Is Vertical the New Horizontal for FTC Merger Enforcement? Recent Agency Challenges and the Way Forward

Is Vertical the New Horizontal for FTC Merger Enforcement? Recent Agency Challenges and the Way Forward

Client Alert

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Since March 2021, the Federal Trade Commission (FTC or Commission) has challenged three proposed acquisitions based on vertical competitive concerns. The parties in two of those transactions—Nvidia/Arm and Lockheed Martin/Aerojet Rocketdyne—recently announced that they were abandoning the deals.1

 Following Nvidia’s abandonment, the Commission announced that the “result is particularly significant because it represents the first abandonment of a litigated vertical merger in many years.”2  The last time a party abandoned a vertical acquisition after the FTC sued was nearly two decades ago.3  Indeed, over the past decade, the FTC brought only six cases based on purely vertical concerns and entered a consent decree to resolve each of them without litigation.4

The FTC’s recent challenges come at a time when the FTC’s Democratic commissioners have repeatedly articulated a focus on vertical mergers. In each case, the FTC acted unanimously to challenge the transaction, alleging that the acquisition involved the sole supplier (or, in Lockheed/Aerojet, the only non-vertically integrated supplier) of critical inputs for downstream competitors. Because these actions involved traditional vertical concerns, however, it remains uncertain how far the FTC will go in challenging vertical transactions based on novel or attenuated theories of competitive harm. And the FTC’s refusal to accept remedy proposals to address its competitive concerns may tell us more about the future than the challenges themselves.

We briefly discuss here the background for the three challenges and key implications of the FTC’s focus on vertical mergers.

The FTC’s Recent Challenges to Vertical Acquisitions

 On September 15, 2021, the FTC on a 3–2 split vote with the Republican commissioners dissenting withdrew the FTC’s and Department of Justice’s (DOJ) 2020 Vertical Merger Guidelines and Commentary. The majority stated that the 2020 Guidelines and Commentary included a “flawed discussion of the purported procompetitive benefits (i.e., efficiencies) of vertical mergers, especially its treatment of the elimination of double marginalization” and failed to address “increasing levels of consolidation across the economy.”6  On January 18, 2022, the FTC and the DOJ Antitrust Division jointly announced a process to develop new merger guidelines.7

Notwithstanding the split vote on withdrawing the Guidelines, each of the three vertical challenges over the past year have been based on unanimous Commission votes. On March 30, 2021, the FTC voted to challenge Illumina’s proposed acquisition of Grail.8  The FTC’s complaint alleged that Illumina was “the only provider of a critical input into [multi-cancer early detection] tests,” and it argued that Illumina’s acquisition of Grail, a major producer of those tests, would substantially reduce competition in the incipient market for multi-cancer detection tests.9  The challenge is currently pending before an administrative law judge.10

On December 2, 2021, the FTC voted to challenge Nvidia’s proposed acquisition of Arm Ltd. from SoftBank Group.11  The FTC alleged that Arm controlled critical intellectual property covering microprocessor designs and architectures that are the “de facto industry standard for CPU process technology.”12  It argued that Nvidia was “one of the world’s largest and most valuable computing companies,” and that a merged firm would have the capability to foreclose access to necessary intellectual property, raise rivals’ costs or disadvantage Nvidia’s competitors in graphics processing units for computing.13  In addition, the FTC claimed that Nvidia was incentivized to “skew [Arm’s] innovation in the direction of Nvidia’s interests,” which would result in a reduction in the amount of “new features or innovations.”14  On February 7, 2022, Nvidia and Arm announced that they were abandoning the transaction, citing “significant regulatory challenges.”15

On January 25, 2022, the FTC voted to challenge Lockheed Martin’s acquisition of Aerojet Rocketdyne.16  The FTC alleged that Aerojet was “the last significant independent, and in some instances sole, U.S. supplier of several critical missile propulsion products used as inputs in multiple weapon systems.”17  It further alleged that as Lockheed Martin was “the world’s largest defense contractor,” it would have “the ability and incentive to foreclose access to, or raise its rivals’ cost for, [Aerojet’s] Critical Propulsion Technologies.”18  On February 13, 2022, Lockheed Martin and Aerojet announced that they were abandoning their proposed deal, citing the FTC’s challenge as the basis for the abandonment.19

