Sorting Out Shifts in European Merger Control: Proposed rule revisions may be friendly to American acquirers.

Former General Electric Co. CEO Jack Welch learned not to take European deal regulators for granted the hard way: Mario Monti, European Competition Commissioner, shot down GE’s bid to buy Honeywell Inc. in 2001. But three court defeats in merger cases last year – the first-ever reversals of the commissioner’s decisions – chipped away at some of Monti’s clout. In response, the commissioner and his minions proposed a series of reforms in their rules for reviewing deals. Along with other proposals, Monti issued a draft Commission Notice on assessing dominance, the central test by which the European Union rates a deal’s effect on competitiveness in a market or industry on the Continent. The changes in the draft Commission Notice presently apply only to horizontal mergers – deals that link competing producers. Rules for vertical and conglomerate deals will be issued later this year. However, there is a sharp debate among competition experts at the commission’s home base in Brussels and elsewhere over whether the changes are window-dressing that in some cases actually strengthen Monti’s hand or sincere attempts at reform of the regulatory system. “The Commission has learned its lesson. It has tinkered with the formula. It’s quite ingenious. Now they will have more power to strike down mergers and have less chance of being overruled,” said Pontus Lindfelt, a competition attorney at White & Case in Brussels. While there had been speculation about dramatic reform, which might have created some kind of independent review of the commission’s decisions, that was not part of the new proposals. Instead, the commission will continue to play the role of prosecutor and judge. And in redefining dominance, the commission chose to stick with its traditional yardstick for evaluating mergers. “Fundamentally, the commission will be using the same process, but with some tweakings,” said Simon Baxter, a Brussels-based lawyer at Clifford Chance who follows mergers. But even as many competition lawyers concurred that the effect of the changes won’t be earth-shattering, others recommended that dealmakers pay close attention to the new approach. “What they’ve changed is more procedural than substantive, but procedural changes can have a lot of practical significance,” notes Barry Hawk, a competition lawyer at Skadden Arps Slate Meagher & Flom. Although it may seem that some of the European initiatives are only variations on existing policies, it behooves U.S. dealmakers to take these changes into account if they are involved in deals – both at home and overseas – that will be reviewed in Brussels. Acquisitions by American firms, even if the target also is a U.S. company (such as in the GE/Honeywell arrangement), fall under the European Commission’s ambit if they have a significant impact on competition on the Continent. However, preliminary views by some competition experts suggest that the revised rules might favor American firms buying abroad. The Motivation The stinging rebukes Monti and his Merger Task Force (MTF) received from the body that reviews the commission’s merger decisions, the Court of First Instance (CFI), were at least partially responsible for the reform package unveiled in December 2002. RBB Economics, a London-based economics consulting firm, said in a report on the commission’s guidelines about the assessment of dominance in horizontal mergers, “The proposed reforms cover not only procedural issues but also substantive ones, and an integral part of this reform process is the improvement of the quality of the economic analysis conducted by DG Competition (the commission’s competition bureau).” “CFI didn’t attack the commission’s arguments as much as it said they had to work more carefully,” says Ky Ewing, a competition expert at Vinson & Elkins in Washington, D.C. Judicial reviews of the three cases, Airtours-First Choice, Schneider-Legrand, and Tetra Laval-Sidel, were highly critical of the MTF’s internal procedures. In Airtours-First Choice, the commission argued that the newly combined company and its two rivals in the U.K. package tour business would have reached a dominant position. The court found the commission hadn’t met the conditions needed to establish dominance. In Schneider-Legrand, the Commission said that the merger of the two electrical equipment manufacturers was incompatible with a common market. It said that as a result of the companies’ high market shares and Schneider’s strength in northern Europe combined with Legrand’s strength in southern Europe, the pact was anticompetitive. The court ruled that the commission’s decision was not logically convincing. In Tetra Laval-Sidel, the commission held that the combination of the packaging companies would become anticompetitive by 2005 because of the likelihood that the merged company would become dominant by leveraging its strength in aseptic carton packaging into other packaging markets. The CFI found fault with the commission’s method of evaluating the possibility of such anticompetitive behavior. The Airtours and Schneider decisions, which were handed down in October 2002, led Monti to appoint Philip Lowe, his Director General of Competition, to the additional post of Deputy Director General for Mergers. In that position, Lowe began to oversee the workings of the MTF. “Airtours was a devastating decision because of the way the court reversed the commission,” Hawk said. He added the MTF had become powerful in the competition bureaucracy and had come to expect a generally tolerant review from the CFI. On Schneider-Legrand, competition attorney Christopher Norall, a partner in the London office of Morrison & Foerster, said in a report that one lesson to be drawn from the case is, “The commission cannot simply ignore the facts and construct an abstract theory of competitive harm without providing any specific evidence for its allegations.” Speaking at the European Commission-International