United States Anti-Trust Rules

In the United States antitrust laws have their origin in the Sherman Act of 1890, which had two principles:

1. All contracts, combinations and conspiracies that restrain trade are prohibited.
2. Conspiracies to monopolize a particular market are prohibited.

Violation of these provisions are punishable. The Sherman Act was ineffective at first because courts interpreted it very broadly and ruled that it was worded so that all contracts would be barred if it were implemented. In 1914, the government responded to this problem through a new law, the Clayton Act. Initially, the Clayton Act addressed only the acquisition of stock in a corporation if the effect was to reduce competition; asset acquisitions were not covered. The act was amended when the loophole began to be exploited. The criteria used to determine whether a merger is anticompetitive were defined in Section 7:

No corporation shall acquire the whole or any part of the stock, or the whole or any part of the assets, of another corporation where in any line of commerce in any section of the country the effect of such an acquisition may be to substantially lessen competition or tend to create a monopoly.

Clayton Act, Section 7

Further improvements in the antitrust treatment of mergers were made by the Hart-Scott-Rodino Antitrust Improvements Act of 1976, commonly abbreviated as HSR. It established the principle that mergers must be reviewed in advance by the FTC and the DOJ. Prior to HSR, the government was in the difficult position of having to disapprove mergers after they had been completed already. This led to the logistical nightmare of having to disassemble merged companies, which was difficult and took a long time to litigate. In the meantime, the merged company was benefiting from its anticompetitive behavior. Since HSR, the government no longer approves mergers after the fact; instead, it gives clearance so that the merger can close.

Under HSR, all mergers above a certain threshold must make a notice filing. The threshold for transaction value increases every year with growth in GDP; it was $76.3 million for fiscal 2015. A second threshold considers the size of the entities: assets or sales in excess of $152.5 million. The FTC and DOJ then decide among themselves which agency will review a given transaction. They must make up their mind whether to challenge the transaction in a set period of time. For all-cash offers, the regulators have 15 days to review the filing; in stock-for-stock offers, 30 days. During this waiting period, the transaction cannot close. If the government does not oppose the transaction, it will either grant early termination of the waiting period or let the period expire unchallenged. Early termination notices are posted on the FTC's website.¹ In stock-for-stock transactions, both firms must supply the required information.

If antitrust concerns are raised in the government's review, the merger will be investigated in more detail. In this process, the agency that reviews the merger asks the company to supply it with more documents voluntarily. The government also conducts interviews with customers and competitors to get a better understanding of the products involved. The typical investigation that leads to no subsequent action lasts 57 days.² If this still is not sufficient, the government requests “additional information and documentary material relevant to the proposed acquisition.” These are also known as second requests and are dreaded by arbitrageurs. A second request leads to a widening of deal spreads because the market perceives the risk of a challenge by the government as having increased significantly. Companies can avoid a second request by withdrawing the initial HSR filing and refiling it with additional information. This will reset the waiting period and avoids the bad publicity of a second request. Second requests often are issued in the last week of the HSR waiting period. The government tries to make full use of the allotted time to avoid unnecessary requests.

Antitrust insiders claim that the government benefits in its investigation often from information that is volunteered by competitors or customers of the merging firms as soon as the merger has been announced publicly.

Most second requests proceedings are resolved amicably between the government and the merging companies. In the best-case scenario, the companies will furnish additional information that clarifies the government's concerns. Other second requests can lead to protracted negotiations. The merging firms often come to a settlement with the FTC or DOJ whereby they agree to divest certain divisions of one of the firms prior to closing the transaction. Exhibit 12.2 shows the announcement of the FTC about the intended sale of some of Fidelity National's subsidiaries in Oregon to remediate concerns about competition upon its merger with Lender Processing Services.

A second request always leads to delays in the closing of the merger and increases costs. The FTC typically requests large amounts of data that can amount to millions of pages of documents. The merger cannot be completed until 20 days after both parties have complied with the second request. In the case of a cash merger, that period is shortened to 10 days. The average time period needed to resolve a second request is 157 days.³ Similarly, data from research firm Arb Journal suggest that over the period from 2002–2010 second requests for public company mergers took on average 172 days to be resolved.

Table 12.1 shows the statistics of HSR filings and second requests from 2004 through 2013, as well as enforcement actions. Only in roughly 1.5 percent of HSR filings will the government issue a second request. This figure reflects a large number of filings of smaller mergers that have no competitive implications at all. However, once a second request has been issued, the risk of regulatory action is very high. In roughly two-thirds of all second request cases, the process reaches the point where the government files a lawsuit to block the merger. Once legal action begins, the deal is dead for practical purposes. Resolution of the litigation can take a long time and will be costly. Therefore, the parties to a merger usually terminate the deal once the government challenges it.