Implications of the FTC’s Recent Vertical Merger Challenges

The FTC’s recent vertical merger challenges and, perhaps more importantly, the Democratic commissioners’ statements condemning traditional approaches to vertical merger enforcement have important implications for firms contemplating vertical transactions or potentially complaining to the FTC about a vertical deal.20

  •  Parties contemplating transactions that integrate a dominant input supplier with an important downstream competitor should expect a substantial FTC investigation and a potential challenge and should be ready to demonstrate why the merged firm would lack the incentive or ability to raise the costs for or refuse to supply downstream competitors.
  • It is much less clear how the FTC will approach vertical transactions that do not fit that mold. Although we expect that the FTC will be aggressive—at least once its Democratic majority is restored—it remains to be seen how it will approach vertical transactions that raise other types of potential issues (e.g., customer foreclosure or information exchange concerns) or involve input suppliers that are not as dominant as the upstream firms in the three recently challenged transactions allegedly are. But firms should assume that the FTC may seriously investigate these types of transactions and should be ready with well-supported arguments to address potential FTC concerns. At the same time, parties contemplating mergers should not overlearn the lessons from the recent challenges or FTC commissioner statements. Many vertical mergers will not receive in-depth investigations or be challenged, and effective advocacy based on well-supported facts can still pay off with a clearance or—if necessary—a litigation win.
  • In each of the recently challenged transactions, the parties had proposed behavioral remedies to address FTC concerns, but the FTC rejected those proposals. The FTC’s rejection of behavioral remedies may be more telling than the challenges themselves, which were based on traditional vertical theories. Firms must expect that there is a very good chance that the current FTC will not agree to resolve a challenge through a behavioral remedy—e.g., a commitment to supply downstream competitors on nondiscriminatory terms and an information firewall—that the FTC had a track record of accepting until recently.21  This strong possibility will typically substantially increase the business risk of a deal that the FTC might challenge on vertical grounds—there may be no remedy short of a divestiture that the FTC will accept. Parties need to expect that they may well have to litigate, rather than settle, if the FTC votes to challenge their deal. It remains to be seen whether the courts will accept FTC challenges based on novel or attenuated competitive concerns.
  • In its statement withdrawing the 2020 Vertical Merger Guidelines, the Democratic FTC majority strongly criticized prior FTC merger reviews for being overly deferential to efficiency claims for vertical mergers, especially claims based on eliminating double marginalization.22  Parties considering vertical mergers should work to develop a compelling, well-supported efficiency rationale for the transaction and be prepared to show how those efficiencies will benefit consumers. The FTC might ultimately credit a strong efficiency in deciding not to challenge the transaction or potentially to accept a behavioral remedy. And even if the FTC does not accept efficiency claims, a court might be more receptive.
  • Although the DOJ’s Antitrust Division has not brought a purely vertical case since the unsuccessful challenge to AT&T’s acquisition of Time Warner in 2016, we expect that it will also aggressively investigate and challenge vertical transactions. The DOJ has not withdrawn the 2020 Vertical Merger Guidelines, but on the same day that the FTC withdrew them, the DOJ announced that it was reevaluating them.23  And on the same day the DOJ jointly announced with the FTC a process for developing new merger guidelines,24  Assistant Attorney General Jonathan Kantor stated that the 2020 Guidelines “overstate the potential efficiencies of vertical mergers and fail to identify important relevant theories of harm.”25
  • Parties pursuing vertical acquisitions that may prove controversial are well advised to seek input from antitrust counsel and economists early in the process in order to assess the competitive landscape, advise on potential antitrust risk, and help to develop evidence and advocacy to use at the FTC—or in court if necessary. Although the FTC has long brought vertical cases on occasion, such cases may well become much more common and be based on new theories or less-compelling facts than cases that the Commission has brought in the past.
  • Competitors or customers that have concerns about a vertical transaction should consider potentially complaining to the FTC, particularly given the Commission’s aggressive enforcement stance. Complaints are more likely to be successful when well supported by facts and advocacy from a complainant’s actual business experience.

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