Bar Association conference in Brussels last November, Monti said, “Indeed, there are no doubt lessons to be drawn from the judgments; in particular; it is clear that the CFI is now holding us to a very high standard of proof and this has clear implications for the way in which we conduct our investigations and draft our decisions.” One bright spot for the regulators was that in the Tetra Laval-Sidel case, the CFI did endorse the MTF’s view that conglomerate mergers, including those that involve bundling or leveraging, fall within the purview of the current merger regulation. Leveraging is a company’s use of market power in a market in which dominance already exists to achieve illegal control in another market. It was part of the justification for rejecting the GE-Honeywell deal, i.e., GE’s huge financial services businesses gave the company an unfair advantage in competing in the aerospace business. However, the CFI found in Tetra Laval-Sidel that the commission was guilty of “manifest” mistakes in analysis and was unable to establish that a dominant position would be created. The U.S. Department of Justice has also, in general, criticized the use of leveraging arguments to reject deals. Attempts to contact commission officials for comment about the rules changes were unsuccessful. The Changes Monti introduced the package of reforms at the European Commission conference in November. He said that the package would be “the most far-reaching reform of European merger control since the adaptation of the EC Merger Regulation in December 1989.” Some of the reforms are administrative and already have been put in effect. Those that require legislative action are expected to be enacted by the end of 2003. Speaking at the same conference, Lowe commented on the central importance of the merger review process in the European Union, saying, “They (discussions about the revisions) go to the heart of the values which underpin our system of merger control in Europe. This system is an expression of one of the most fundamental tenets of the European Union – that is, the principle of an open market economy with free and fair competition.” Monti’s package of reforms includes publishing for the first time a draft set of best practice guidelines on the conduct of merger investigations. “Putting the guidelines out there, as U.S. agencies have done for some time, will help companies’ advisers as they try to predict how the commission. will react to proposed mergers,” said Charles Stark, a competition lawyer in the Brussels office of Wilmer, Cutler & Pickering. Among the changes Monti has suggested are the extension of the merger review timetable by up to seven weeks in an attempt to introduce more flexibility for the MTF and its applicants. It will also give the commission’s deal-handlers more time to consider proposals for remedying any anticompetitive effects that are put forth by merging parties. Another change in the deadlines for deals will allow parties to request three weeks to be added to Phase II of merger reviews, the phase for reviewing deals that face potential challenge. The commission also will have the right to ask parties to agree to add up to four weeks to the Phase II review in complex cases. Monti also said the commission will introduce a number of steps designed to increase the transparency of its internal decisionmaking process. One step will be the creation of a system of devil’s advocate panels, overseen by Lowe, which will give second opinions on the findings of deal team research. These panels will be staffed by DG Competition staffers outside of the MTF. In another move toward increased transparency, the commission will allow companies to look at the MTF’s file soon after the transaction moves into Phase II. Parties will also be allowed to examine submissions from opponents of the deal before the commission issues its statement of objections. “I really like the changes that enhance the parties ability to defend their points of view. It will be useful for parties to be able to access the agencies’ files and for the merging parties to see what complainants have said against the deal,” said George Addy, an antitrust lawyer at Davies Ward Phillips & Vineberg in Toronto. The proposals also will provide more professional staff support for the commission’s hearing officer, whose job is to ensure that the rights of merger parties are upheld. Another innovation is the establishment of a chief economist’s office that will review the work of the MTF deal teams to guarantee that its decisions are based on solid economic theories. Lowe said that the occupant of this newly created position would provide guidance on methodological issues of economics and assistance on individual cases. On complex cases, a member of the chief economist’s team may join the MTF’s case team in reviewing a potential merger. Ewing said the creation of a chief economist is an important development because it signals that the commission is moving closer to the U.S.-style of a more thorough economic analysis of deals. In addition, Monti’s package of reforms will allow member states to play a larger role in merger control. It will allow the advisory committee of member state representatives access to the commission’s files and permit them to take part in meetings with the merging parties from the start of a Phase II investigation. At present, the merger regulation calls for the commission to consult with the member state representatives, but the process has been criticized as being little more than a rubber stamp. Discussing another nuance in the relationship between member state regulators and the MTF, Steven Newborn, Washington-based global head of antitrust at Clifford Chance Rogers & Wells, said one of the little noticed things in the Monti-Lowe package of reforms is an increased freedom for Brussels to refer cases to member countries and for member countries to refer cases to Brussels. “There is a loss of certainty about where your deal will be reviewed. This means that you have to