On June 27, 2023, the U.S. Federal Trade Commission (FTC) and the U.S. Department of Justice (DOJ) announced a Notice of Proposed Rulemaking representing the most substantial alterations to the Hart-Scott-Rodino Act (HSR) since it was enacted by Congress in 1976.
In amending the premerger notification process, the FTC cites the desire to screen for anti-competitive concerns more effectively. The agency also hopes to fill common gaps in filings, such as inadequate information regarding deal rationale or details supporting how certain investment vehicles are structured.
If implemented, the proposed changes would dramatically increase the disclosure burden for private equity firms and related parties involved in the deal process for M&A activity.
An Emphasis on Private Equity
Commentators broadly agree that many of the new rules are directly aimed at private equity transactions. FTC Commissioner Rohit Chopra has publicly singled out private equity as an enforcement target, stating that “buy-and-build” strategies enable sponsors to “quietly increase market power and reduce competition,” facilitating “a higher valuation when the combined company is eventually sold.”
Meanwhile, FTC Chair Lina Khan has described private equity buy-and-build strategies as an “extractive business model” and identified industry consolidation through private equity transactions as a top enforcement priority.
Among other areas within private equity affected by the recent action, the proposed rules specifically call out “roll-up strategies.” Under new HSR regulations, reviewing agencies would have the authority to weigh the cumulative competitive effect of a series of acquisitions rather than just an individual deal. According to the proposal, a firm engaging in multiple, small acquisitions in the same business line could still violate antitrust laws, even if no single deal would harm competition or create a monopoly.
The agencies may, in addition, investigate a pattern or strategy of growth by assessing the acquirer’s “history and current or future strategic incentives.” This would include examining the parties’ consummated and unconsummated acquisitions and their current and future plans as described in ordinary course business documents.
Additional Disclosures Targeting Investors
Some of the most significant changes proposed by the agency relate to reporting on persons involved with acquisitions. Current rules allow limited partnerships to identify only the general partner. However, with the implementation of the new regulations, acquiring persons would need to identify all “minority holders,” defined as “all entities or individuals, including limited partners, that hold 5% or more of the voting securities or non-corporate interests of one of the identified entities.”
Firms would further be required to furnish an organizational chart of associates for all funds and master limited partnerships. This would need to identify and show the relationships between all entities that are affiliates or associates. Filers would also need to list officers and directors — including board observers — who have held such positions for the past two years and those who would serve in such capacity post-transaction.
In addition, filing parties would need to identify interest holders that exert a “material influence” on the transacting party. This applies to individuals who provide credit totaling 10% or more of the entity’s value. But it would also cover holders of non-voting securities, options or warrants whose value is at least 10% of the entity or could be converted to 10% or more of the voting securities or non-corporate interests. These impositions may place uncertainty on lender-financed transactions within the private equity environment.
Additional Complexity for Private Equity
Along with more complicated disclosures around persons involved within the transaction landscape, filers would be required to submit a substantial amount of additional documentation related to the transaction.
Perhaps most notably, the proposed changes would, in many cases, call for all drafts of transaction documents provided to an officer, director or deal team lead. As such, firms would need to be intentional about the records they produce as they lay the groundwork for an acquisition.
Per new guidelines, firms would need to produce the following:
- Detailed summaries of the proposed transaction. This would include a closing timeline of events, a transaction diagram and a narrative describing the deal rationale.
- All agreements between the parties that were in effect at the time of filing or one year previous.
- Information on acquisitions from the prior 10 years by both acquiring and acquired parties, without any size threshold.
- An expansion of documents relating to potential transaction synergies, competition, markets or third-party advisor documents analyzing the transaction.
- Narrative descriptions of horizontal relationships (markets in which the reporting parties currently compete or are expected to compete in the future).
- Narrative descriptions of vertical relationships (supplier relationships between the parties).
- Information regarding customers for overlapping services and products of the merging parties, including contact information for customers.
- Detailed labor market information. This would include classifications of employees of the merging parties based on current Standard Occupational Classification (SOC) system categories and commuting zones, as well as worker and workplace safety records.
The proposed changes are expected to add considerable complexity, cost and time to transacting parties’ preparation of HSR filings. In fact, the FTC estimates that the time required for the average filing will increase from 37 to 144 hours — and many argue this is grossly underestimated.
On the Horizon
At present, the proposed rules are subject to a 60-day public comment period, which closes on August 28, 2023. Following this, the regulations will undergo an Office of Management and Budget review and potential legal challenge under the Administrative Procedure Act. The final rules are anticipated to go into effect by the end of 2023.
While there is still some uncertainty around exactly when these changes will be rolled out, private equity firms can begin preparing now. Those likely to be impacted by the modifications to the HSR should review the full Notice of Proposed Rulemaking and consider how it will affect future filings.
Firms will likely need to dedicate additional time, labor and financial resources to the premerger notification process. New filings could take weeks or months to compile — especially in the case of complicated transactions.
Firms and portfolio companies should also review the procedures they have in place to ensure compliance. In particular, as drafts of documents pertaining to proposed deals would now be required, firms must avoid creating misleading or vague communications when describing competitors, market share or competitive rationale for a transaction.
If passed, the regulations will undoubtedly create new hurdles within the private equity space. However, those who use the coming months to review and reinforce their internal processes will be best placed to adapt when the change comes.
Tom Chinonis is a former M&A attorney with a global law firm who now serves as Managing Director at Townsend Search Group. Mr. Chinonis’ practice focuses primarily on executive placement on behalf of middle market private equity firms across the country.