^* Fiscal year 2013 covers the period of October 1, 2012 through September 30, 2013

Sources: Federal Trade Commission, Department of Justice, “Hart-Scott-Rodino Annual Report. Fiscal Year 2013.” May 2014; Federal Trade Commission, “Competition Enforcement Database”

Litigation brought by the DOJ is heard in federal court. The DOJ will seek a judgment to enjoin the merger. In contrast, litigation brought by the FTC is initially heard by an administrative law judge. The decision of the administrative law judge is then reviewed by the FTC commissioners and can be appealed in federal court. The FTC's ruling comes in the form of a cease-and-desist order rather than an injunction.

The overriding principle is the question of market power and concentration. The first analysis is whether a merger increases concentration in the relevant market. A market is defined as

a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area likely would impose at least a “small but significant and nontransitory” increase in price, assuming the terms of sale of all other products are held constant. A relevant market is a group of products and a geographic area that is no bigger than necessary to satisfy this test.

Horizontal Merger Guidelines, U.S. Department of Justice and the Federal Trade Commission

This definition of a market is very vague, and regulators have a history of shifting definitions in unpredictable ways. The relevant market two dimensions: geographic and product reach. Product reach is defined by potential substitutes that consumer might use when faced with a price increase. The analysis will try to determine whether there is a group of products for which a monopolist can impose a nontransitory price increase. Consumers' price elasticity is the economic variable that is evaluated here. If consumers' demand is inelastic for a 5 percent increase in the price of the products of both merging firms, then there are potential adverse competitive effects in the product market. The geographic reach is determined analogously: What is the smallest region in which a price increase would not be transitory?

Once a market has been found, the concentration in that market is calculated through the Herfindahl-Hirschman Index (HHI). The HHI is the sum of the square of the percentage market share of each firm:

1

where

The HHI ranges from zero to 10,000, where the maximum of 10,000 is reached when one single firm has a market share of 100 percent. For a hypothetical market with perfect competition of an infinite number of firms each with infinitesimal market share, the HHI will approach zero. The higher the value of the index, the more concentrated the market is. Regulators will consider the anticipated HHI after the closing of the merger. Three threshold levels are relevant for government action:

1. HHI below 1,000 after the merger. There is no concentration.
2. HHI between 1,000 and 1,800 after the merger. The market is moderately concentrated. If the merger leads to an increase of more than 100 points in the HHI, there is a risk that it may be anticompetitive. An increase of less than 100 points is not considered to have competitive consequences. This allows for the merger of smaller participants.
3. HHI above 1,800 after the merger. The market is considered highly concentrated. Nevertheless, if the increase due to the HHI is less than 50, the merger is unlikely to have an anticompetitive impact. Such a small increase occurs when smaller market participants merge.

To put these levels into context, an HHI of 1,000 represents a market of 10 firms each having a 10 percent market share. An HHI of 1,800 corresponds to a market of 5 firms each with 18 percent market share, plus a large number of smaller firms with an aggregate market share of 10 percent.

Table 12.2 shows the government's investigation of mergers as a function of the change in the HHI and the level of the HHI in the industry following the merger. It can be seen that for mergers in highly concentrated industries, there are few closed cases, and the vast majority ends in enforcement. In contrast, for industries with a low HHI after the merger, the ratio of investigations that are closed without action relative to the ones that are enforced is much more balanced.

Source: Federal Trade Commission, Horizontal Merger Investigation Data, Fiscal Years 1996–2011, issued in January 2013.

Since 1984, the index levels are no longer adhered to mechanically but have become flexible guidelines. Qualitative factors are also taken into account now—notably, changes in market conditions and the degree of differentiation of products.

When analyzing the banking industry, where consolidation of banks on the local and regional level is common, a helpful tool is available to arbitrageurs that also serves to illustrate the workings of the HHI. The Federal Reserve Bank of St. Louis maintains a database of market shares of banks in regional markets named CASSIDI. It is accessible to the public and can be a useful tool in examining bank mergers. The data are based on Federal Deposit Insurance Corporation (FDIC) filings by banks and is usually 12 to 18 months old, so that any conclusions drawn should be taken with a grain of salt. The $5.1 billion merger between Hudson City Bancorp and M&T Bank is a good example of how the HHI and the CASSIDI tool work. An arbitrageur can use the CASSIDI system to calculate the HHI in different markets in which the merging banks operate. CASSIDI identifies only two overlapping banking markets for the two firms, one being the Metro New York City area, the other Philadelphia. Each of these markets is analyzed individually. For example, in the market of Metropolitan New York, the total HHI is 1,437 prior to the merger and is projected to decline by 25 points after the merger, whereas that of Philadelphia has a HHI of 1,028 pre-merger and would decline by only 5 points. CASSIDI's calculation for Metropolitan New York is reproduced in Table 12.3.

