To fully understand antitrust laws and regulatory enforcement, we must understand prosecutorial discretion. At the federal level, antitrust enforcement is heavily influenced by the personal beliefs of the sitting President. Take, for example, Teddy Roosevelt’s “trust busting” initiatives, or more recently, the Trump administration’s surprisingly aggressive action to stop the merger between media giants AT&T and Time Warner.
In this Module, we will explain the ideas used by law enforcement in deciding whether to prosecute proposed mergers or acquisitions. Then, we’ll review early antitrust laws in addition to the newer laws enacted by Congress. In particular, the Hart-Scott-Rodino Antitrust Improvement Act, also knows as the “HSR Act,” passed in 1976, which expanded the powers of the federal government in the area of antitrust and permitted states to enforce the Act’s antitrust prohibitions.
Finally, this module reviews the impact of federal securities laws on merger and acquisition activities, including the pre-merger proposal stage and soliciting shareholders’ approval for public company mergers. For federal securities laws to apply, at least one of the companies involved must be publicly-held.
Key Antitrust Enforcement Concepts & Principles
Federal antitrust prosecutors use various concepts, tools and procedures to investigate and decide whether to stop a proposed merger or acquisition.
- Procedural Rules: The Department of Justice relies on the corporate notice requirements of the HRS Act to identify potential antitrust violations based on proposed merger or acquisition materials submitted for review. The Federal Trade Commission (FTC) uses its internal investigative powers to identify companies that are in violation of antitrust provisions of the FTC Act. The FTC staff investigators and attorneys will then recommend prosecution and this recommendation will be reviewed by the five-member FTC board. If the board approves prosecution, the FTC will initiate an administrative hearing before a federal administrative judge.
In contrast, the Department of Justice litigates all cases in the federal court system, beginning at the federal district court. The DOJ has the power to bring criminal and civil actions against antitrust violators. The FTC is limited to civil litigation only, and corporations losing in FTC administrative court may appeal to the federal circuit courts of appeals.
- The Consent Decree: A consent decree is a type of settlement agreement entered into by the DOJ and the corporate violator of antitrust laws. The corporate violator does not have to admit to any specific violation of law and can simply admit to agreeing to engage in the alleged market behavior. Similarly, the FTC enters into “settlements” during the early phase of its investigation, and these settlements are filed with the federal court as consent decrees, which give power to the court to retain jurisdiction on the matter until the companies have fully complied with the terms of the consent decrees.
- Market Share Concentration: Regulators define a market in terms of the customers’ abilities and willingness to substitute one product for another in response to a price increase. The market may be geographically defined, with its scope limited by product transportation costs.
- Coordinated Effects: The effects of a merger involving competitors may lead the post-merger company to coordinate product output or pricing with competition in the same market. Thus, the surviving company’s actions on reducing output, for example, could lead other, smaller competitors to follow suit, resulting in price increases.
- Ease of Entry:After the merger, how difficult will the entry into the market become for a potential, new competitor? In other words, will the merger suffocate potential new entrants, thus reducing competition?
- Efficiencies: A merger between two competitors may result in lower product prices, better quality and better customer services, all of which are encouraged by antitrust regulators. One key factor in merger approval is whether the average fixed costs per product unit is reduced, supporting the efficiency argument.
- Alternatives to Imminent Failure: Sometimes, a failing firm must seek a merger partner or acquirer to survive. Consolidation in mature industries often leads to “super firms” pushing aside the less competitive firms. When a merger may be the only alternative to liquidation, it is more likely to be approved, as when the DOJ allowed American Airlines, then in a Chapter 11 bankruptcy proceeding, to merge with US Airways.[1]
A merger or acquisition involving large, public companies may touch on an array of state and federal laws. Let’s examine the key laws that impact mergers and acquisitions in deeper detail, focusing on federal antitrust laws, as they are the first major barriers to the completion of successful mergers. Keep in mind that state and federal regulators share responsibility in overseeing some of the aspects of mergers and acquisitions.
The Sherman Antitrust Act
Federal antitrust laws were adopted to address the anti-competitive effects created by a merger or an acquisition. While the Sherman Act was adopted over 125 years ago, today it provides the authority to prevent unreasonable restraint on competition or unfair methods of competition. The first substantial merger activity in US history involving major industries mostly involved combinations of two firms from the same industry (“horizontal” mergers). These combinations led to concentration of market power and the creation of powerful monopolies. Congress responded to the growing power of these monopolies by enacting the Sherman Antitrust Act of 1890. Section 1 of the Act[2] prohibits agreements that unreasonably restrain competition. The statute imposes both criminal and civil penalties for violations. A private party may sue under the Sherman Act and may be allowed treble damages and attorneys’ fees. The Sherman Act remains a powerful weapon in the government’s arsenal 125 years after passage.
