The general guideline for anti-trust legislation was created in the Clayton Act of 1914, which outlawed any mergers having monopolistic effects. The relevant section of the Act is Section 7, which prohibits a merger “where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.” Section 15 of the Act gives the government the authority to seek a court order to halt such a merger.
The Hart-Scott-Rodino Antitrust Improvement Act of 1976 (HSR Act) creates procedures to facilitate the government’s review of potentially monopolistic transactions. Specifically, it requires an acquiring company to report prospective acquisitions to the Federal Trade Commission (FTC) and the Department of Justice (DoJ), but only under certain circumstances. If an acquirer is subject to this Act, it cannot complete an acquisition for at least 30 days, thereby giving government regulators sufficient time to review the anti-trust implications of the prospective transaction. If the acquisition appears to pose a threat to competition, then either the FTC or DoJ can issue an additional request for information that extends the waiting period by 20 days. As a result of its examination, the government can file an injunction to halt the acquisition.
The acquirer must describe the proposed transaction on the Notification and Report Form for Certain Mergers and Acquisitions (FTC Form C4). The form describes the parties to the transaction, the monetary value of the deal, the percentage of ownership to be acquired, geographic market information, and the industry within which the acquisition is being made. It is extremely important to file this form, since the penalty is up to $11,000 per day for non-compliance. The rules for determining who must file the form are complex, but essentially the following two conditions must be met:
- One party to the transaction has net sales or total assets of at least $100 million, and the other party has net sales or total assets of at least $10 million, and
- The acquirer will hold more than $15 million of the target’s stock and/or assets, or will hold more than 50% of the voting securities of a target having at least $25 million in net sales or assets.
Once the government receives the notification form, it reviews the anti-competitive aspects of the proposed transaction, using its Horizontal Merger Guidelines (which can be viewed at www.usdoj.gov). The government is particularly interested in any increase in the concentration of market share, which it describes in Section 1.5 of the Guidelines.
As noted in Section 1.5, when reviewing a proposed transaction for its impact on market concentration, the DoJ uses the Herfindahl-Hirschman Index (HHI). This is an indicator of the amount of competition between companies in a specific industry. The basic calculation is the sum of the squares of the market shares of each firm in an industry. If an industry’s HHI is in the range of 0-999, it is considered to be a competitive market with no dominant players. If its HHI is between 1000 and 1800, then it is moderately concentrated, while any score above 1800 indicates a highly concentrated industry. For example, if an industry consists of four firms with market shares of 15% 20%, 25%, and 40%, then its HHI is 2850 (15² + 20² + 25² + 40²).
Any transaction that increases the HHI by more than 100 points in an already concentrated market will raise anti-trust concerns. Thus, it is considerably more difficult for a company with significant market share to acquire another firm in the same industry than it would be for a company with minor market share to acquire the same firm. For example, Company A has five percent market share, which is an HHI of 25 (5²), and wants to acquire Company B, which also has five percent market share. The post-acquisition HHI of the two companies is 100 (10²). With a net HHI gain of 50 points, this transaction would likely be acceptable to the DoJ. However, if Company C, with 10% market share, were to acquire Company B, then its HHI would rise from 100 (10²) to 225 (15²). This second transaction would increase Company C’s score by 125 within that market, while eliminating the 25 score of Company B, resulting in a net HHI increase within the industry of 100 points. This would likely flag the transaction within the DoJ.
The worst-case scenario is for a company having very large market share, since its HHI score essentially bars it from acquiring anyone. For example, a company having 50% market share has a score of 2500 (50²), so even acquiring a company with just one percent market share will increase its score to 2601 (51²). Thus, the HHI eventually produces a hard limit on a company’s ability to increase its size through acquisitions in a single market.
The government may still approve a proposed transaction under the failing company doctrine, even if it results in a significant increase in the HHI. This doctrine is dealt with in Section 5 of the Horizontal Merger Guidelines, which states that:
A merger is not likely to create or enhance market power if the imminent failure of one of the merging firms would cause the assets of that firm to exit the relevant market. In such circumstances, post-merger performance in the relevant market may be no worse than market performance had the merger been blocked and the assets left the market.
A merger is not likely to create or enhance market power if the following circumstances are met: 1) the allegedly failing firm would be unable to meet its financial obligations in the near future; 2) it would not be able to reorganize successfully under Chapter 11 of the Bankruptcy Act; 3) it has made unsuccessful good-faith efforts to elicit reasonable alternative offers of acquisition of the assets of the failing firmthat would both keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed merger; and 4) absent the acquisition, the assets of the failing firm would exit the relevant market.
Section 5 also states that the same logic applies to a failing company division. To fall within the failing company doctrine, a selling company’s division must have negative cash flow on an operating basis, and the company must plan to “exit its assets from the market” in the near future in the absence of a sale transaction.
In summary, smaller companies falling below the minimum standards of the HSR Act are essentially immune from anti-trust legislation, but larger companies having significant market shares may find that their acquisition activities are seriously constrained.