ABA Section of Business Law

Business Law Today
September/October 2001 (Volume 11, Number 1)

Sharing before the deal is done
Information exchanges and antitrust

By Debra J. Pearlstein and Adam C. Hemlock

It's the Monday morning after a grueling two weeks of late-night meetings. Your company has been in intense negotiations to acquire a competitor that will bring new customers and an experienced workforce to your business. Finally, after agreeing on valuation, the parties signed the deal this past weekend. The closing of the deal will take a couple of months to allow for further due diligence and regulatory clearance.

You get a phone call from the VP of sales, who wants your OK to start working with her counterpart at the target firm to coordinate integration of the two sales operations and begin harmonizing the respective firms' pricing policies.

While this type of communication may seem innocent and normal for two businesses in the process of merging, the reality is that communication like that described above can lead to major civil, and possibly criminal, antitrust liability. Even if the closing of the deal seems like a formality, information exchanges and coordination between parties prior to consummation of a merger or acquisition are still subject to the antitrust laws.

That is not to say that such information exchanges are prohibited - on the contrary, reasonable exchanges of information are necessary for the parties to properly conduct due diligence and agree on deal valuation; such exchanges are even permitted to a limited extent in order to plan for post-closing integration.
By following some simple guidelines for handling pre-closing information exchanges, in-house counsel and outside lawyers can effectively limit the antitrust risks associated with pre-closing M&A activity.

The Sherman Act (15 U.S.C. §§1 et seq.) generally prohibits agreements between companies that have an unreasonable anticompetitive effect on a relevant market. The most extreme examples of this proscribed conduct are horizontal price-fixing, customer allocation and other "hard-core" cartel activities. This "hard core" cartel conduct is a per se violation of the antitrust laws, meaning that it is illegal even without requiring proof of its actual effect on competition.

However, certain agreements and joint activities that are less injurious to competition are usually judged under the "rule of reason" standard. Under the rule of reason, the procompetitive benefits of the conduct at issue are balanced against the anticompetitive effects, and only if the overall effect of the activity is anticompetitive is the activity deemed to violate the Sherman Act.

Information exchanges are generally judged under the rule of reason, and are not themselves per se illegal. Courts have found information exchanges to be against the antitrust laws, however, when the nature of the industry (such as high concentration or easy interchangeability between competitors' products) is such that information exchanges are likely to facilitate an unlawful express or tacit agreement that has an anticompetitive effect on the market.

The federal antitrust pre-merger clearance process also plays a role in whether and when information can be exchanged pre-closing. Under the Hart-Scott-Rodino Act, parties to transactions that meet certain size-of-person and size-of-transaction thresholds are required to file notification with the Federal Trade Commission and Department of Justice, and are prohibited from closing the transaction until a waiting period expires. The HSR waiting period is often 30 days or less for deals with little or no competitive effect. However, large transactions between meaningful competitors in the same product market may trigger government investigations with review periods lasting months.

The key point to remember is that, until the transaction closes, the antitrust laws treat the two parties to the deal as independent companies. Thus, even though both sides of the deal may have the good faith intent to consummate the transaction, they are still independent entities that are legally capable of engaging in unlawful joint activity.

This may be a nuisance to business people, who are often eager to begin integrating the two companies and stop thinking of the merger partner as a "competitor." However, until the deal closes and the two entities legally become one, the companies must continue to treat each other as competitors and not seek to intrude on each other's independent operations.

Federal antitrust officials have made clear in speeches that they would bring a challenge to pre-merger information exchanges under appropriate circumstances.
So now, some guidelines for information exchange:

Setting the stage - Prior to any exploratory talks or meetings between prospective parties to a transaction involving competitors, in-house counsel should sensitize the negotiating executives to antitrust considerations and their application to communications between competitors. Executives participating in such discussions should fully understand the limits on the type and use of information to be exchanged, as well as the risks involved if appropriate guidelines are not followed.

The parties often sign a confidentiality agreement that requires each party to hold confidential the information exchanged, and not to use it for any purpose other than the negotiations. During communications between potential merger partners, it should be made very clear that, if the deal is not consummated, there is no agreement or understanding whatsoever between the parties relating to any future operations of the two companies.

Executives also should be sensitized to the fact that communications between the prospective merger partners, especially written documents, may be discoverable by the government (in an antitrust investigation) or by private parties (in private civil litigation), so they should be careful concerning how information about or descriptions of the deal are memorialized.

What kinds of information can be exchanged? The general rule is that the information exchanged prior to signing a definitive agreement should be only that reasonably necessary for the legitimate purposes of due diligence and deal valuation. For example, in order to confirm the value of the acquired firm's assets, it is reasonable for that firm to provide an appraiser's report.