make sure you are putting forth an integrated approach to supporting the deal,” he stated. In making this point, Newborn reiterated an observation made by Kevin Arquit, formerly with White & Case but now with Simpson Thacher & Bartlett, in the September 2001 issue of Mergers & Acquisitions. Discussing the commission’s thumbs-down verdict on GE-Honeywell, Arquit had said, “What it says is that when you are putting together your arguments for one jurisdiction, you have to be aware that the very argument that gets you off the hook in one jurisdiction may put you on the hook in another.” While Arquit was comparing U.S. and European approaches and Newborn was addressing the need to make pleadings appropriate for both Brussels and individual European national authorities, the message is the same: Practitioners must create one-size-fits-all arguments, especially on complex deals that are likely to get the most intense going-over. Overall, Stark said that the net result of the changes is that there will be less risk that mergers will get struck down by theories that aren’t supported by the facts or by theories that don’t have solid support in mainstream economics. Rejecting SLC The biggest thing that the Monti-Lowe proposals left alone was the primary test of whether a merger is anticompetitive. The commission decided to continue to use its “collective dominance” rule instead of moving to the “substantial lessening of competition” test that is the norm in the U.S., England, Australia, Ireland, and elsewhere. “Dominance clearly captures the situation of several firms acting as one by co-coordinating their behavior,” said John Vickers, Director General of the Office of Fair Trading, Britain’s mergers watchdog, in a speech last year. But he questioned whether the dominance theory is able to capture all-important instances of “unilateral effects.” These are circumstances in which firms continue to act independently, and without coordination, but substantially less competitively as a result of a merger. The debate over lessening of competition versus collective dominance matters because one of the commission’s additions to the new horizontal merger guidelines is an attempt to close an alleged gap in the existing dominance test. The commission proposed a new category of “non-collusive oligopoly” and “unilateral effects,” which might proceed from such a structure as a reason to block a merger. According to the commission, “a non-collusive oligopoly is a merger that may diminish the degree of competition in an oligopolistic market by eliminating important competitive constraints between the merging parties.” Dereck Ridyard, a principal at RBB Economics, said that the introduction of non-collusive oligopolies implicitly widens the scope of mergers that the commission may challenge. “Using this new category could make merger control much stricter. We do have potential concerns about what they are doing here,” he said. If the purpose of the broadened rules is merely to plug a gap in the existing merger regulations that will make “collective dominance” more workable, few commission-watchers would object. But from Lindfelt’s perspective, the rule change has a more utilitarian purpose: to protect the commission from further judicial reversals. “By changing the formula for which companies can be seen to be creating or strengthening a dominant position, the commission will now be able to apply the dominance test to non-collusive or oligarchic situations,” he said. He added that political realities now will dictate that the commission be more careful as it considers challenging deals. But Lindfelt said that the commission would have more power to strike down mergers and less chance of being overruled under the new horizontal merger guidelines. For his part, Monti said at the conference that the court setbacks would not slow down the commission, noting, “Let me reassure you that, if the Commission reaches the conclusion that a merger is likely to give rise to serious competition concerns, it has a duty to intervene and will continue to do so.” But some competition experts see a more cautious approach in the commission’s handling of the merger of Carnival Corp. and P&O Princess Cruises PLC, a major consolidating deal in the cruise ship industry that was approved in January. “The cruise merger shows a dry run of the new arrangements,” Ridyard said. “Half way through, the commission opened up its case to the parties,” he said. In a press report, a former commission Competition Chief, Claus-Dieter Ehlermann, suggested that the commission’s decision to clear Carnival/P&O Princess despite strong initial reservations might be a sign of a new hesitation to tackle difficult deals. Lessons for U.S. Dealmakers Monti’s package of reforms will make it easier for U.S. companies to match up the requirements of U.S. and European Union regulatory regimes, according to Michael Reynolds, a competition specialist at Allen & Overy in Brussels. He said that the new regulations would bring the process more in line with Hart-Scott-Rodino timetables in the U.S. He added that the elimination of the commission’s “guillotine” time limits, which had prevented companies from reaching settlements because they ran out of time, will also help companies get their mergers approved. From Stark’s perspective, the commission’s actions will help to offset “a concern we had been hearing from companies considering a merger that their deal might get killed by overenthusiastic merger enforcement.” He said that the commission’s package of reforms made some policy shifts in analysis that will bring them more in line with mainstream U.S. economic theory. But competition experts caution that the reform package is still fluid and may be further adjusted. In addition, one competition specialist, Malcolm Nicholson, an attorney at Slaughter & May in London, said, “The fine tuning can make a difference. It’s more important how the rules are applied than how they are proposed.” Copyright 2003 Thomson Media Inc. All Rights Reserved.