitrust ideology, and she mentioned “private equity” 12 different times.

“We are also studying closely the empirical work examining the effects of private equity expansion into healthcare,” she continued, “and have been alarmed by studies showing that some private equity buyouts have resulted in not just higher prices but also dramatic fall-off in quality – in some cases resulting in higher mortality rates.”

On March 5, Kanter, Khan and her fellow FTC Democrats held a virtual “workshop” on private equity in healthcare. Khan announced her agency and the Department of Health and Human Services were opening “a public inquiry to examine the role of private equity in healthcare, as well as corporate profiteering in healthcare.”

Deterrent effect on M&A?

Other funds may not have the time or the money to resist an FTC lawsuit. Antitrust litigation is very expensive. Unlike, say, fighting against an SEC rule, individual firms can’t count on their trade associations or other advocates to chip in to fight an antitrust suit. Fund managers are on their own.

One veteran antitrust lawyer told Private Funds CFO that the legal costs of a so-called second request – where antitrust enforcers ask firms for more details about a proposed merger while they decide whether to sue to block it – averages around $2 million and takes between six and nine months to resolve. Smaller buyout firms must now reckon with the possibility that their next acquisition could well turn into a bet-the-company lawsuit.

“They are raising the costs,” Hogan Lovells partner Logan Breed says of Washington’s antitrust enforcers. “They are raising the risks. On all these deals, people now need to calculate the potential cost of an extended FTC or DOJ investigation into their modeling. It may well have a deterrent effect on mergers and acquisitions. And that’s intentional.”

Indeed, in her Valentine’s Day speech to the AMA, Khan bragged that her agency has blocked seven healthcare company mergers in the past two years alone. “Our actions are putting industry participants on notice,” she said. “We hear that corporate dealmakers are increasingly assessing the legality of the transaction at the beginning of the process rather than at the end, and that some mergers are no longer making it out of the boardroom if the antitrust risk is viewed as high. As a law enforcer, deterring illegal deals is a mark of success.”

How merger review works

Antitrust enforcers can stop and start the clock

Under the Hart-Scott-Rodino Act, companies on both sides of an acquisition are required to file proposed mergers above a given dollar threshold with the Federal Trade Commission (FTC) and the Department of Justice (DOJ) antitrust division. Either of those agencies then takes over the case and has 30 days to review the proposal. If an agency doesn’t respond within that time period, the merger can be consummated.

Sometimes an agency will have questions they want answered before taking any formal action. Antitrust lawyers call such moments “pull-and-refile,” and the 30-day review clock is reset.

If the FTC or DOJ aren’t satisfied with the answers they’ve gotten after a pull-and-refile, the agency files a formal, second request for information. That stops the review clock, too. A merger can’t be completed until the lead agency is satisfied with the answers it has received to a second request.

A second request can be the death knell for a merger because it means firms have to spend a lot of time and money – it can take months and many millions of dollars – to answer the government’s questions, says Amanda Wait, a former FTC lawyer who is now a partner with DLA Piper.

“I did it once in six weeks, and those were the worst six weeks of my life,” she says. “I don’t recommend it. It depends on how much money your client wants to spend, how much time they want to dedicate to this and how motivated the other party is.”

Assuming your firm slogs it out on a second request, and answers the government’s questions fully, the lead agency then has another 30 days either to let the merger go through, or seek an injunction in federal court to block it. Sometimes, firms can avoid a lawsuit by agreeing to merger conditions – divesting from some companies in a similar market, for instance.

M&A dealflow has already slumped amid inflation and rising interest rates. Private equity’s global deal value fell by 40 percent in the first three quarters of 2023, an analysis by affiliate title PE Hub finds. Overall global mergers and acquisitions fell by 26 percent when compared with the first three quarters of 2022, according to PE Hub. Private equity-backed M&A value fell to $116.8 billion, the lowest quarterly total since the depths of the pandemic. Overall, private equity deals amounted to $404.1 billion, a three-year low, PE Hub reports.

Khan and Kanter are taking risks of their own with attacks on the industry, Breed says. The consumer welfare standard against which they tilt has been settled law for almost three generations now. The modern judiciary is as skeptical of government regulation as it has been in decades. “If the courts shoot down some of these cases,” Breed says, “future enforcers will be hamstrung by those facts, because there will be case law and precedent.”

One problem is that the courts can take a long time to decide such cases. Another problem is that Khan’s and Kanter’s teams have been careful in picking their targets, and careful to phrase their suits and guidance documents in the language of the consumer welfare standard – focusing, for instance, on how a supposed violation raises prices for ordinary customers.

“They’re not adopting new policies, but they’re using old policies in new ways,” says Amanda Wait, a former FTC lawyer who is now a partner with DLA Piper. “They’re using all available tools in their toolbox, and they’re looking for violations under the laws they enforce.”

No political safe haven

In the old days of, say, a decade ago, an industry finding itself hard-pressed by a Democratic administration might turn to the Republicans for relief. That’s not as safe a bet as it used to be, Kovacic says. It was the Donald Trump-era FTC that opened an investigation into Amazon, and Trump and his congressional allies have been banging on about the power of “Big Tech” for years. Supply chain problems brought first by the covid pandemic and then by Russia’s invasion of Ukraine have only intensified the anger of farmers, a traditional Republican bloc. It’s not hard to see that the populist right’s anger aimed at “Wall Street” could land hard on private equity and venture capital managers.

“There are clearly Republicans in the House and Senate who are very enthusiastic about antitrust enforcement, particularly with regard to Big Tech,” Kovacic says.

Separately, big private equity firms’ embrace of ESG has alienated many hard-right Republicans. A handful of red states have passed laws or rules aimed at punishing “woke” capitalism, and the Supreme Court’s decision against the constitutionality of two universities’ recruitment diversity programs last year have thrown the legality of some DE&I initiatives into question.