^† Deposits of thrift institutions are weighted at 50 percent, unless otherwise noted. Deposits of thrift subsidiaries of commercial banking organizations, however, are weighted at 100 percent.

^** Deposit data (in millions of dollars) are as of June 30, 2013, and reflect currently known ownership structure.

Source: Adapted from Federal Reserve Bank of St. Louis, CASSIDI™: Competitive Analysis and Structure Source Instrument for Depository Institutions. Run on September 21, 2014.

Following the merger of the two institutions, the HHI in this market increased by only two points to 1,374, as seen in Table 12.4. Therefore, no competitive threat exists and the banks are unlikely to have to dispose of any branches, much less see their entire merger threatened.

^* Deposits of thrift institutions are weighted at 50 percent, unless otherwise noted. Deposits of thrift subsidiaries of commercial banking organizations, however, are weighted at 100 percent.

Note: This transaction exceeds established merger guidelines, suggesting that it could have an adverse effect on competition in this banking market. Please contact the Buyer's primary federal banking regulator for more information.

Source: Adapted from Federal Reserve Bank of St. Louis, CASSIDI™: Competitive Analysis and Structure Source Instrument for Depository Institutions. Run on September 21, 2014.

Over time, other factors have been added to the evaluation of anticompetitive effects of mergers. Today, the DOJ will also consider the possibility of entry of new competitors, any efficiency gains from the combination that would offset any anticompetitive effects, and take the potential exit of one of the merger parties into account in the event that the merger were not to occur.

The enforcement of antitrust risk by the government is highly variable and depends on the current political situation as well as the individuals in charge of the DOJ and FTC. The effect of the addition of more and more factors to the analysis of anticompetitive effects of mergers probably has contributed also to the decreasing government antitrust activity this decade.

It is unclear whether regulators are preparing to become more aggressive. In 2007, the FTC failed to obtain a preliminary injunction to block the acquisition of Wild Oats by Whole Foods. Normally, regulators will stop litigating when courts refuse to grant preliminary injunctions, if only because a victory after the merger has concluded makes an unwinding of the combined entity difficult. In the Wild Oats/Whole Foods merger, however, the FTC continued to litigate and won an appeal in the middle of 2008. During the first quarter of 2009, the merged Whole Foods settled the litigation with the government by agreeing to sell 32 stores, mostly in Arizona and Colorado. The significance of this settlement lies in the breakup of a firm that had merged already. Such drastic measures had not been taken in decades and could be the harbinger of a new, more stringent, approach to the implementation of anti-trust laws.

International Anti-Competition Merger Regulation

The analysis of antitrust risk is complicated even more by the increasingly global nature of large corporations. As a result, antitrust concerns arise no longer just from U.S. regulators in U.S. mergers, but more frequently from foreign regulators when two U.S. firms have dominant market share in these foreign markets. One of the largest transactions to stumble over foreign antitrust enforcement was the aborted $115 billion merger of Sprint and MCI WorldCom in 2000. The European Commission (EC), which enforces antitrust laws in the European Union, blocked the transaction. Similarly, in 2001 the $40 billion of GE and Honeywell was blocked by the EC even though it had already been okayed by U.S. regulators.⁴

International antitrust issues can arise in transactions that look solid from a U.S. perspective. As companies become increasingly global, arbitrageurs will run into international antitrust issues more frequently. Antitrust enforcement is a risk not only in the major economies of the world; it also can become a problem if the merging U.S. companies happen to have a dominant position among each other in smaller markets abroad. The author was once invested in a transaction that suddenly was held up in a country in South America where the firm had a dominant position, even though this export market was a small fraction of the firm's overall sales. As globalization progresses, even supposedly domestic deals will increasingly have international implications.

In the European Union, merger control is exercised by the European Commission's Directorate-General for Competition in Brussels in the executive branch of the Union. While the ultimate decision to enjoin a merger rests with the competition commissioner, day-to-day enforcement for mergers is performed by a deputy director general with special responsibility for mergers, who reports to the deputy director general for antitrust, who in turn reports to the director general for competition.

Mergers and acquisitions that would significantly reduce competition in the single European market are prohibited. The applicable regulation is Council Regulation (EC) No 139/2004. However, the Commission is only responsible for mergers that meet certain thresholds. These EU thresholds are

1. First Threshold:
   1. The parties achieve a combined worldwide turnover of more than €5 billion; and
   2. At least two parties achieve a turnover of more than €250 million in the EU;
   or
2. Second Threshold:
   1. The parties' combined worldwide turnover exceeds €2.5 billion; and
   2. In each of three Member States the parties' combined turnover exceeds €100 million; and
   3. In each of the same three Member States the turnover of each of the parties exceeds €25 million; and
   4. The EU turnover of each of the parties exceeds €100 million.

