Heightened Scrutiny of Vertical Mergers in the United States
The FTC Takes an Aggressive Stance

Vertical mergers have historically been credited with pro-competitive effects. Recently, however, U.S. antitrust regulators are questioning whether lenient treatment of vertical mergers is warranted. Since March 2021, the Federal Trade Commission (“FTC”) has challenged three vertical mergers. The parties in two of the cases subsequently terminated the deals this year, citing regulatory hurdles. In this Newsletter, we discuss: (1) the U.S. regulatory agencies’ reassessment of their vertical merger policies; (2) the FTC’s recent challenges to three vertical mergers; and (3) the implications for firms considering a vertical merger and for other market participants who are potentially impacted by a proposed merger.

1. U.S. Regulators Reassess Their Vertical Merger Policies

In July 2021, President Biden issued the “Executive Order on Promoting Competition in the American Economy,” which sets forth 72 initiatives designed to “combat the excessive concentration of industry, abuses of market power, and harmful effects of monopoly and monopsony.” Among the initiatives, the Executive Order called on the antitrust agencies to evaluate whether their vertical and horizontal enforcement guidelines require revision.

Accordingly, in September 2021, the FTC announced that it was rescinding the Vertical Merger Guidelines (“Guidelines”), jointly issued with the U.S. Department of Justice (“DOJ”) in 2020. The Guidelines had outlined both agencies’ analytical techniques and enforcement policies for non-horizontal mergers and provided commentary on prior investigations that utilized the framework.

The FTC said the Guidelines adopted “unsound economic theories that are unsupported by the law or market realities.” As such, the FTC was “withdrawing its approval in order to prevent industry or judicial reliance on a flawed approach.” Shortly thereafter, the DOJ stated that it was reevaluating its position on the Guidelines. In January 2022, the FTC and DOJ jointly announced that they would seek public comments to develop new vertical merger guidelines that “better-reflect market realities.” The agencies are likely to issue new joint guidelines in later 2022.

2. FTC’s Recent Vertical Merger Challenges

Illumina Inc./GRAIL

In March 2021, the FTC challenged Illumina’s $7.1 billion proposed acquisition of GRAIL, which is the leading developer of a non-invasive multi-cancer early detection (“MCED”) test. Illumina is a DNA sequencing and analysis company that develops next-generation sequencing (“NGS”) technology. The FTC alleged that the deal would substantially lessen competition in the MCED test market because Illumina is the only viable supplier of DNA sequencing -- a critical component used by MCED test manufacturers including GRAIL. Because of Illumina’s dominant position, the FTC alleges that the deal would enable Illumina to monopolize the MCED test market. As a result, the FTC claims that the acquisition would stifle research and development for MCED testing, diminish the quality of MCED tests, and make such tests more costly. The challenge is pending before the FTC administrative court. The European Union is also reviewing the deal.

NVIDIA Corporation/Arm Ltd.

In December 2021, the FTC filed an administrative complaint against NVIDIA over its $40 billion proposed acquisition of Arm from the SoftBank Group. This challenge came while the proposed transaction was being investigated by regulators in China, the EU, Japan, South Korea, and the United Kingdom. The FTC alleged that Arm controls critical intellectual property covering microprocessor designs and architectures that are the “de facto industry standard for CPU process technology.” The merged firm purportedly could foreclose competitors’ access to necessary intellectual property and raise their costs. Further, the FTC alleged that the deal would harm competition because NVIDA could access commercially sensitive information about its competitors who are Arm’s licensees. In February 2022, the parties announced that they were terminating the transaction because of “significant regulatory challenges.”

Lockheed Martin Corporation/Aerojet Rocketdyne Holdings Inc.

In January 2022, the FTC sued to challenge Lockheed’s $4.4 billion proposed vertical merger with Aerojet Rocketdyne, “the country’s last independent supplier of key missile propulsion inputs.” The FTC said that this was the “first litigated defense merger challenge” brought “in decades.” According to the FTC, the acquisition would give Lockheed, the world’s largest defense contractor, control of critical inputs for various missile systems and, as such, the ability and incentive to foreclose its competitors’ access to these components. Further, the FTC claimed that because Aerojet has access to commercially sensitive information about Lockheed’s rivals, Lockheed could exploit this information to foreclose competition. As a result, according to the FTC, the deal would increase prices and diminish quality and innovation for weapons systems that are critical for U.S. security. The U.S. Department of Defense (“DoD”) assisted with the investigation. The FTC’s enforcement action dovetailed with a DoD report that recommended stronger merger oversight of the “highly-concentrated” defense industry. In February 2022, the parties terminated the proposed deal.

3. Key Takeaways

These recent vertical merger challenges are consistent with the Biden Administration’s concern that the concentration of power in the technology, pharmaceuticals, agriculture, healthcare and finance sectors, has harmed consumers and workers as well as slowed economic growth. The FTC’s focus seems to be whether the vertically integrated firm could cut-off the supply of inputs to a competitor (i.e., total foreclosure) or deteriorate the conditions under which the inputs are provided, for instance, by increasing prices or lowering quality (i.e., partial foreclosure).

The FTC likely will investigate and possibly challenge any vertical merger involving a dominant player and essential input (especially if related to the technology and healthcare sectors). Parties should expect to prove that the merged firm would lack the ability and incentive to control the supply of such inputs and/or would not exploit its access to rivals’ commercially sensitive information.

Further, the FTC might not agree to resolve a challenge through a behavioral remedy, which would have been acceptable to address similar concerns in the past. The parties in the three transactions had proposed behavioral remedies such as agreeing to supply competitors on nondiscriminatory terms and to create firewalls. The FTC rejected those proposals. Going forward, the FTC might emphasize structural remedies such as divesture of critical assets or cessation of certain economic activities. These structural remedies, however, might be a disproportionate solution to prevent hypothetical effects on competition and could undermine important vertical efficiencies. Parties facing a regulatory challenge should consider the possibly of litigation given this lack of clarity on the legal standards for evaluating vertical mergers.

Market participants who could be impacted from a merger should consider raising their concerns with the U.S. and foreign regulators. In the three challenges, competitors and other market participants voiced strong opposition in the United States and overseas. Because the enforcement policies are in flux, third-party grievances might be accorded more weight and ultimately could facilitate the FTC’s efforts to block a potential vertical merger.

(Written by: Christopher Studebaker)

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*This column is provided for educational and informational purposes only and is not intended and should not be construed as legal advice.
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