Commentary: Kenneth Davidson, Right Regulation: The Due Burden of Premerger Notification

Aug 30 2004

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August 30, 2005

Author: Kenneth M. Davidson, AAI Senior Fellow

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RIGHT REGULATION: The Due Burden of Premerger Notification

For more than 20 years, I worked on problems relating to the premerger notification required by Title II of the Hart-Scott-Rodino (“HSR”) Act. That work provides some perspective on the burdens imposed on persons who have filing obligations and the repeated requests to lessen those burdens. This perspective has led me to conclude that the burden of premerger notification, which falls most heavily on persons receiving Second Requests, can be lessened most effectively by requiring a more complete and better framed initial notification. Improved initial notifications should provide staff with sufficient information to conclude that fewer Second Requests are warranted and a better basis for concluding that a narrower Second Request will provide staff with sufficient information to resolve its competitive concerns.

This approach to the initial notification obligation is contrary to traditional suggestions to lessen the burden of filing notifications. According to Bobi Baruch, who was head of premerger for many of HSR’s early years, each new Bureau Director called her to his (or her) office with a suggestion to dramatically lessen the notification burden for most persons required to file. It was well known that only a tiny percentage of transactions raised any possibility of an antitrust violation. Accordingly, the new Director suggested that persons whose proposed transactions did not raise such possibility be required to file only a “short form” notification. With great deference, Bobi would agree that the idea was admirable or even brilliant, depending on her mood. Then she would meekly enquire how we would know, in advance of receiving the information in the notification, which persons or transactions should be allowed to file the short form. Receiving no answer to this question, she would sigh and regretfully return to her office.

Still the issue of notification burden remains so the antitrust agencies and the private bar continue to wrestle with ways in which to reduce the burden. The focus, however, has tended to shift to that tiny fraction of filings in which the antitrust agencies invoke their authority under section 7A(e) of the HSR Act to request additional information (the so-called Second Request). There good reason for the greater concern with the burden imposed by Second Requests. An initial notification will typically fit into one or two redwell accordion folders; whereas, the complete response to a Second Request may require the submission of hundreds or even thousands of boxes of documents. One transaction allegedly resulted in the submission of 5 thousand boxes. And with the advent of electronic communications, the number of responsive documents has grown substantially. The Bureau’s ability to examine large submissions has also increased with the creation of a corps of crack “honors paralegals” drawn from high ranking recent college graduates and the development of electronic search techniques.

Complaints from the private bar about the potential that Second Requests might be unduly burdensome found sympathy in both the antitrust agencies and the Congress. In the year 2000, Congress passed an Act requiring the antitrust agencies to establish a set of procedures which, among other things, requires each agency to appoint a senior agency official who is not responsible for merger investigations to hear appeals from persons receiving Second Requests that the requirements be narrowed. The theory of these procedures was sound. It was designed to insure that Commission staff would not abuse their authority to include unnecessary, irrelevant and burdensome items in the Second Request. Unfortunately the burden was created not by an abusive, out of control staff; thus there was generally little ground for appeal. The problem is the same one presented to Bobi Baruch. The staff has no basis for deciding no investigation is necessary (and therefore a “short form” is appropriate) until it has examined the information from the initial notification. Similarly, the staff has reason to request additional information concerning all markets that can not be ruled out as not presenting competitive problems. Nor could staff exclude the files of any person who might have received or created files relevant to the transaction.

The House conferees reporting on the compromise bill that ultimately became the HSR Act said: The House conferees contemplate that, in most cases, the Government will be requesting the very data that is already available to the merging parties, and has already been assembled and analyzed by them. If the merging parties are prepared to rely on it, all of it should be available to the Government. The initial notification form requests the submission of a lot less and somewhat more information than that focused upon by the House.

