Private equity in the antitrust crosshairs

September 2022  |  SPECIAL REPORT: PRIVATE EQUITY

Financier Worldwide Magazine

September 2022 Issue

Private equity (PE) as an investment strategy has been around for over a century. Companies need capital to function, and PE can provide it. And while the industry sometimes gets a bad rap in the public’s eye, it has largely operated under the antitrust radar. That is because antitrust authorities have historically been more interested in what PE’s portfolio companies have been doing, as they are the ones actually competing in their marketplaces. PE is in many respects simply an investor.

But if there was any antitrust complacency in PE, that time has ended. Both the Federal Trade Commission (FTC) and the Department of Justice (DOJ) have publicly announced initiatives to scrutinise PE involvement in transactions and have expressed deep scepticism of PE’s impact on competition. They say PE promotes consolidation, and if a PE firm holds too much in one industry, the portfolio companies’ incentive to compete diminishes. Those are all, of course, mere arguments at this point, often with little basis. But they are leading to some significant changes and enhanced risk throughout the PE investment lifecycle.

Parental liability

As the Supreme Court has explained, it is a “general principle of corporate law, deeply ingrained in our economic and legal systems” that “a parent corporation is not liable for the acts of its subsidiaries”. Mere ownership, common control and active oversight of a subsidiary is not sufficient to pierce the corporate separateness between two affiliates because “courts generally presume that the directors are wearing their ‘subsidiary hats’ and not their ‘parent hats’ when acting for the subsidiary”. This deeply ingrained principle protects PE owners, since they can only be held liable under the antitrust laws if they directly participate in the wrongdoing, or they act as the portfolio company’s alter ego.

This presumption against parental liability has historically deterred most plaintiffs from taking on the difficult task of piercing corporate separateness. But if a recent decision in Packaged Seafood is any indication, plaintiffs looking for deep pockets to pick may increasingly look to PE. In Packaged Seafood, the court found plaintiffs had adequately alleged an antitrust claim against the PE owner of Bumble Bee. Plaintiffs claimed the PE firm learned of the alleged conspiracy during due diligence and participated in the conspiracy by meeting with the owner of a competitor, and promising to support rational market behaviour. While Packaged Seafood does not indicate a change in the law, it does show some courts may be more willing to entertain allegations that PE went beyond “activities that…are consistent with the parent’s investor status” and spilled into active conspiratorial participation.

Competitor common-ownership

Wikipedia defines the term ‘roll-up’ as “a process used by investors (commonly PE firms) where multiple small companies in the same market are acquired and merged”. It is no surprise that PE features so prominently, as it is a tried-and-true strategy for generating efficiencies and corporate value. And it has raised antitrust concerns only in rare cases where the PE firm orchestrates a merger of an industry’s leading firms.

In other cases, however, the PE firm may simply hold investments – including minority investments – in multiple firms operating in the same market. While it may seem obvious that a PE firm may want to invest in familiar industries to increase its exposure, and thus experience and expertise, in those segments of the economy, the FTC and DOJ are starting to take notice, and are questioning whether such investments mute the zeal to compete. Since 2015, economic literature has percolated the argument that common-ownership of competitor stocks by institutional investors can lead to higher prices. Those papers argue that businesses have less incentive to compete when they have significant minority shareholders in common with their competitors. The literature is starting to have a practical effect. Both the DOJ and the FTC have professed an interest in tackling these so-called ‘roll-up’ investments, particularly where, as the FTC’s director of the Bureau of Competition recently explained, the firm’s “roll up strategies allow them to accrue market power off the Commission’s radar”.

Interlocking directorates

The DOJ has said it intends to make more use of section 8 of the Clayton Act, which prohibits interlocking directorates (where a person simultaneously serves as a director or officer of competing corporations). Jonathan Kanter, assistant attorney general, said: “For too long, our section 8 enforcement has essentially been limited to our merger review process. We are ramping up efforts to identify violations across the broader economy, and we will not hesitate to bring section 8 cases to break up interlocking directorates.” If section 8 is read to include a PE firm as a ‘person’, which the FTC has done in past writings, this could be particularly challenging for PE firms that often acquire board seats across a variety of portfolio companies. Still, there are various exemptions and safe harbours to section 8 based on the level of competitive overlap and other metrics. This means PE will need to pay closer attention to portfolio board positions held across the firm, and the level of any competitive overlap with other portfolio companies.

Divestiture buyers

In recent months, the DOJ and FTC have voiced significant scepticism of PE transactions. A deputy assistant attorney general for the DOJ’s antitrust division said in prepared remarks that, while “private equity can play an important role in our economy”, an “undue focus on short-term profits and aggressive cost-cutting” leads “the division [to] often look[] more favourably on a market participant as a buyer of assets than a private equity firm”. Mr Kanter has said, “Very often settlement divestitures [involve] private equity firms [often] motivated by either reducing costs at a company, which will make it less competitive, or squeezing out value by concentrating [the] industry in a roll-up”.

These, of course, are simply assumptions. Indeed, cost-cutting done right is in service of efficiency, which is almost uniformly recognised as a procompetitive goal. But whether founded or unfounded, a PE divestiture buyer will garner closer scrutiny in today’s environment. That simply means that the transaction parties – and the PE buyer – must be ready to defend their choice of buyer as the best option for the promotion of competition. PE buyers that already have significant holdings in the industry will have a more difficult time obtaining approval, and PE buyers should almost always expect to be subject to a preapproval condition.

Prior approval requirements

In 2021, the FTC returned to “its prior practice of routinely requiring merging parties subject to a Commission order to obtain prior approval from the FTC before closing any future transaction affecting each relevant market for which a violation was alleged”. Unlike their ‘prior notice’ cousins, ‘prior approval’ provisions are particularly onerous because they give the FTC carte blanche to reject any future sale of the divested assets. It was not lost on the FTC that this policy change would disproportionately impact PE, whose business model is based on flipping acquired businesses. On the contrary, the FTC explained that this provision was designed precisely to “better track and prevent unlawful acquisitions by private equity firms”.

While PE is certainly in the antitrust crosshairs, none of this by any means spells the end of PE. Nor does it mean that the antitrust attacks on PE will be successful. It simply means that PE firms must raise their antitrust antennae whenever considering a new deal and in their daily interactions with their portfolio companies. No longer in the antitrust shadows, PE is being called upon to make its case for the benefits it brings to transactions and companies. In most cases, it should not be hard to do.

 

Colin R. Kass is a partner and David Munkittrick is senior counsel at Proskauer Rose LLP. Mr Kass can be contacted on +1 (202) 416 6890 or by email: ckass@proskauer.com. Mr Munkittrick can be contacted on +1 (212) 969 3226 or by email: dmunkittrick@proskauer.com.

© Financier Worldwide

BY

Colin R. Kass and David Munkittrick

Proskauer Rose LLP

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