However, the provision of the details on the target firm's upcoming bid on a project for which it is competing with the acquiring firm is clearly not reasonably necessary to determine the value of the assets, and would result in material antitrust risk.
Once the deal is signed, it may be OK to exchange some information for the purpose of planning integration (but not to begin integration). Subjects that might be appropriate to discuss at this juncture include management organization, management information systems (such as computer systems compatibility), use of office space and other facilities; high-level fixed costs (but not variable costs specific to product areas in which both companies compete); and areas of potential cost savings for the combined companies.

However, while these subjects are usually safe for discussion prior to closing, they still should be handled under the guidelines discussed (that is, with appropriate procedural safeguards and monitoring by counsel).

The parties should also attempt, whenever possible, to limit the exchange of competitively sensitive information. Depending on the industry, this can include information regarding pricing; production or selling costs; profitability; current or prospective customers; market shares; methods of distribution; and strategic plans that will be pursued independently if the transaction is not consummated. The sensitivity of these kinds of information also depends on other criteria discussed here, such as the timing of the disclosure and the persons receiving the information.

Safer exchanges usually involve information regarding tax liabilities, human resources (but not detailed wage/salary information), regulatory compliance, valuation of assets, projected synergies and efficiencies as well as projected revenues and profitability for the combined business (but not tied to specific products, customers, markets or pricing decisions).

The parties can also reduce antitrust risk by exchanging aggregated data rather than individualized data (for example, exchanging aggregated information on sales made over the last three years rather than data on individual transactions).
What is the purpose of the information exchange? Certain information may be exchanged between two prospective merger parties when the purpose of the information exchange is legitimate. A purpose is legitimate if it is reasonably necessary in order to carry out the lawful objectives of the transaction.

The two most common purposes of such communications are due diligence and valuation; if there is a circumstance where information is required for another purpose, it should first be cleared by antitrust counsel. Also, unless the transaction is a pure merger (rather than an acquisition by one party of another), the information flow should generally be one way from the target to the acquiror (rather than both parties providing and receiving information).

However, to the extent that the consideration for the deal is the acquiring firm's stock, the target firm may wish to conduct due diligence to verify the stock's value.
One of the most obvious illegitimate purposes of pre-merger information exchange is to coordinate pricing or engage in other joint activities. As described more fully below, while the parties may discuss plans for integrating operations and exploring how to jointly coordinate their businesses, the parties to the transaction should not begin actual coordination of management or operations until the deal is done. In this regard, exchanges of information that would facilitate such coordination must be handled with the appropriate safeguards.

Counsel also should be aware of the possibility that merger talks may be initiated by a party with the intent to acquire confidential or proprietary commercial information, which can lead to liability under fraud, trade secret, and possibly other laws.
Finally, the most extreme illegitimate purpose of merger discussions may be to cloak efforts to facilitate price fixing or other cartel activity when no merger is actually intended. Counsel discovering such "sham" merger discussions are well-advised to proceed with great caution and sensitivity, as government officials have warned against such conduct and there is a serious potential for criminal liability for the companies and any participating individuals.

Who is receiving the information? Antitrust risks can also be mitigated by selecting a limited number of persons to view and handle exchanged competitive information. As a general principle, information exchanges should be limited to senior executives who are immediately responsible for negotiating or approving the transaction, and outside lawyers and consultants who have entered into appropriate confidentiality agreements.

Commercially sensitive information should be limited to outside lawyers and consultants, who can often "filter" the information and relay it to business people in an aggregated format. However, this also depends on the sensitivity of the information, and certain information that is not competitively sensitive may be provided to more people.

Another option is to create a "clean team" of employees who have access to exchanged information but are limited in how they may use or communicate the information to other employees in the company. The advantage of this approach is that the reviewers of the information can be people who are experienced in the relevant business (as opposed to outside lawyers, who may not be as sensitive to certain business issues).

The clean team can review information received from the other side and prepare summary reports based on such information (but not provide the information itself). However, an employee's participation on the clean team may make that employee unavailable, for a period of time, to participate in areas of the business where knowledge of the exchanged information may affect their decision making on pricing or other key aspects of competition.

How will the information be treated? The method by which information is exchanged between the parties is also important for purposes of limiting antitrust risk.

The first step is for the parties to enter into a confidentiality agreement. The agreement should make clear that any information exchanged shall be used solely for purposes of evaluating the transaction. The confidentiality agreement should set forth procedures for the identification and delivery of the information (including creating one or more "levels" of confidentiality, depending on the sensitivity of the information exchanged). Each party should agree to use the information solely for the legitimate purposes of evaluating the transaction and conducting due diligence, and the information should be returned or destroyed once the legitimate purpose has ended.

Antitrust counsel for the two parties may also enter into a joint defense agreement among themselves so that they may exchange competitively sensitive information for use in their analyses and, if and when the Department of Justice or Federal Trade Commission investigates the deal, in any joint defense of the transaction.