Most of the required information is quite general in nature and provides only superficial information about possible competitive problems that might be created by the merger. The largest portion of the information concerns reports of each merging company of its income detailed according to NAICS classifications. These classifications are so broad that they almost never coincide with the narrow market in which antitrust implications are examined. At the same time, the classifications are sufficiently vague that on rare occasions direct competitors will report their income under different classifications. Nevertheless, these reports are useful and not especially burdensome because firms are required to prepare NAICS forms for other purposes. Other items require the submission of copies of other forms required by other federal or state agencies, such as SEC 10K Forms or annual reports. In addition, the parties are required to submit two kinds of information that relate to the proposed merger: first a description of the proposed transaction (the acquisition of specified assets or specified amounts of voting securities); and second, certain documents prepared by or for an officer or director in connection with the proposed transaction.

It is this second set of documents, those that are required by Item 4(c), that were described by the House. These are the only documents that are likely to contain an examination of the implications of the proposed transaction, including competitive implications. Despite the potentially critical importance of such documents to competitive analysis, the government has not been particularly vigorous in its enforcement of the obligation to submit such documents. Typically, a firm will submit four or even fewer 4(c) documents. Sometimes the only document is the resolution of the board of directors approving the proposed merger or a brief document recommending that the board approve the acquisition. Rarely do submissions include studies done by the corporate development division, or the division that will operate the acquired entity. Having spent over 20 years investigating violations of the HSR Act, I have found that such documents are routinely created by and for corporate officers. Indeed, it is hard to imagine how a large bureaucratic business could make a reportable acquisition without careful study and written justification forecasting the performance of the merged firm. Nor is it likely that such officers would fail to consult existing internally generated reports on a competitor that it was considering buying.

During my years at the FTC, I periodically argued that the government should aggressively enforce 4(c) obligations. My suggestion was repeatedly rebuffed on the grounds that resources were better spent on antitrust investigations than on investigating technical filing obligations. Furthermore, it was sometimes suggested that, although it seemed obvious that large firms were routinely failing to file required documents, that, in the absence of some reason to believe that the proposed transaction raised competitive concerns, widespread enforcement of Item 4(c) would be perceived as unwarranted harassment of filing persons. I believe this reasoning is incorrect as a substantive matter and as a prediction of how many civil penalty cases would be required to attain effective compliance with Item 4(c).

As a substantive matter, the information contained in response to Item 4(c) is potentially the most important information in a notification. A full response to Item 4(c) can or should contain the most relevant information for many proposed transactions. It should allow staff to decide more quickly that no competitive problem exists or focus more quickly the investigation on possible antitrust violations. The response to this item should be the heart of the review of many transactions. Indeed, I have been assured by more than one merger attorney of the critical importance that 4(c) documents have played in alerting them to potential violations that were completely unapparent from public sources and other responses in the filing. In most cases, however, a full response should provide greater reassurance to the staff that no competitive problem exists.

The question of how many successful civil penalty actions would have to be brought to obtain relatively full compliance is of course an estimate, an educated guess. My guess is that if the government made clear through speeches that it intended to fully enforce the requirements of Item 4(c) and instituted investigations against likely violators, it would not take many successful civil penalty actions to obtain general compliance with Item 4(c). With fully compliance, staff should be much more aware of the areas of competitive concern and ought to be able to frame narrower Second Requests.

I have long believed that systematic enforcement of the requirements of Item 4(c) presents the possibility of a win-win solution for the government and merging parties. I think the chances of success could be enhanced by a rewording of Item 4(c) to make sure that some documents that are routinely created merging parties should be included. The current wording is complex and appears to apply to only to certain kinds of documents that are prepared for only certain enumerated officials and that focus on particular kinds of analysis are required by the rule. It virtually invites a recalcitrant filer to argue that some prong of the lengthy description that was intended to be inclusive actually excludes or at least arguably excludes relevant documents. In particular, the current wording does not make clear that routine planning documents that are prepared in the ordinary course of business should be filed. Frequently such reports and planning documents discuss competitive conditions that may include an analysis of the operations of the merging party if it is a competitor. Such documents are likely to play a role in the merger decision even if they are not created for that purpose. Having spent many years writing regulations, I do not underestimate the intellectual, bureaucratic or political difficulties of promulgating a new simple more comprehensive notification requirement, but I believe the time and trouble of writing a rule that more closely reflects the intention of Congress would be in the public interest and the interest of the antitrust agencies and the merging parties.