If the Commission is in charge, then national authorities cannot impose their own review. Mergers below the EU threshold fall under the responsibility of national competition authorities, each of which has its own set of rules.

When these thresholds are met companies seeking to merge have to notify the Commission of their plans. Once the notification has been filed the Commission has 25 working days to review the transaction. This is known as a Phase I review. If there are competition concerns the companies can offer remedies at this stage, which will extend the review period by 10 working days.

If a merger is not cleared during Phase I then a Phase II investigation is launched. These are more extensive analyses of competition effects that takes 90 working days. Extension are possible if parties offer remedies after the 55th working day (by 15 working days) or if the parties agree to an extension (by 20 working days). If all of the extensions are added up and an allowance for weekends and holidays is made, then six calendar months are a good estimate for the maximum length of a Phase II review. The typical timeframe for a Phase II review is between 5 and 7 months, which is of similar order of magnitude as a second request in the United States.

It can be seen from this brief description that the analysis of antitrust risk in mergers is extremely technical and specialized. Some arbitrageurs specialize in transactions that have antitrust risk and profit from their ability to analyze challenges better than the market on average. Other arbitrageurs hire lawyers who specialize in antitrust law to help analyze antitrust risk. If an arbitrageur does not have a good understanding of the risk or access to superior legal advice, it is best to stay away from mergers that have antitrust risk.

Table 12.5 gives an overview of the thresholds at which various countries require notification of proposed merger to the local competition authorities. This information can help arbitrageurs identify in which countries competition problems might arise for a given merger.

United States

In the United States, companies incorporate under state laws and also liquidate or merge according to procedures prescribed by the states. A merger itself is a relatively simple activity in most states: It is sufficient for an authorized company official to file a certificate of merger with the relevant state body. In Delaware, this is the secretary of state's Division of Corporations.

During the merger wave of the 1980s, companies managed to convince their local state governments to implement anti-takeover legislation. States became protectors of entrenched management that sought to fight off hostile takeovers. This put state governments in direct conflict with the SEC, which casts itself as an investor advocate and maintains that state anti-takeover provisions are an infringement to interstate commerce.

The devil lies in the details leading up to the merger. State laws offer companies many takeover defenses to fend of potential suitors and thwart merger attempts. These defenses have been described in detail in Chapter 8.

Unfortunately, state politicians occasionally are tempted to flex muscles when a local company wants to fend off a hostile acquirer. One of the most notorious cases was the battle for shopping mall owner Taubman Centers, Inc., between a group of Taubman family members and Simon Properties Group, another commercial real estate firm. Australian mall operator Westfield America Trust joined Simon in its attempt to acquire Taubman. In late 2002, Simon Properties and Westfield offered to acquire Taubman for $17.50 per share, a premium to the $14.80 closing price before the announcement. Taubman had an entrenched family that controlled the firm through Series B shares as well as through a voting agreement between the family members and their friends that gave them control over 33.6 percent of the shares. The Series B shares had been issued years earlier when the GM pension fund wanted to swap its interests in some of Taubman's properties into shares of the firm.

Simon first increased its bid to $18, and later, in January 2003, to $20 per share, a 25 percent premium to its trading price before the offer. Of the outside shareholders, 85 percent accepted Simon Properties' $20 bid. When the Taubman family refused to sell, Simon sued in Michigan state court to have the voting agreement voided under that state's control share acquisition act. This in itself is rather unusual: A hostile buyer is normally the victim of a control share act and does not seek to benefit from it. During the litigation, it was discovered that the true reason for the issuance of the Series B shares had been to thwart an attempted takeover by another firm, Rouse Company. This takeover proposal had never been revealed to shareholders.

The court sided with Simon and prevented the Taubman family from voting its shares. However, the battle for Taubman then shifted from the court system to the state legislature of Michigan. Taubman lobbied Michigan's lawmakers to pass a law that would make it legal for groups of shareholders to vote their shares together without triggering the provisions of the Michigan control shares act. After intense lobbying, the Michigan senate passed the law in a vote of 24 to 14 in September 2004.

The day after Michigan's governor signed the law, Simon Properties withdrew its acquisition proposal.

It is very difficult for arbitrageurs to estimate the probability of success of a lobbying campaign on the state level. It is safe to assume that state politicians will bow to the demands of local companies rather than help out of state acquirers. However, the intensity of a local defense hardly ever reaches the levels seen in the Taubman case. In the acquisition of Anheuser-Busch by InBev, Missouri governor Matt Blunt opposed the deal publicly and even directed the Missouri Department of Economic Development to see if there was a way to stop it. Despite the high profile of Anheuser-Busch, the transaction was completed because, ultimately, the willingness of the target firm to be acquired trumped the political machinations.

