FTC and DOJ Release First Business Merger Guidelines Mandating Detailed Anti-Competitive Review

On December 18, the Federal Trade Commission and Department of Justice made good on the release of the most sweeping set of regulations revisions yet regarding what the government must review and agree upon regarding the competitive impact of business mergers in the United States.

It also defines, far more definitively than ever before, what constitutes a legal block to those mergers, with legal provisions recrafted for the age of digital competition.

Along with these changes, the revised merger review requirements also anticipate potential legal challenges to their rules. Since multiple federal agencies have been taken to court in recent years over allegations of overreach relative to the laws granting them authority to regulate their areas, the FTC and DOJ considered just these sorts of lawsuits as they drafted the new rules.

The following is a summary of what the new regulations now require for any businesses looking to merge or go through an acquisition.

An Explanation of Where the FTC and DOJ Derive Their Authority to Regulate Mergers and Acquisitions

As the agencies point out in the overview of their new rules, the Federal Trade Commission, and the Department of Justice, working together, have always had an ongoing obligation to ensure businesses do not violate antitrust laws.

Those laws in turn derive their power in part from the Equal Protection Clause of the Fourteenth Amendment to the U.S. Constitution, which provides for “the equal protection of the laws”. While that amendment was passed in 1866 as a means of enshrining protections for all individual Americans in the post-Civil-War era, over time the law was used as an early means of ensuring businesses could not conspire in any way to deny anyone, including other businesses, from equal protection under the law.

Over time Congress, effectively prodded by the courts, realized the amendment was not enough to protect the American people from the overarching powers of business, especially big businesses working together to restrain trade in one form or another.

That led first to the passage of the Sherman Antitrust Act on July 2, 1890. That law was the earliest to allow the government to put curbs on blocking actions by businesses which could reduce economic competition. It is the act which for the first time made illegal all agreements between businesses designed to fix prices, divide up markets between companies, restrain industrial output, and block competition. It is also the law which instituted the first anti-monopoly provisions in the country.

After slightly over two decades since that Act was passed, Congress passed the Clayton Antitrust Act, on October 14, 1914, as a means of tightening some of the loopholes from the earlier Act and providing the Federal government with increased powers regarding business regulations. It includes explicit prohibitions on predatory and discriminatory pricing designed to reduce competition or hurt one group at the expense of another, mergers which would restrain competition, and other “unethical” behaviors by business. The Clayton Antitrust Act is also the first federal legislation which allowed for individuals and small businesses to sue other businesses for their anticompetitive actions, as well as the first which protects the rights of labor to organize and protest peacefully against what they see as wrongful labor practices by their employers.

According to the new rules regarding merger and acquisitions reviews, the FTC and the DOJ, referred to through the rest of the text as “the Agencies”, are charged with the enforcement of “federal antitrust laws, specifically Sections 1 and 2 of the Sherman Act, 15 U.S.C. §§ 1, 2; Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45; and Sections 3, 7, and 8 of the Clayton Act, 15 U.S.C. §§ 14, 18, 19.”

“’Federal antitrust law is a central safeguard for the Nation’s free market structures’ that ensures ‘the preservation of economic freedom and our free-enterprise system’”, the text of the new rules explains.  That law, it goes on, “rests on the premise that ‘[t]he unrestrained interaction of competitive forces will yield the best allocation of our economic resources, the lowest prices, the highest quality and the greatest material progress, while at the same time providing an environment conducive to the preservation of our democratic political and social institutions’.”

The new rules rest heavily on the Clayton Act, and specifically Section 7 of that Act, which the Agencies say was “designed to arrest anticompetitive tendencies in their incipiency”, which implies reviews of mergers as an approval step. It goes on to cite further details of that Act and its interpretations of the Act as they related to business review in the following paragraph.

 “Section 7 of the Clayton Act … prohibits mergers and acquisitions where ‘in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.’ Competition is a process of rivalry that incentivizes businesses to offer lower prices, improve wages and working conditions, enhance quality and resiliency, innovate, and expand choice, among many other benefits. Mergers that substantially lessen competition or tend to create a monopoly increase, extend, or entrench market power and deprive the public of these benefits. Mergers can lessen competition when they diminish competitive constraints, reduce the number or attractiveness of alternatives available to trading partners, or reduce the intensity with which market participants compete.”

A Summary of What the DOJ and FTC Will Now Be Passing Judgment on In All M&A Reviews

With that as background, the DOJ and FTC included in their new regulations release a list of eleven formal guidelines they will now be following as a means of evaluating whether a business merger or acquisition will be allowed to proceed. They are summarized below, excerpted as is from the new rules document.

