A roadmap for future US enforcement of vertical mergers?

March 2024 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

March 2024 Issue

The Federal Trade Commission (FTC) declared victory in December after Illumina, a maker of genetic sequencing technology used to develop cancer screening tests, agreed to divest Grail, a developer of cancer screening tests, following a long and bruising antitrust regulatory process in the US and the European Union.

Illumina’s decision came on the heels of a ruling by the US Court of Appeal for the Fifth Circuit that actually vacated a 2023 FTC decision requiring the divestiture and sent the case back to the FTC for further adjudication. Despite technically losing the appeal, the FTC is touting the Fifth Circuit’s decision as “a major win” that “provides a clear roadmap” for future challenges to vertical mergers.

While the Fifth Circuit did endorse certain aspects of the FTC’s decision in the case, the future implications of the decision are less clear than the FTC has advertised. Moreover, other than Illumina/Grail, the antitrust agencies have struggled to block vertical mergers in court and must overcome a history of unfavourable court decisions to do so in the future. Finally, the saga shined a spotlight on the FTC’s ability to block mergers through the agency’s unique administrative court process.

A long and winding legal road

In September 2020, Illumina announced an agreement to acquire Grail, which was founded as a division of Illumina before being spun out as a standalone company in 2016. Illumina asserted that the merger would drive increased innovation in cancer diagnostics and bring Grail’s technology to a broader audience. The FTC sued to block the proposed merger in March 2021.

The agency alleged that the merger would substantially lessen competition in the US market for multi-cancer early-detection (MCED) tests by diminishing innovation, potentially increasing prices, and reducing the choice and quality of MCED tests. The FTC simultaneously filed an action in its administrative court and sought a preliminary injunction in federal court to prevent the companies from closing the deal. But, in April 2021, the European Commission (EC) belatedly asserted jurisdiction over the merger.

The FTC then voluntarily dismissed its federal court action in May 2021 based on the belief that Illumina would not close the merger over a pending EC investigation. Illumina disagreed with the EC’s assertion of jurisdiction, however, and closed the deal over the FTC’s and EC’s objections in August 2021.

The FTC continued to litigate in its administrative court, seeking to unwind the deal. After a six-week trial, the FTC’s chief administrative law judge (ALJ) dismissed the FTC’s complaint. In a 197-page opinion, the ALJ concluded that the merger was unlikely to substantially lessen competition because: (i) whatever ability Illumina had to foreclose Grail’s competitors post-acquisition already existed pre-acquisition; (ii) Illumina would not have a strong incentive to harm Grail’s competitors given how far behind they were in developing competing tests; and (iii) Illumina’s proposed contractual remedy, pursuant to which Illumina would provide its sequencing platform to Grail’s rivals at the same price and with the same access that it provided to Grail for a period of up to 12 years, would effectively constrain Illumina from acting on its ability to foreclose Grail’s rivals.

Under the FTC’s administrative process, the ruling was appealed to FTC commissioners (the Commission, i.e., the same four commissioners who supported the challenge to the merger originally). The Commission unsurprisingly reversed the ALJ’s decision and ordered Illumina to divest Grail. In its decision, the Commission concluded that the ALJ improperly focused on the potential foreclosure of competing MCED tests on the market at the time without factoring in tests in development, and failed to acknowledge that any losses Illumina would suffer by denying Grail’s rivals access to its sequencing platforms would be offset by the gains to be expected with increased testing sales. Illumina then appealed to the Fifth Circuit.

While the US litigation process unfolded, the merger was subject to a similarly byzantine review process in Europe. After a series of appeals and wrangling over novel legal theories, the EC ordered Illumina to divest Grail in October 2023, months before the Fifth Circuit decision.

Fifth Circuit ruling

In its decision, the Fifth Circuit found substantial evidence to support the conclusion that, post-merger, Illumina would have the ability and a “significantly increased incentive to crowd out Grail’s competitors from the market”. Specifically, the court cited Illumina’s own admission that it could foreclose Grail’s rivals by denying them access to its sequencing platform, which is a key input for all MCED tests currently in development.

The court pointed to the combination of Illumina’s control over the input and Grail’s status as the “first-mover” in the nascent MCED clinical testing industry to conclude Illumina would have the incentive to foreclose Grail’s rivals at the expense of short-term profits to achieve its long-term goal of becoming the market leader in clinical testing.

But even though the Fifth Circuit concluded that the merger was likely to substantially lessen competition in violation of the Clayton Act, it also concluded that the Commission failed to properly consider the competitive impact of a contractual commitment Illumina had proposed to address competitive concerns. The proposed remedy required Illumina to provide its sequencing platform to Grail’s rivals at the same price and with the same access that it provided to Grail. Specifically, the Fifth Circuit concluded that the Commission imposed too high of a burden on the parties and did not give the proposed remedy appropriate weight in evaluating the potential effects of the merger.