U.S. states also have antitrust laws. They are rarely a problem because federal antitrust regulations trump those of states. Other state laws, however, can conflict with federal antitrust regulations. Highly regulated industries, such as utilities or telecommunications, often are mandated by state law to operate in ways that are considered anticompetitive under federal antitrust laws. Fortunately, lawyers have created a state action doctrine, which gives these firms immunity from federal antitrust laws.

Takeovers of utilities often fail because of opposition by state agencies charged with regulating the industry. The bodies often have wide-ranging powers and will block mergers if there is a risk, often more perceived than real, that rates for the state's residents will increase if a merger passes.

Banking and insurance mergers can take a long time to complete because state banking or insurance regulators have to approve the transaction in each state where the banks or insurance companies are active.

One of the more extreme cases of interference of such a state agency with a merger was the acquisition of Unisource Energy by private equity firm KKR in 2003. The Arizona Corporation Commission refused to approve the transaction. KKR made a number of proposals to mitigate the concern of the commissioners that rates would have to be raised in order to repay the debt accumulated in the buyout. KKR proposed to “ring fence” customers of the utility by issuing the debt separately through the holding company rather than through the utility. KKR also promised to keep the headquarters and management in Arizona. Nevertheless, the Arizona Corporation Commission refused to approve the transaction. It has been reported anecdotally that the major point of contention was KKR's unwillingness to reveal details of its calculation of the internal rate of return that it expected to make on the transaction. Fortunately for shareholders, the price of Unisource increased after the transaction had collapsed (see Figure 4.1).

It should be noted that the increase in the price only shows that KKR was underpaying for Unisource. The true value of the firm became apparent to the market only due to KKR's proposal.

Some of the most wide-ranging powers to interfere with businesses are available to state gaming regulators. Exhibit 12.3 shows the disclosure in the proxy statement of Wynn Resorts. The exhibit describes the power that Nevada Gaming Authorities have over casino companies. These powers include the forced sale of stock if a shareholder is deemed not acceptable.

For arbitrageurs, there is a real risk that a buyer is not acceptable to a gaming commission. For example, New Jersey withdrew the license of the Tropicana Casino shortly after its acquisition of Aztar Inc. had been completed. New Jersey justified its decision with Tropicana's failure to maintain a first-class casino. Fortunately for arbitrageurs, the transaction had closed already. Bond investors, however, took losses when Tropicana had to file for bankruptcy following the loss of its license. In hindsight, the harsh action of the regulator looks foolish as the New Jersey casino industry since has been decimated by competition from newly opened gaming facilities in neighboring Pennsylvania. It has also been rumored that Stanley Ho, one of Macao's gaming magnates, has been denied entry into U.S. gaming markets by state regulators over suitability concerns (see Exhibit 12.3 for an example of suitability disputes).

Canadian Provinces

In Canada, provincial governments have a similar role in corporate law as those in the United States. Some provinces take a more aggressive stance against mergers than others, for no apparent reason other than political maneuvering. Quebec in particular has a record of anti-merger rhetoric and action. This will be discussed below.

United States

One such government agency that operated in relative obscurity for many years but suddenly came to prominence is the Committee on Foreign Investments in the U.S. (CFIUS), an interagency committee that is chaired by the Treasury Department. It was established in 1975 during the Ford administration by an executive order and brought under presidential oversight in 1988 through the Exon-Florio Amendment. Since then, CFIUS has operated in relative obscurity until the sale in the year 2006 of British shipping firm P&O to Dubai Ports World, a company controlled by the government of Dubai. P&O operated a number of ports in the United States. Even though CFIUS saw no threat to national security from the transaction, it fell through eventually after another port operator managed to organize congressional opposition to the transaction. The publicity surrounding this merger led to legislative changes that expand the role of CFIUS in approving the acquisition of U.S. assets by foreign acquirers. Ever since, CFIUS approvals have been on arbitrageurs' radar screens.

Even before the Dubai Ports saga, CFIUS had an impact on occasional transactions that were subject to its review. One such transaction that normally would have flown under the radar screen of regulators was the 2005 acquisition of Cypress Communications by Arcapita, Inc., formerly Crescent Capital Investments. Arcapita is an investment bank in Bahrain that invests according to Islamic principles. Private equity fund may be a more accurate description of its business. The value of the acquisition was only $40 million. Cypress submitted the acquisition to a voluntary review by CFIUS on April 4, 2005, and disclosed it in a press release on May 12. It is noteworthy that several other SEC filings between April 4 and May 12 did not mention the submission to CFIUS. Arcapita had already done a number of investments in the United States, including some household names, such as Church's Chicken and TLC Health Care Services.

