Trustbusters ready themselves for private fund enforcement

A divided Federal Trade Commission voted 3-2 for three omnibus resolutions that allow a single Trade Commissioner to sign off on an antitrust investigation. Traditionally, a majority of Commissioners have to authorize what the agency calls “compulsory process.” Now, staff will have a freer hand to investigate allegations of collusion, anti-competitive mergers and acquisitions and the marketing practices of the car rental industry.

The mergers resolution goes further. Under the Hart-Scott-Rodino Act of 1976, companies must report any mergers at or above $101 million to the FTC and the Department of Justice. Authorities at either agency can sue to block deals “in any line of commerce” if the agency thinks a proposed merger would “lessen competition or to tend to create a monopoly.” The Trade Commission’s newest resolution allows staff to open cases involving cheaper deals.

Toppling vertical integration

The resolutions are the latest march in what some critics say is the Biden administration’s religious crusade against vertical integration. Private fund advisers find themselves dwelling outside the new faith.

“They are taking lots of steps to increase the transaction costs and penalties for consolidation because they believe it’s generally a bad thing,” says Logan Breed, who helps lead Hogan Lovells’ antitrust practice from Washington.

Since the Reagan era, Breed and others tell RCW, Washington regulators of both parties have focused mostly (though not solely) on horizontal mergers – Coke buying Pepsi, say. More than that, when regulators were worried that a merger could be anticompetitive, they usually tried to impose conditions – divestitures, for instance – that would fix the problem instead of suing to block the entire merger.

‘In the crosshairs’

That tone changed in 2017, when the Trump administration sued to block AT&T’s $85.4 billion takeover of Time-Warner, Breed says. Regulators lost that battle in court. But they didn’t like it. Under new management – Federal Trade Commission Chairwoman Lina Khan and Jonathan Kanter at Justice’s Antitrust Division – the old orthodoxy has been tossed out the window, he says.

“They’re willing to push the boundaries. And they’re jettisoning their previous guidelines. They’re literally deleting them in some cases,” Breed says. “Private equity transactions are getting additional scrutiny, even the ones that don’t present the classic horizontal Coke-and-Pepsi problems that mergers have traditionally stumbled over. You see the agencies going after deals vigorously that wouldn’t traditionally have been challenged.”

Indeed, the antitrust team over at Debevoise & Plimpton says FTC second requests and even warning letters are getting “more common, broader, tougher.” The private funds industry, the lawyers concluded after a webinar last year, “is in the crosshairs.”

‘Distort, strip, degrade’

In early August, German private equity adviser JAB ($50 billion in AUM), settled its second antitrust suit in as many years. Under that settlement, JAB agreed to sell off clinics in California and Texas before closing its $1.1 billion takeover of SAGE Veterinary. The headline on the Trade Commission’s August 5 press release announcing the settlement said, “FTC Approves Final Order Protecting Pet Owners from Private Equity Firm’s Anticompetitive Acquisition of Veterinary Services Clinics.”

“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 Democrats said in a joint statement accompanying the settlement release.

“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.”

And in late June, the Justice Department sued to block the sale of one of Enlightenment Capital’s ($790 billion in AUM) portfolio companies to Booz Allen Hamilton. Kanter claims that the subsidiary, EverWatch Corp, is the only other company besides Booz Allen that can sell modeling and simulation services for the National Security Agency’s signals intelligence program. The proposed $440 million merger, Kanter said in a news release announcing the lawsuit, “imperils competition in a market that is vital to our national security.”

National security

“National security” has become something of a shibboleth for antitrust regulators, too. The Biden administration is the first in American history to declare “corruption” a threat to national security. That happened before Russia invaded Ukraine. Since then, things have intensified.

“From the United States to the EU to China,” Debevoise’s team observed ahead of Russia’s invasion, “more and more countries are introducing foreign investment regimes, or revising existing ones by widening the scope of application to include sectors not previously considered ‘sensitive.’”

The lawyers saw “significant compliance complications” coming for private fund advisers, “given the amount and detail of information that can be requested.” Increasingly, the team added, that “includes information on the limited partners of PE-backed deals, including passive, minority- and fund-of-fund investors.”

Health (and wellness)

Regulators have all but promised more antitrust axes will fall on the private funds industry. They have even told the industry on which field they’re most likely to fight: healthcare. In early June, Kanter’s top aide, Andrew Forman, delivered a speech to an American Bar Association conference. He said the Antitrust Division was “thinking a lot about enhancing antitrust enforcement around a variety of issues surrounding private equity,” but especially in healthcare, where private deals totaled $1.2 trillion last year alone.

“I want to be clear,” Forman said. “Private equity can play an important role in our economy. But certain private equity transactions and conduct suggest an undue focus on short-term profits and aggressive cost-cutting.”

Would-be trustbusters were thinking about new or revised rules for private equity deals, Forman added. Among other tempting targets, regulators were:

• Concerned about private equity “roll-ups,” (“namely, whether in particular circumstances of often smaller transactions can cumulatively or otherwise lead to a substantial lessening of competition”)
• Thinking about bringing cases to prevent deals where private funds “either blunt the incentive of the target company to act as a maverick or a disrupt or otherwise cause the target company to focus solely on short-term financial gains and not on advancing innovation or quality”
• “Very focused” on enforcing Sec. 8 of the Clayton Antitrust Act (1914), which prevents people from serving as executives or board members of rival companies
• “Aware of what appears to be some” Hart-Scott-Rodino “filing deficiencies,” Forman said. “This has us asking ourselves whether private equity companies may not be taking seriously enough their obligations under the HSR Act. We are evaluating our next steps on that front.”

Practice tips

So what are private fund compliance officers to do to prepare for this new regulatory mindset? Hogan’s Breed has a few suggestions:

1. Don’t get it in writing. “You should be very careful about what you’re writing down on your emails, your texts, everything,” Breed says, “because the chance that someone in Washington is going to read them have just increased, and you don’t want anything to be misinterpreted.”
2. Look closely at risk-shifting provisions in proposed deals. “If you’re the target, because the odds of an investigation are higher than ever before, you may want some protection like a reverse break fee in case the deal falls apart,” he says.
3. Don’t overpromise. Some merger agreements have language committing one or both companies to do whatever it takes to get a merger through – divestments, restructurings, and the like. That kind of thing is a lot riskier now, Breed says. “I’m advising acquirers to avoid any ‘hell or high water’ commitments, because it’s just impossible to know how far that could go right now,” he says.
4. Look at the map. It’s not just the US that’s cracking down on private fund mergers, Breed says. Regulators in the EU, UK and even Australia have got aggressive, especially on tech mergers. “The geographies in which your target operates is another thing to pay attention to,” he says.
5. Give yourself time. If regulators bring a case against one of your firm’s mergers, you’ll “need to have the time to litigate it or the deal falls apart,” Breed says. He urges fund advisers to use longer longstop dates in proposed deals.