FTC victory lap

Within days of the Fifth Circuit’s decision, Illumina announced that it would divest Grail rather than continue to litigate. The FTC issued a bullish statement touting the appellate court’s decision as one that “provides a clear roadmap” for future vertical merger challenges. Tellingly, the FTC also added three citations from the appellate opinion to the FTC and US Department of Justice’s updated merger guidelines, which were issued just three days after the Fifth Circuit released its opinion.

More immediately, the decision represents an endorsement of the FTC’s recently revised approach to market definition and analysis of potential harm in vertical mergers. The decision accepted the Commission’s use of the Brown Shoe practical indicia test, which was first announced in the US Supreme Court’s 1962 decision Brown Shoe Co. v. U.S. to define the relevant market.

Brown Shoe examines a number of categories of anecdotal market evidence, such as the product’s peculiar characteristics and uses, distinct customers and prices, to determine the bounds of the market affected by a merger. The Fifth Circuit agreed with the FTC that the relevant market should consist of research, development and commercialisation of MCED tests, because MCED tests that could potentially compete with Grail’s MCED test are still in development and not yet available for consumers. The decades-old Brown Shoe test had in recent years fallen out of favour as enforcers and courts have shifted their focus from facts to econometric analysis to identify relevant product markets.

Although the Fifth Circuit concluded that the merger was unlawful under the “ability-and-incentive” test that is typically applied in vertical merger challenges, it simultaneously endorsed the FTC’s use of the more flexible Brown Shoe factors for purposes of analysing vertical theories of competitive harm, agreeing with the Commission that at least four factors – likely foreclosure, nature and purpose of the transaction, degree of post-merger market power and barriers to entry – supported the conclusion that the merger would likely substantially harm competition.

Uncertain implications

There is no doubt that the FTC obtained its desired outcome when Illumina agreed to divest Grail; however, there is reason to doubt that the Fifth Circuit opinion will compel other courts to suddenly become much more receptive to challenges to vertical mergers.

First, vertical mergers have been viewed as presumptively procompetitive by courts for decades, and courts have repeatedly recognised that the FTC faces a tougher path to block a vertical merger than a horizontal merger.

Second, the Fifth Circuit’s ruling was very specific to the facts of the case. Illumina is the sole supplier of a key input (its sequencing platform) required for all MCED tests currently in development, and Grail’s MCED test is currently the only test available on the market.

Third, the FTC has been largely silent on the Fifth Circuit’s findings with respect to how the FTC must evaluate remedies in vertical mergers. In its reversal of the ALJ’s decision, the Commission held that Illumina was required to show that its proposed remedy would completely mitigate the anticompetitive effects of the transaction.

But, because Illumina had already implemented its proposed remedy, the Fifth Circuit concluded that, when a proposed remedy has been finalised, merging parties need only show that, because of the remedy, the merger is no longer likely to substantially lessen competition. The Fifth Circuit’s ruling is just the latest in a string of recent court opinions that have rejected the FTC’s approach to evaluating remedies and instead adopted legal standards that are more favourable to merging parties.

Thus, the decision offers merging parties an opportunity to litigate their competitive remedies earlier in the process using a lower burden of proof so long as they propose the remedy before a complaint is filed.

Regardless of how one interprets the Fifth Circuit’s opinion, it appears clear that the FTC feels empowered by the opinion to continue its vertical merger enforcement efforts. The agency will no doubt again use its unique administrative process to achieve its goals, even though it means overturning its own ALJ to get there.

While parties to vertical mergers should keep in mind the FTC’s aggressive efforts in this area, courts have expressed a willingness to accept contractual commitments or other behavioural remedies as a potential salve for competitive concerns. Companies willing to defend merger challenges should evaluate whether their merger lends itself to adopting this type of approach.

Tara L. Reinhart is a partner, Michael J. Sheerin is a counsel and Zachary C. Siegler is an associate at Skadden, Arps, Slate, Meagher & Flom LLP. Ms Reinhart can be contacted on +1 (202) 371 7630 or by email: tara.reinhart@skadden.com. Mr Sheerin can be contacted on +1 (212) 735 3583 or by email: michael.sheerin@skadden.com. Mr Siegler can be contacted on +1 (212) 735 3547 or by email: zachary.siegler@skadden.com.

Tara L. Reinhart, Michael J. Sheerin and Zachary C. Siegler

Skadden, Arps, Slate, Meagher & Flom LLP