Section 2 of the Act[3] prohibits monopolization, attempted monopolization and conspiracies to monopolize trade. The civil and criminal penalties for Section 2 violations are the same as those under Section 1. While prosecutors and private plaintiffs rarely use Section 2 in antitrust actions, the government has recently employed the statute in some major antitrust litigation. In 1997, the FTC used Section 2 to stop the proposed merger between Staples and Office Depot.[4] This merger would have combined two of the top three superstore office products chains in the U.S. The third major competitor was Office Max.
The key issue in the case was a definition of the relevant product market, as defining the relevant product market is a central question in the application of Section 2. Market definition is a prerequisite to determining whether the merger of two competitors would qualify as “attempted monopolization”. The FTC ruled that the relevant product market was comprised of “superstore office products chains,” including Staples, Office Depot and Office Max. The FTC used Staples’ internal documents to show that raising prices on products would be easier in the post-merger market if only two major competitors would survive, resulting in monopolization by the Staples-Office Depot combination. Earlier, in another major case, the government used Section 2 in United States v. Microsoft.[5] This litigation spanned a period of ten years and was one of the largest litigated cases by the United States government, involving hundreds of attorneys from the Department of Justice and the FTC. During the 10-year litigation, the FTC pursued various antitrust claims against Microsoft involving its pricing policies and computer source code that, the FTC argued, undermined competition in the software industry.
Finally, Microsoft agreed to a Consent Decree, an agreement to end certain anti-competitive practices such as its software development and pricing practices. However, Microsoft, as is typical under these consent decrees, did not admit to any violations of the Sherman Act.[6]
Other Federal Antitrust Laws
The Federal Trade Commission Act of 1914
Adding governmental power to enforce antitrust behavior, the Congress passed the Federal Trade Commission Act in 1914.[7] The Act established the Federal Trade Commission to enforce Section 5(a) of the FTC Act which prohibited “unfair methods of competition.” Section 7 of the Act made it illegal for one company to acquire the stock of another company if such a stock transaction would adversely affect competition. The Act is limited to civil actions by the government, unlike the Sherman Act which permits both civil and criminal prosecution by the Department of Justice.
The Clayton Act (also passed in 1914)
In the same year that it passed the FTC Act, Congress also passed the Clayton Act. Section 7 of the Act[8] prohibits mergers and all other forms of acquisitions that may substantially lessen competition. Under Section 3 of the Act,[9] parties are prohibited from entering into ‘exclusive-dealing’ agreements. This statute is civil in nature and is mainly redundant, as these acts mostly fall under the broader coverage of the Sherman Act. While the Sherman Act prohibitions were aimed at monopolization, the Clayton Act closed a loophole in the Sherman Act by prohibiting merger and acquisition activities aimed at curbing competition.
Celler-Kefauver Act of 1950
Another loophole was closed with the passage of the Celler-Kefauver Act[10] in 1950. The Clayton Act was amended by giving the power to the FTC to prohibit assets and stock purchases. After the Celler-Kefauver Act, a company could no longer get around the Clayton Act by acquiring the assets of the target company to avoid the scrutiny involved in a “merger.”
Hart-Scott-Rodino Antitrust Improvement Act of 1976
This federal law introduced new enforcement powers to both the federal and state governments. The Hart-Scott-Rodino Antitrust Improvement Act[11] gave the DOJ and the states’ attorneys general the power to stop proposed mergers and acquisitions prior to initiating the transactions. The Act requires that a company establishes a waiting period to give the government the opportunity to evaluate whether the proposed transaction will violat antitrust laws and it requires the companies to provide statutory notice to prosecutors of the effects of the proposed merger. The Hart-Scott Act can be broken down into three major parts. Title I gives the Department of Justice the power to obtain internal records of companies seeking to merge if the government believes the merger will lead to antitrust violations.
