The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) (collectively, “Agencies”) released the final version of the Vertical Merger Guidelines (“Vertical Guidelines”) on June 30, 2020. The new Vertical Guidelines, which had not been updated in more than 35 years, outline how the Agencies will evaluate whether vertical mergers violate the federal antitrust laws.
The Vertical Guidelines mark the latest evolution of the Agencies' thinking on vertical mergers, reflecting increased skepticism about a presumption that vertical mergers are generally procompetitive, and identifying competitive concerns that can arise in deals that have not traditionally been considered “vertical.” Over the past few years, regulators and politicians have questioned long-standing beliefs that vertical mergers are generally procompetitive and generate cost savings for consumers. The Agencies have taken a more aggressive posture in addressing vertical concerns in transactions. Parties contemplating a merger will benefit from conducting more pre-transaction due diligence on potential vertical merger risks and should expect vertical relationships to be a greater focus during the merger clearance process.
Below are five key takeaways from the release of the Vertical Guidelines:
The Vertical Guidelines describe an expansive set of potential theories of vertical harm.
Traditionally, the Agencies considered vertical transactions were anticompetitive when they increased either (1) the likelihood that a competitor would foreclose access to or raise the cost of a vital input, product or a significant portion of downstream customers, or (2) the risk of post-merger coordination among firms. The Vertical Guidelines make clear that harm can occur both through these traditional means, as well as a broader set of circumstances. Specifically, the Vertical Guidelines expressly lists vertical harms from mergers that increase the cost of entry into a relevant market, mergers that disadvantage rivals through the acquisition of a complementary product, and “diagonal” mergers (i.e., vertical mergers that are unlikely to generate significant benefits from the elimination of double marginalization because the merged company will control an upstream input that is incompatible with the downstream product).
While the list of potential vertical theories is broad and each scenario is highly fact-dependent, the Vertical Guidelines also include a general framework consistent with the historical approach for evaluating these transactions, focused on the “ability” and “incentive” of the merging parties to harm rivals as a result of the transaction. The key inquiry is two-fold: (1) whether the acquisition of an upstream or downstream product would allow the merging parties to cause rivals to lose significant sales or otherwise compete less aggressively (i.e., ability), and (2) whether the merging parties would find it profitable to do so (i.e., incentive). The Vertical Guidelines do not attempt to articulate all potential anticompetitive scenarios and leave open the possibility that additional theories of harm could be identified in the future. This flexibility for the Agencies does not lend itself to a clean-cut rule for business decision-makers. As with horizontal transactions, consultation with an antitrust practitioner prior to entering into a vertical transaction (broadly defined) will remain important to navigate potential regulatory issues.
The quasi safe-harbor threshold proposed in the draft Guidelines found its way to the chopping block in the final version.
One of the provisions that received significant attention in the draft Vertical Guidelines released in January was a provision that said the Agencies were “unlikely to challenge a vertical merger where the parties to the merger have a share in the relevant market of less than 20 percent, and the related product is used in less than 20 percent of the relevant market.” While the draft Vertical Guidelines noted this was not a hard and fast rule, this provision became a target for all sides. Skeptics of increased vertical merger enforcement suggested that such a low threshold would lead to increased scrutiny for transactions that are unlikely to generate competitive harm, especially since the procompetitive effects of the elimination of double marginalization are likely to far outweigh any tenuous anticompetitive concerns of a vertical merger. On the other hand, advocates for more stringent vertical merger enforcement, including a number of prominent U.S. Senate Democrats, argued that there was no principled justification for the 20 percent threshold, which they viewed as a safe harbor that in practice would likely become “a rigid screen, despite the agencies' original intentions.”
Ultimately, the provision referencing a specific market share was removed from the final Guidelines, leaving merging parties without any guidance as to where Agencies may draw a line based on market share.
While merging parties are expected to provide proof of alleged efficiencies, the burden of proof will mirror the Agencies' burden in proving competitive harm.
One of the more significant changes from January's draft Vertical Guidelines is the expansion of the section addressing how the Agencies evaluate the procompetitive benefits of vertical transactions. The January draft contained a relatively short section addressing how vertical transactions can lead to the elimination of double marginalization and some of the circumstances when the elimination of double marginalization may not be realized or considered merger specific. The final Vertical Guidelines contain a more robust discussion that includes two key additions to the January draft:
- First, if the merging parties want to rebut a claim of vertical harm, they must “provide substantiation for claims that they will benefit from the elimination of double marginalization.”