When will the information be exchanged? While lawyers and executives should be attentive to antitrust issues during the entire M&A process, to some extent there is a "sliding scale" of sensitivity over the life of the deal. In other words, information that should not be exchanged today might be disclosed between the parties later in the planning process, as consummation of the merger gets nearer in time, as baseline issues are resolved and the need for more detailed coordination increases, and as any areas of potential government concern have been narrowed.

The period of negotiations leading up to the signing of the agreement requires the most sensitivity to antitrust issues. Due diligence may be conducted during this time, but appropriate guidelines should be in place and antitrust counsel should play an active role in monitoring and structuring the communications. Once the deal is signed and the fact of the transaction is "public," broader information exchanges may be permitted for the legitimate purposes of greater due diligence and valuation, as well as some planning for post-consummation integration.

There is still a period of risk in information exchange after due diligence is completed and valuation is settled, but before consummation of the deal. This is especially the case if the Hart-Scott-Rodino waiting period is in effect (that is, the government's investigation is pending). During this period, the parties' desire to plan for integration is at odds with the antitrust goal of maintaining independent, competitive operations.

However, to the extent that the information exchanged is not competitively sensitive (such as information necessary to integrate the two companies' back office operations), and the information is distributed to the appropriate personnel, communications between the parties need not be completely terminated during this period.

In addition, joint or coordinated communications with customers may be permitted, as long as the parties make clear that they will continue to sell to the customers independently prior to consummation.

How will the information be exchanged? The parties to the transaction can reduce the risks associated with information exchanges by formalizing the logistics of the exchanges. This can be done by first limiting the number of exchanges - the fewer the exchanges, the better. There should be designated contact persons on each side who are responsible for sending and receiving information, and these people should be well aware of the guidelines for the use and distribution of that information. Exchanges of information should be "formalized" - they should be accompanied by cover letters listing the information they contain, the level of confidentiality that should be applied to the documents, etc.

If meetings are held to exchange information verbally, then an agenda should be agreed to beforehand and adhered to during the meeting. Meetings at which competitively sensitive issues may be raised should be attended by antitrust counsel. Also, employees should keep "communication logs" to keep track of each communication with the other side.

Counsel to parties participating in a M&A transaction must also be alert to attempts by the acquiror to exert control over the acquired entity prior to the consummation of the deal. Subsequent to the signing of a deal but prior to the closing, the acquiror is often eager to begin integrating the target firm and exerting control over its management. The antitrust laws generally do not permit two competitors to coordinate on price or other competitive criteria.

The mere fact that the parties are going to merge (but have not yet done so) does not give the two companies license to begin coordination on market activities. Thus, separate and apart from the problems of controlling information exchanges, lawyers for both sides need to make sure that the companies operate independently until closing.

There have been cases where U.S. antitrust authorities have brought enforcement actions against parties that "jumped the gun" and began coordinating their operations prior to closing of the deal.

A recent example is U.S. v. Laitram Corp., where the acquiror (Input/Output Inc.) began to exert control over the acquired company (DigiCOURSE) prior to the end of the waiting period and closing of the transaction.

Among the steps taken to exercise control over DigiCOURSE, the FTC cited an internal Input/Output memo announcing the reorganization of Input/Output and assigning DigiCOURSE officers to positions within Input/Output. The FTC claimed that at least three other individuals from DigiCOURSE's Houston sales office moved into Input/Output's offices.

The FTC also alleged that the president of DigiCOURSE was consulted by Input/Output officers and asked to review and comment on the possible acquisition by Input/Output of another company in the same industry. Input/Output and DigiCOURSE each paid $225,000 in civil fines following a consent decree and settlement with the FTC.

It is important to note that the FTC and DOJ could bring such a claim regardless of whether the waiting period had terminated; the issue here was whether the parties violated the Sherman Act (not necessarily whether they violated any Hart-Scott-Rodino rule).

Merging parties can avoid material antitrust risk by keeping mindful of the guidelines outlined here. While these antitrust guidelines should be followed, it is also true that antitrust considerations should not get in the way of legitimate transactions - while the antitrust laws may require some vigilance by lawyers and parties on M&A deals, it is difficult to conceive a situation where legitimate, reasonably required exchanges of information cannot be handled appropriately without creating material antitrust risk.

Finally, merging parties should maintain their independence and remember that they are not one entity until the deal closes. With careful counseling and appropriate participation by antitrust lawyers, companies can avoid antitrust risks during their M&A deals.

Pearlstein is a partner at Weil, Gotshal & Manges LLP in New York City. Her e-mail is debra.pearlstein@weil.com. Hemlock is an associate at the same firm. His e-mail is adam.hemlock@weil.com.