“Guideline 1: Mergers Raise a Presumption of Illegality When They Significantly Increase Concentration in a Highly Concentrated Market. Market concentration is often a useful indicator of a merger’s likely effects on competition. The Agencies therefore presume, unless sufficiently disproved or rebutted, that a merger between competitors that significantly increases concentration and creates or further consolidates a highly concentrated market may substantially lessen competition.

“Guideline 2: Mergers Can Violate the Law When They Eliminate Substantial Competition Between Firms. The Agencies examine whether competition between the merging parties is substantial since their merger will necessarily eliminate any competition between them.

“Guideline 3: Mergers Can Violate the Law When They Increase the Risk of Coordination. The Agencies examine whether a merger increases the risk of anticompetitive coordination. A market that is highly concentrated or has seen prior anticompetitive coordination is inherently vulnerable and the Agencies will infer, subject to rebuttal evidence, that the merger may substantially lessen competition. In a market that is not highly concentrated, the Agencies investigate whether facts suggest a greater risk of coordination than market structure alone would suggest.

“Guideline 4: Mergers Can Violate the Law When They Eliminate a Potential Entrant in a Concentrated Market. The Agencies examine whether, in a concentrated market, a merger would (a) eliminate a potential entrant or (b) eliminate current competitive pressure from a perceived potential entrant.

“Guideline 5: Mergers Can Violate the Law When They Create a Firm That May Limit Access to Products or Services That Its Rivals Use to Compete. When a merger creates a firm that can limit access to products or services that its rivals use to compete, the Agencies examine the extent to which the merger creates a risk that the merged firm will limit rivals’ access, gain or increase access to competitively sensitive information, or deter rivals from investing in the market.

“Guideline 6: Mergers Can Violate the Law When They Entrench or Extend a Dominant Position. The Agencies examine whether one of the merging firms already has a dominant position that the merger may reinforce, thereby tending to create a monopoly. They also examine whether the merger may extend that dominant position to substantially lessen competition or tend to create a monopoly in another market.

“Guideline 7: When an Industry Undergoes a Trend Toward Consolidation, the Agencies Consider Whether It Increases the Risk a Merger May Substantially Lessen Competition or Tend to Create a Monopoly. A trend toward consolidation can be an important factor in understanding the risks to competition presented by a merger. The Agencies consider this evidence carefully when applying the frameworks in Guidelines 1-6.

“Guideline 8: When a Merger is Part of a Series of Multiple Acquisitions, the Agencies May Examine the Whole Series. If an individual transaction is part of a firm’s pattern or strategy of multiple acquisitions, the Agencies consider the cumulative effect of the pattern or strategy when applying the frameworks in Guidelines 1-6.

“Guideline 9: When a Merger Involves a Multi-Sided Platform, the Agencies Examine Competition Between Platforms, on a Platform, or to Displace a Platform. Multi-sided platforms have characteristics that can exacerbate or accelerate competition problems. The Agencies consider the distinctive characteristics of multi-sided platforms when applying the frameworks in Guidelines 1-6.

“Guideline 10: When a Merger Involves Competing Buyers, the Agencies Examine Whether It May Substantially Lessen Competition for Workers, Creators, Suppliers, or Other Providers. The Agencies apply the frameworks in Guidelines 1-6 to assess whether a merger between buyers, including employers, may substantially lessen competition or tend to create a monopoly.

“Guideline 11: When an Acquisition Involves Partial Ownership or Minority Interests, the Agencies Examine Its Impact on Competition. The Agencies apply the frameworks in Guidelines 1-6 to assess if an acquisition of partial control or common ownership may substantially lessen competition.”

The remaining sections of the 50-page list of mandatory review requirements the Agencies have listed provide further details of how to analyze and measure what does, might, and does not constitute anticompetitive merger activity under each of these guidelines.

As an example of how the FTC and DOJ do this, take the case of the first guideline citing the risks which might occur when a merger “significantly increase[s] concentration” in a market. They first cite Supreme Court backing for this type of guideline posing a risk under the Clayton Act, then go into an explanation of how the Agencies typically use what is known as the Herfindahl-Hirschman Index.