Cypress filed “voluntarily” with CFIUS. This is a euphemism that the government uses to make the regulation appear less burdensome. In reality, if a company were not to make a “voluntary” filing, it would be contacted by one of the government agencies that form CFIUS, such as Homeland Security, Defense, or State, and would be encouraged to make a “voluntary” filing in strong terms.

CFIUS must review mergers in which the acquirer is a foreign government or an entity controlled by a foreign government. However, unlike in antitrust legislation, where clear thresholds are set, the requirements are vague for CFIUS filings. An acquisition must give a foreign entity control over a U.S. firm. CFIUS has 30 days to review whether the transaction affects national security. In order to give CFIUS maximum flexibility, the term national security has not been defined. CFIUS takes a number of factors into account when making that determination:[

1. domestic production needed for projected national defense requirements,
2. the capability and capacity of domestic industries to meet national defense requirements, including the availability of human resources, products, technology, materials, and other supplies and services,
3. the control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the United States to meet the requirements of national security,
4. the potential effects of the proposed or pending transaction on sales of military goods, equipment, or technology to any country […]
5. the potential effects of the proposed or pending transaction on United States international technological leadership in areas affecting United States national security;
6. the potential national security-related effects on United States critical infrastructure, including major energy assets;
7. the potential national security-related effects on United States critical technologies;
8. whether the covered transaction is a foreign government-controlled transaction
9. factors involving non-proliferation and government-sponsored terrorism
10. the long-term projection of United States requirements for sources of energy and other critical resources and material

50 U.S.C. 2170(f)

Following the initial 30-day review, there is an extended 45-day investigation period for certain transactions, including:

• A transaction that threatens to impair U.S. national security, and that threat has not been resolved within the 30-day review period.
• A transactions involving foreign government control, such as sovereign wealth funds.
• A transaction resulting in foreign control over critical infrastructure that CFIUS believes could threaten national security if one of the agencies constituting CFIUS requests a full investigation and CFIUS agrees.

Legislation was changed in October 2007, and CFIUS's new rules have so far not led to an increase in merger denials. Nevertheless, it is clear that we have entered an era in which scrutiny of foreign acquirers will expose arbitrageurs to higher regulatory risk. The committee membership has been widened to include the director of National Intelligence, as well as the U.S. trade representative, and CFIUS is now answerable to Congress. This increases the political risk substantially. Political oversight rests with majority and minority leaders of the House and Senate, the chair and ranking members of the Senate Banking Committee and the House Financial Services Committee, any House or Senate committee having oversight over the lead agency in the CFIUS review, and implicitly the members of the districts concerned as well as the relevant state governors. As Dubai Ports and 3Com illustrate, the risk is not purely regulatory. The political environment at the time of a merger is the real driver of deal hiccups, and national security concerns can be a pretext for political games. The 2007 legislation only reinforces this threat, because the results of an investigation now have to be provided to Congress. This will open investigations to political scrutiny by politicians, special interest groups, and business competitors. Even arbitrageurs could potentially use the political process to block an acquisition after taking a position that would benefit from a collapse of a deal. It is extremely difficult to estimate deal completion risk under these circumstances. The politicized character of CFIUS became apparent when British hedge fund The Children's Investment Fund (TCI) attempted to obtain board representation on rail carrier CSX in 2008. TCI owned 8.5 percent of CSX and had no plans to acquire CSX itself but rather to force it to sell itself to another firm. Most likely, CSX would remain a U.S.-owned firm. Nevertheless, several lawmakers were pressing CFIUS to investigate TCI for trying to take over critical infrastructure. It appears that CSX had convinced these lawmakers that a harmless proxy contest for board representation had national security implications. Yet political interference sometimes can dissipate when the transaction is friendly: In the acquisition of Anheuser-Busch by InBev, no national security issues existed. The representative in the district of Anheuser-Busch's headquarters acquiesced to the transaction when it turned out to become friendly and did not attempt to create a politically motivated national security problem.

Chinese buyers, in particular, are likely to be at risk in the near future of extra scrutiny under CFIUS. For example, when China's state-owned Tsinghua Unigroup proposed to acquire Micron Technology, a leading U.S. manufacturer of DRAM chips, in the summer of the year 2015, Republican Congressman Dana Rohrabacker, a senior member on the House Committee on Foreign Affairs, told the news service Dealreporter that “we face an arrogant power grab by a clique that runs China with an iron fist, and that iron fist should be of grave concern as a security threat to the United States.” This comment followed a letter that Rohrabacker had sent to Treasury Secretary Jack Lew a few weeks earlier, which contained similar warnings.⁸

Companies are beginning to take CFIUS risks into account in their merger agreements. For example, in the 2013 agreement between Avago Technologies and LSI Industries a clause dealing specifically with CFIUS was inserted:

Notwithstanding anything to the contrary in this Agreement, including specifically Section 7.01(c) and Section 7.01(d), each of Ultimate Parent and the Company (as well as any of their respective Subsidiaries or Affiliates) shall take, or cause to be taken, such actions and agree to any reasonable action, restriction or condition to mitigate any national security concerns as may be requested or required by CFIUS or any other agency or branch of the U.S. government in connection with, or as a condition of, obtaining the CFIUS Clearance, except if any of the aforementioned actions, either individually or in the aggregate, is or would reasonably be expected to be significant to the business of the Acquired Companies, taken as a whole.