Under Title II for 2018, any proposed merger or acquisition transaction having a specified value (which increases periodically and was at least $84.4 million as of 2018) must be submitted to the FTC for review. A bidding firm (one making the offer to acquire another firm or merge with another firm) must submit the notice to the FTC at the same time it makes an offer for the target firm. Under Title III of the Act, state attorneys general are granted the power to bring legal actions for treble damages on behalf of their citizens who have been injured by violations of the US antitrust laws. This is a powerful weapon for state attorneys general.
Federal Securities Laws
Federal securities laws and regulations apply whenever a merger or acquisition involves at least one public company. A transaction involving only privately-held companies will not trigger the federal securities laws. The Securities Act of 1933[12] covers registration of securities and regulates securities sold in the public markets. A security was defined by the Supreme Court as an investment contract, which means any contract or transaction whereby a person invests funds expecting a profit.[13] Under this definition, a merger or acquisition transaction is an investment contract that falls under the regulation of the act.
The Securities Act of 1934[14] established the S.E.C. and regulates broker-dealers. Section 14 of the 1934 Act dictates disclosure requirements for proxy fights in the context of hostile takeovers. Similarly, Sections 16(a) & (b) of the 1934 Act, which define non-public information and penalties for insider trading of securities, may be raised in the context of both hostile and non-hostile acquisitions. Proxy solicitations are regulated by Section 14 of the 1934 Act. In a proxy contest, different groups, such as incumbent management versus outsiders, fight for control of a corporation. Each side fights to represent the shareholders, acting as their proxies to vote on who will be selected to sit on the board of directors. The winning side will lead the board of directors and gain control of the corporation.
Proxy fights are common in hostile takeovers, where outsiders try to get control of a public corporation via a cash bid for enough of the outstanding shares of the corporation’s common stock to control the corporation. Under Section 14, the SEC regulates and sets guidelines for materials that must be distributed to shareholders in a proxy solicitation. Sections 16(a) & (b) of the 1934 Act define and regulate insider trading of securities. An insider is a holder of 5% or greater ownership of the corporation’s common voting stock. Once the 5% threshold is met, the holder must report the accumulated ownership to the SEC. Often, crossing the 5% threshold means the holder is interested in acquiring more shares with the goal of gaining majority control via a hostile takeover of the target corporation.
The Williams Act of 1938[15] enacted amendments to the Securities Act of 1934 by requiring that any entity reaching 5% or greater of the common shares in a corporation must file a notice with the SEC within ten days of reaching the threshold level. The SEC notice form must include the name of the acquirer, corporate associates and affiliates, purpose of the acquisition of the shares, financing behind the acquisition and the sources of that financing, among other key disclosures.
In the wake of various corrupt practices and scandals involving senior corporate executives, Congress adopted the Sarbanes-Oxley Act[16] in 2002. The Act requires certification of all financial statements filed with the SEC by public corporations. Violations of the Act, such as intentionally misstating earnings, can lead to criminal and civil penalties. The Act is an important facilitator in the public’s access to accurate and trustworthy financial data, which is the foundation for making informed judgments on proposed hostile or friendly mergers. The SEC Regulation FD[17] (or “Fair Disclosure” regulation) was adopted by the SEC to force companies’ managements and their advisors to use simple, clear and understandable language in producing disclosure documents to investors, such as Forms 10K or 10Q.
Conclusion
Antitrust and securities laws have been amended over time to match the complexity and sophistication involved in M&A activity. The regulatory environment will also continue to evolve as corporate managers and investors create new ways to circumvent the laws via loopholes or come up with new legal theories to create exemptions.
In our next module, we’ll turn to hostile takeovers and discuss the mechanisms of the takeovers and the rules that govern these transactions.
[1] https://www.justice.gov/atr/case/us-et-al-v-us-airways-group-inc-and-amr-corporation
[2] 15 U.S.C. 1.
[3] Id. § 2.
[4] FTC v. Staples, 970 F. Supp. 1066 (D.D.C. 1997).
[5] United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001).
[6] https://www.justice.gov/atr/memorandum-opinion-us-v-microsoft-corp.
[7] USC 15 at § 45(a).
[8] Id. §§12-27.
[9] Id. §14.
[10] 81 P.L. 899.
[11] 15 U.S.C.S. § 18a.
[12] 15 U.S.C.S. § 77a et seq.
[13] SEC v. W. J.Howey Co., 328 U.S. 293 (1946).
[14] 15 U.S.C.S. § 78a et seq.
[15] 90 P.L. 439.
[16] 107 P.L. 204.
[17] 17C.F.R. § 230.501.