The HHI, as it is called by acronym, is, it says, based on “the sum of the squares of the market shares” in each market area; its value reaches a peak of 10,000 when there is only one firm operating in the market. It then defines the requirements for considering a block on a merger when either of the following test cases occur:

1.       The post-merger HHI of the combination is greater than 1,800 and the change in HHI is greater than 100, or:

2.       The merged firm’s net market share becomes greater than 30% and the change in HHI is greater than 100.

While that might seem overly analytical, it is based on a substantial historical analysis of how such market shares can impact competitive behavior. It also provides a means both for the Agencies to evaluate a merger quickly with respect to Guideline 1 as well as a template companies proposing to execute a merger or an acquisition can use when they prepare their own documents arguing how they do not violate the new guidelines going forward.

How to interpret each guideline is described in detail in “Applying the Merger Guidelines”, in section 2 of the new rules.

Commentary

In all of this, one should be cautious in hoping for too much positive change in restricting potentially business-throttling mergers, even with the now mandatory rules about testing for anticompetitive impacts of M&A situations. This is because the government, for all the laws which it claims to operate within, is still among other things, a political machine which exists in no small part thanks to the relationships, lobbying, and in many cases political contributions by those enterprises.

Another caveat is that almost every one of these guidelines depends in one way or another on how the companies, the FTC, and the DOJ define the markets they are analyzing. It is already common, for example, for companies to define the markets they are serving in the broadest possible terms when it comes to their own explanations of how what they are doing will have no negative impact on the markets in the long run.

As just one example of that, a company such as Netflix which dominates the streaming entertainment industry might argue that if they were to acquire another major streaming competitor, that they should be measured in their anticompetitive impact with respect to similar entertainment provided on cable, conventional television, and theatrical releases of movies. On that broad basis, the acquisition Netflix is considering might not add up to much change in the overall market share it had prior to the purchase of a streaming competitor. On the narrower basis of just streaming services, as this part of the entertainment industry is currently rapidly consolidating, with formerly independent competitors such as Hulu now controlled by Disney and its Disney+ line of services, other companies decreasing their offerings, and still others making the decision to exit altogether, Netflix’s acquisition of one of the smaller competitors could have a far more sizeable impact when defined just as streaming. The changes to market share under this narrower definition of the market could be far more significant, depending on what is being acquired.

The new rules also provide little guidance about how to evaluate -- and do something about -- the growing group of companies in the United States which are already de facto near-monopolies in their own area of business. Amazon in e-commerce, Google in the field of online advertising and search, Spotify in streaming music markets, and Microsoft in Office Software are just a few examples of companies which dominate their market sectors, control pricing, distribution channels, and regularly exercise their monopoly power to eliminate competition. Though the Department of Justice has of recent not been shy in going after these monopolies for their actions, current laws and regulations available to the DOJ and FTC do not provide much legal backing to help deconstruct these industries if necessary in order to ensure more effective competition.

Despite all these concerns, consumer activist groups who believe the wave of mergers and acquisitions in the 21st century has had a negative impact on competition and consumers’ pocketbooks have mostly hailed the issuance of the new rules from the Federal Trade Commission and the Department of Justice as a game-changing regulatory milestone.

“For more than 40 years, the merger guidelines have been void of a review for competition," said Joe Maxwell, Chief Strategy Officer and co-founder for Farm Action. "During this period of time, unprecedented concentration across U.S. markets has driven farmers and small businesses out of business."

Maxwell offered thanks to the DOJ and FTC "for delivering on their commitment to restore competition to our economy” through issuance of the new regulations.

Open Markets Institute legal director Sandeep Vaheesan took those comments further by commending those involved in drafting new rules tied far more closely to the intent of the Acts which they are designed to enforce than in the past.

“By relying on market share tests for deciding the legality of certain mergers, the new guidelines are more faithful to the Clayton Act than the 2010 horizontal merger guidelines were," Vaheesan explained. "They are also more in accord with empirical research on the effects of mergers and acquisitions, which finds that corporate consolidation can harm democratic balances and institutions, as well as workers, producers, and consumers."

Erik Peingert, research manager and editor at the American Economic Liberties Project, also praised the new rules for their comprehensiveness and innovation in how they will direct the DOJ and FTC to measure the anticompetitive impacts of mergers and acquisitions.

"The finalized merger guidelines are a game-changer for antitrust enforcement, incorporating decades of new learnings and thousands of public comments from working families and small businesses,” he said.

"After almost 50 years of significant underenforcement, we're thrilled to see the antitrust agencies make a comprehensive update to the merger guidelines, and look forward to seeing them vigorously enforced," he went on. "The new guidelines provide a roadmap to bring first principles of the antitrust laws into the 21st century."