Source: Merger agreement filed on Form 8-K with the SEC on December 12, 2013.

From a public policy perspective, the sudden focus on national security is troublesome, because it comes at a time where foreign investment is desperately needed. The United States runs a twin deficit of the current account and budget and relies heavily on capital inflows to finance these deficits in the presence of a negative savings rate. Aggressive enforcement of national security concerns to deflect political pressure can have serious economic repercussions.

Canada

In recent years, Canada has been more aggressive in blocking foreign mergers on national interest grounds than the United States has. The Investment Canada Act (ICA) and related regulations trace their origins to 1973, when its predecessor regulator Foreign Investment Review Agency was established to review whether particular foreign investments are beneficial to Canada. Like its U.S. counterpart, the agency Investment Canada had a sleepy presence until it rose from obscurity at around the same time as CFIUS, during the 2008 acquisition of MacDonald Detwiller and Associates (MDA) by Alliant Techsystems when the government invoked the ICA to block the merger. As Alliant is a defense company, it is believed that national security was the motivation for this decision. Interestingly, the U.S. did not block the acquisition of Space Systems/Loral by MDA four years later, so the defense aspect of MDA cannot be too significant.

All transactions above a certain threshold level need to be reviewed. For acquirers from WTO member states the level concerns asset values, is adjusted annually and amounted to C$344 million, C$354 million, and C$369 million in the years 2013, 2014, and 2015, respectively. Starting April 2015, a change in the metric from asset value to enterprise value became effective, along with a gradual increase of that value from an initial C$600 million to C$1 billion over the next four years. However, the C$369 million book value test will remain in effect for acquisitions by state-owned enterprises and in the case of the acquisition of cultural businesses.

In the approval process, the Minister of Industry must decide whether a merger provides a “net benefit to Canada.” Factors in the analysis include the following:

• The effect of the investment on economic activity in Canada;
• The degree of participation by Canadians in the business in question;
• The effect of the investment on productivity, efficiency, technological development, product innovation and product variety in Canada;
• The effect of the investment on competition;
• The compatibility of the investment with national industrial, economic and cultural policies; and
• The contribution to Canada's ability to compete globally.

The Minister generally requires undertakings before giving approval.

In addition to the “net benefit” test, the government also performs a national security test. The financial thresholds do not apply to the national security test.

The political nature of ICA became apparent through two other transactions that were never officially blocked but where the government made its concerns clear through the ICA process. What is particularly worrying from an arbitrageur's point of view is the lack of clear process and the somewhat haphazard approach taken by the government.

When Australian mining conglomerate BHP Billiton (BHP) attempted to acquire Potash Corporation of Saskatchewan Inc. in the year 2010 through a hostile takeover, the government of the Province of Saskatchewan was vocal in its objection to the merger over fears of job losses in the province. Due to the intransparent decision making of the Minister, it is not known to what extent his decision to deny a finding of a net benefit was driven by the political intervention of the provincial government, which by law is supposed to have no input into the decision. Rather than continue negotiations, BHP gave up on the transaction and withdrew its bid.

In the summer of the year 2012, two foreign state-owned oil companies attempted to acquire Canadian energy companies: Malaysian oil firm Petronas Bhd sought to acquire Progress Energy Resources Corp. for C$6 billion, and China National Offshore Oil Co. (CNOOC) tried to purchase Nexen Inc. for C$15.1 billion. Arbitrageurs had concerns soon after the announcement that the acquisition by CNOOC could run into regulatory problems and the spread on the merger widened accordingly. Less anticipated, however, was the announcement by Prime Minister Harper on October 19 to block the acquisition of Progress Energy by Petronas. This decision was regarded widely as a political compromise: Harper most likely wanted to target the CNOOC merger but did not want to confront the Chinese government directly. Therefore, he blocked the Progress transaction as a warning shot. Both transactions were eventually completed but the episode illustrates well the political nature of the ICA review process.

The Progress Energy debacle led the government to tighten rules for the acquisition of Canadian companies by foreign state-owned enterprises (SOEs), with a particular view to energy assets and oil sands. Prime Minister Harper outlined these new factors in a statement made when the approval of the Progress/Petronas acquisition was announced:

First, the degree of control or influence a state-owned enterprise would likely exert on the Canadian business that is being acquired.