Meanwhile, the Biden administration has been chipping away at the courts, Kovacic says. The president has appointed some 150 new federal judges in the last three years. With all of those new antitrust lawyers coming into industry, it’s at least thinkable that some of them will break through somewhere in the years to come, he says.

“To carry out a project like this takes time, and one of the elements of time is finding or convincing judges to see things your way,” Kovacic says. “You have to win a few presidential elections to make it work. You will have to withstand some defeats, but you need time.”

Age of uncertainty

There are steps firms can take to protect themselves from trustbusters. It begins with understanding the emerging realities of Washington’s antitrust crusade, and how they affect your firm’s business model, experts say.

Whatever the actual threat of Washington’s new antitrust ideologies, though, the neo-Brandeisians have already revived an age-old threat for fund managers: uncertainty.

“The well-established norms in a lot of these areas are just not well established anymore,” says Daniel Kaufman, a former acting director of the FTC’s consumer protection bureau who is now a partner at BakerHostetler. “There’s a lot more uncertainty due to the agencies – the FTC in particular – interpreting old rules more broadly. They’ve certainly put out new notices, but they’ve also expanded the scope of the old guidance. There’s a lot more potential peril based on how the FTC is interpreting certain laws and rules.”

Antitrust: 7 practice tips

Washington’s new merger skepticism can be overcome, but managers must understand (and communicate) their risks clearly, experts say.

Washington’s new merger skepticism doesn’t have to mean you must abandon buyouts. Private Funds CFO speaks with several antitrust experts about ways you can improve your chances of getting a merger through the arduous approval process. Here are some of their ideas:

Know your risk tolerance

If you know that Washington is going to take a longer, harder look at a given merger, ask yourself how important the acquisition is to your firm, says Jonno Forman, a litigation partner with BakerHostetler. Know your firm’s merger history, chapter and verse: even seemingly small deals can be challenged if antitrust enforcers think these are part of an anticompetitive roll-up.
“Any private equity manager needs to understand just how close their business strategy, expansion and offerings are going to be scrutinized,” he says. “It’s not necessarily one acquisition in isolation, but a pattern or history of acquisitions that may be scrutinized.”

Lawyer up early

“Make sure you have good, sophisticated lawyers and economists early in the process,” says James Keyte, a director at both the Fordham Competition Law Institute and the Brattle Group. “You don’t have to overspend, but make sure you have the right team to analyze in detail the risks and rewards of each transaction.”

Ultimately “what you’re really assessing is the likelihood that the agencies can get a judge to enjoin the precipitating deal, and that’s an assessment of both case law and the kind of facts that can be litigated to success in merger cases,” he continues.

As eager as Federal Trade Commission (FTC) chairwoman Lina Khan or Department of Justice antitrust leader Jonathan Kanter may be to remake antitrust law, “no government lawyer wants to go to court with a dead-bang loser,” Keyte says. “What we see, then, is that the government is still litigating cases that have fairly traditional theories of liability, implicitly conceding that the further these agencies get away from traditional theories of harm, the harder it is to get an injunction from a court.”

Silo your deals

“If the goal is to minimize the opportunity for the FTC to frame what you’re doing as an anticompetitive roll-up, I think it’s helpful to evaluate the return on investments of each of these investments individually,” says Hogan Lovells partner Logan Breed.

Keep deal teams separate from one another, Breed says, and resist the temptation to draw overarching themes from one deal to the next. “The theory of harm is that if you roll all these companies up, then you can raise prices,” he says. “If the economic valuation of each of these acquisitions is predicated on some uplift from having all of them completed, the FTC can spin that into an anticompetitive story.”

Do not put it in writing

Try to read your own internal or investor communications as if you were an antitrust enforcement lawyer, says Amanda Wait, a former FTC lawyer who is now a partner with DLA Piper.

“A lot of the time people write things down, thinking they’re saying one thing, but when you read it with an antitrust lens, it scans differently,” she says. “You can prevent your board or staff from writing down dumb stuff. You can train them to phrase things differently.”

In internal and external communications, for instance, remind staff or board members to analyze a proposed merger for how it will help consumers by, say, lowering costs or expanding access to a needed good or service, Wait says. “There’s only so much you can do because the structure of an industry is what it is, but you can prevent it from getting worse.”

Think about board appointments

Antitrust enforcers have taken aim at interlocking board memberships, saying they’re worried that the web of insiders can lead to unfair market concentration.

It follows, then, that firms “should be careful about who you’re putting on boards,” says Hogan Lovell’s Breed. “That’s one thing you can do easily.”

Diversify

Washington is hostile to industry roll-ups, particularly in healthcare. When analyzing a given merger, it might be useful to think about whether you should diversify your investments, either by industry or by geography, Breed says.

“If firms have stakes in multiple operating companies in a given market, and they have some cash, maybe they choose to put that cash somewhere else. If you’re a PE firm making investments in the healthcare markets, maybe you choose to branch out into other geographies.”

Be patient (and willing to fight)

“It’s still possible to do deals, even big deals,” says William Kovacic, a former FTC chair who now teaches antitrust law at George Washington University. “You have to be willing to fight cases. You have to be willing to carry the costs and go through the time it takes.”

Make sure your team and your investors understand the new uncertainties, and costs, of a given merger, Kovacic says.

“Dealmaking is harder. Everything antitrust enforcers are doing with soft-power tools is, I’m sure, discouraging some transactions and making others more difficult to accomplish. They don’t trust the intentions of private equity, they’re doubtful about incentives, they’ve almost singled out private equity as a less-trustworthy acquirer. It doesn’t rule them out, but the cost of doing deals, the uncertainty of deals, has increased.”