- Second, the guidelines seek to address a perceived asymmetry between the Agencies' burden of proof for alleging competitive harm and the merging parties' burden of proof to assert an efficiencies defense. Specifically, the Vertical Guidelines say that “[c]reditable quantifications of the elimination of double marginalization are generally of similar precision and reliability to the Agencies' quantifications of likely foreclosure, raising rivals' costs, or other competitive effects.”
This addition strikes a balance between the recent skepticism that vertical merger efficiencies are too often presumed to be significant and the need to allow merging parties to effectively assert efficiency claims for vertical transactions.
Continued silence on remedies may further suspicions of a rift between the Agencies over whether to require structural solutions to vertical concerns.
One criticism of the draft Vertical Guidelines released in January was the lack of guidance on the preferred remedies for vertical transactions that raise competitive concerns. The final Vertical Guidelines continue to be silent on this issue, leaving open to speculation whether the Agencies will continue to be amenable to the use of behavioral remedies to address vertical concerns. While the Agencies likely will continue to rely on their prior guidance on remedies released separately by the DOJ and FTC, as well as recent public statements from DOJ/FTC leadership, the lack of clarity will continue to frustrate merging companies and antitrust practitioners.
One plausible explanation for the omission is that the Agencies attempted to structure the Vertical Guidelines consistent with the framework of the 2010 Horizontal Merger Guidelines, which are largely silent on the appropriate remedies for transactions that raise competition concerns. By limiting both the Horizontal and Vertical Guidelines to analytical techniques that the Agencies use to evaluate transactions, the Agencies stand by the need for separate remedy guidance issued by the DOJ and FTC.
A slightly more skeptical explanation would be that the Agencies could not reach a consensus on the proper guidance for vertical merger remedies. Public statements of Assistant Attorney General Makan Delrahim make clear that the DOJ may be reluctant to accept behavioral remedies for vertical harms. In a 2018 speech at The Deal's Third Annual Corporate Governance Conference, Delrahim suggested that the only solutions to vertical concerns were structural remedies. “As I have previously expressed, where a reasonable probability of anticompetitive effects exists, the role of the enforcer is to eliminate the risk and let the markets dictate prices—not to design elaborate remedies that purport to reduce that risk while usurping regulatory powers. Structural remedies to an illegal merger, such as divestitures, substantially eliminate the risk of harm and preserve natural incentives for businesses to compete.”
On the other hand, the leadership at the FTC's Bureau of Competition has expressed a greater willingness to continue to entertain behavioral remedies as possible solutions to vertical transactions, if structural remedies are unworkable. For example, in a speech at the Credit Suisse 2018 Washington Perspectives Conference, the then Director of the Bureau of Competition said, “If we have a valid theory of harm, we start by looking at structural remedies for most vertical mergers. If that can't be achieved without sacrificing the efficiencies that motivate the merger, then we can look at conduct remedies.” These slightly different views have led to speculation among practitioners that there is a policy difference brewing between the Agencies. Forgoing this opportunity to issue joint guidance on the preferred remedies will further this speculation.
Dissenting opinions from Democratic FTC Commissioners suggest a Democratic administration would seek more rigorous enforcement of vertical transactions.
Notably, the FTC's two Democratic Commissioners, Rohit Chopra and Rebecca Kelly Slaughter, voted against the issuance of the new Vertical Guidelines. In separate dissenting statements, both argued that the Vertical Guidelines do not go far enough to combat the competitive harms of vertical mergers and support the belief that vertical mergers are presumptively beneficial. Commissioner Chopra expressed concern that the Vertical Guidelines did not sufficiently address the ways vertical transactions could theoretically suppress new entry. Commissioner Slaughter argued that the Vertical Guidelines over-emphasize the benefits of vertical mergers while ignoring recent economic thinking that the elimination of double marginalization may not be achieved in all vertical mergers.
These two dissenting statements are the latest in a series of dissents from Commissioners Chopra and Slaughter, most of which advocate for more aggressive antitrust enforcement. This dynamic suggests that if the Democratic candidate for president wins the election in November, a Democratic-controlled DOJ and FTC could be more aggressive in seeking to challenge transactions based on novel theories of competitive harm and may be even more willing than previous administrations to challenge vertical transactions.
The Vertical Guidelines released by the Agencies reinforce that vertical merger enforcement will be a more significant priority for both Agencies moving forward. The final version of the Vertical Guidelines can be found at: https://www.justice.gov/atr/page/file/1290686/download.
The Horizontal Merger Guidelines, which were last updated on August 19, 2010, can be found at: https://www.justice.gov/sites/default/files/atr/legacy/2010/08/19/hmg-2010.pdf.
Originally published 03 July, 2020
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