Second, the degree of control or influence that a state-owned enterprise would likely exert on the industry in which the Canadian business operates.

Third, and most importantly, the extent to which the foreign government in question is likely to exercise control or influence over the state-owned enterprise acquiring the Canadian business.

Statement by Prime Minister Stephen Harper, December 7, 2012

The definition of what constitutes an SOE is very broad. Not only companies that are owned or controlled by a foreign government are considered SOEs, but also those that are influenced by a government, potentially widening the scope of the SOE review process to a much wider range of companies. While the review threshold for non-SOE firms is planned to be raised to C$1 billion enterprise value, it will remain at the asset-based levels listed above for acquirers that are SOEs. The impact of the 2012 reforms has been disastrous for foreign investment: investment by SOEs in the oil and gas sector declined by over 90 percent between 2012 and 2013.

One area that has received particular focus recently are layoffs following a merger. This became a sensitive issue after U.S. Steel laid off two thousand workers shortly after its acquisition of Stelco in the year 2007. Industry Canada alleged that this was in violation of its undertakings. While this concerns post-closing activities and thus is not directly relevant to an arbitrageur it could make it harder for proposed transactions to pass through the Industry Canada review if there are reasons to be concerned about the sincerity of the acquirer.

Unfortunately, it is not just the national government of Canada that has thrown a wrench into the wheel of M&A activity, the Province of Quebec has been similarly prolific in a fight against the ghost of hostile takeovers. Its principal motivation is to keep company headquarters in the Province. Under proposals made in February 2014, shareholders would have variable voting rights in takeovers based on the length of time for which they have held shares. For shares held for more than two years, shareholders would have received additional voting rights. This would have reduced the influence that arbitrageurs can have on the outcome of a merger. Other measures sought to eliminate the rationale for merging in the first place, such as a five-year ban on combining assets of the target with those of the acquirer. At the same time, Canadian Securities Administrators (CSA), the umbrella organization for regulators of the 13 provinces, promoted an alternative more modest proposal. It looked as if Canada would end up with two dramatically different regimes for takeover regulation in different provinces. However, by September 2014, all Canadian securities regulators had agreed on a common reform that changed takeover regimes only marginally. Most notably, a minimum bid condition for 50 percent of the shares was introduced, the minimum bid period was set to 120 days, and bids are extended automatically for 10 days once the minimum bid conditions are met.

Europe

Europe has not been as active as one might expect with respect to national security and national interest regulation. This may not even be necessary because governments can exert influence on large mergers merely through public pressure.

One country that aggressively seeks to exert political pressure on foreign takeovers under the pretense of national security is France. A first version of the law in the year 2005 regulated the takeover of firms in the defense sector. During the $17 billion hostile approach of General Electric for Alstom Economy, Minister Arnaud Montebourg issued a decree that extended the 2005 law to acquisitions by foreign firms in five sectors deemed strategic: energy, water, transport, telecoms, and health. The timing of the decree illustrates its political nature: It was issued not only in the middle of the battle over Alstom, but also 10 days prior to the elections for the European Parliament, for which the government fared poorly in opinion polls.⁵ Although Montebourg announced that he was not planning to use the decree actively, experience tells investors that future governments likely will not feel bound by that statement.

Nationalist concerns can also appear in countries that generally are considered as economically open. International Consolidated Airlines Group, S.A., the owner of British Airways, made a bid for Aer Lingus Plc on December 18, 2014, for €2.30/share. This bid, and a subsequent increase to €2.40, was rejected by Aer Lingus's board as insufficient. It was only on January 26, 2015, when IAG presented a €2.55/share bid that the Aer Lingus board said it was willing to present the proposal to shareholders. This was the third time since the year 2006 that a takeover bid had been made for Aer Lingus, with all prior bids blocked by successive governments. At that point Ireland's Deputy Prime Minister Joan Burton became involved and expressed concern over travel access to Ireland. At the same time, the airline employees' trade union Impact warned of layoffs as a result of the merger and was joined in these warnings by opposition politicians. As a result, the transport minister announced that sale of the Irish government's 25.1 percent stake to IAG would be put to vote in parliament. At this point, the merger had become entirely politicized. The opposition fretted over job losses, whereas the government found its pet niche in the question of air access to Ireland. During the course of the ensuing talks between IAG, the government, and unions, some politicians and unions reversed their opposition to the merger. However, the government and opposition remained hostile. At the time of writing, it looked as if the government may eventually be swayed to accept the bid under the condition that Aer Lingus retains its slots at Heathrow in order to ensure sufficient transportation capacity to Ireland.