The Federal Trade Commission, through its blog, last week cautioned against the pre-closing exchange of competitively sensitive information—especially current (and future) prices, strategic plans and costs.
While acknowledging buyers’ legitimate need for detailed information to negotiate and implement mergers and acquisitions, the agency warned that the exchange of this information, especially in transactions involving direct or potential competitors, poses risks of “gun jumping” in violation of the Hart-Scott-Rodino (HSR) Act and violations of the Sherman Antitrust Act, which prohibits anticompetitive conduct. To minimize these risks, the FTC recommends that, as a general rule, competitively sensitive data be disclosed to buyers late in the due diligence process. Where current pricing, cost and customer-specific data must be disclosed to permit a buyer to evaluate a transaction, the agency recommends the parties employ a “clean team" to review the data.
This can be a cumbersome and expensive process. Do the risks warrant the time and expense? In many cases, the answer is “yes,” for several reasons.
HSR and Antitrust Risks Are Related but Different
The HSR Act requires parties to a transaction satisfying statutory size of person and size of transaction tests to file reports with the U.S. Department of Justice and Federal Trade Commission, then wait 30 days to permit the agencies to determine whether investigations are warranted. If they are, the waiting period is extended until the companies have substantially complied with the investigating agency’s information requests (called "second requests"), a process that may take many months.
Unlawful HSR gun jumping occurs when, before expiration of the waiting period, the buyer exercises rights attendant to beneficial ownership of the target, including the power to control (or materially influence) the target’s important business decisions. Such decisions include bid/no bid decisions, pricing and marketing programs and strategies, and strategic initiatives, including product introductions.
Gun jumping exposes the parties to daily fines (currently $41,484/day) and restarting the clock on the waiting period.
Four points about HSR exposure are important. First, HSR is a notification statute, not a substantive law prohibiting anticompetitive conduct. For this reason, gun jumping is unlawful regardless of whether the buyer and seller are actual or potential competitors.
Second, as a practical matter, gun jumping is most likely to come to the agency's attention in a transaction undergoing HSR review. In some cases, disgruntled employees of the target (hoping to kill the deal) may bring this conduct to the agency’s attention.
If the investigating agency learns of gun jumping, it may open an independent investigation, which can be lengthy and expensive. Gun jumping may also violate any foreign merger control laws that apply to the transaction.
Third, gun jumping does not require evidence that the underlying transaction is unlawfully anticompetitive.
Finally, once the HSR review period expires, gun jumping is no longer a risk from an HSR standpoint. However, there may be an ongoing antitrust risk.
Sherman Act violations require evidence of a lessening of competition. Sherman Act section 1 bars anticompetitive agreements between two parties (typically actual or potential competitors). Sherman Act section 2 bars anticompetitive conduct by a single firm that has market power in a relevant product market.
Sherman Act violations subject defendants to civil and criminal liability, as well as substantial monetary penalties. As discussed below, Sherman Act violations may arise before and during the HSR review period, and, in some cases, after the review period has expired.
Reciprocal and Unilateral Information Exchanges Both Pose HSR and Antitrust Risks
The reciprocal (“two-way”) exchange of competitively sensitive information (in connection with, for example, a "merger of equals") poses far more risk than a unilateral (“one-way”) disclosure from seller to buyer. Although reciprocal exchange may not of itself violate the HSR Act or the Sherman Act, it may call into question the lawfulness of subsequent conduct by the parties prior to expiration of the waiting period—for example, ostensibly independent decisions by both firms to raise their prices or refocus their sales efforts on non-overlapping categories of customers. This conduct may strongly suggest both HSR gun jumping and a per se violation of section 1 of the Sherman Act (customer allocation).
Unilateral data disclosure may also call into question the lawfulness of subsequent conduct. Consider a hypothetical. Company A is negotiating to buy Company B. The firms are neither actual nor potential competitors. Through due diligence, Company A’s CEO reviews Company B's current cost and pricing data, as well as its strategic plan, which proposes a new line of products incorporating cutting-edge technology never before employed in this market. Company A’s CEO calls Company B’s and tells him to consider raising his prices because his margins are too small. She also cautions him against developing the new product because of attendant technological risks, which could seriously diminish the value of the merged companies. Company B’s CEO raises his prices, and abandons the new product launch.
This conduct constitutes classic HSR gun jumping. It is unlikely to violate the Sherman Act, however, because the firms are neither actual nor potential competitors.
Changing the facts, assume Company A is a major player in Company B's market and has been losing sales to it because of its low prices. Like Company B, Company A is considering developing a product line incorporating the new technology. Company B’s CEO is aware of his company’s price advantage over Company A, as well as Company A's new product plans. Company A’s CEO calls Company B’s, recommending that during the review period he raise his prices and abandon developing the new product. He agrees to both recommendations.
The agreement between competitors constitutes both gun jumping in violation of HSR, and per se Sherman Act section 1 violations (price-fixing and product market allocation).
Sherman Act (but not HSR Act) liability may also arise after a deal collapses. Assume in our hypothetical the deal dies for reasons unrelated to HSR review, and the HSR waiting period has expired. Aware of Company B's plans to develop a new product line, Company A’s CEO directs her lawyers to file a series of sham patent infringement cases against Company B to prevent it from developing the product. Because the HSR period has expired, gun jumping is not a concern. Company A may be liable, however, for monopolization or attempted monopolization in violation of Sherman Act section 2.
The FTC's guidance is intended to minimize the likelihood of any of these scenarios taking place. The agency strongly recommends the following:
- Early in the negotiation and due diligence process, the parties develop a plan to monitor and control the flow of all information. The plan should include detailed protocols governing the content and timing of the disclosure of competitively sensitive information, especially current and future prices, strategic plans and costs.
- Regarding data content, where at all possible, the parties should use historical (not current or future) price and cost data. If current information is necessary, it should be provided on an aggregate, rather than a product-specific basis. Customer information should be provided on an aggregate (rather than individual basis), or, where individual data is necessary, with the identities of specific customers masked.
- On the timing of disclosure, in auctions or similar multi-bidder processes, the seller should minimize the amount of competitively sensitive information made available to buyers. Once a buyer has been identified, competitively sensitive information should be disclosed late in the due diligence process, when the parties are more certain the deal will take place.
- Where a buyer needs current, unaggregated pricing, customer and cost information to evaluate a transaction and to plan for implementation, the buyer should employ a "clean team" that excludes buyer personnel responsible for competitive planning, pricing or marketing strategies. If there are few appropriate employee candidates for the team, (for example, a small buyer organization in which all senior managers play some role in each of these areas) the buyer should employ third-party consultants who are familiar with the markets at issue.
The clean team itself should develop protocols governing how competitively sensitive information will be treated. Clean team reports to the buyer’s management should consist of masked, aggregated data, which should, prior to release, be carefully reviewed and edited not to disclose competitively sensitive seller information.
The delay and expense attendant with the use of a clean team must be weighed against the risks of investigation and possible litigation. For transactions between direct competitors in which the target’s employees, customers or suppliers may feel threatened, those risks can be substantial.
This update has been republished in Transaction Advisors on 04.23.2018.
© 2018 Perkins Coie LLP