Private equity (PE) is in focus for antitrust authorities. In a merger control context, concerns around roll-up and keeping the bigger picture in mind occupy both Jonathan Kanter at the DOJ and Lina Khan at the FTC. My colleague Stijn Huijts covered this in his 13 June 2022 blog.
Consideration of the PE angle is not limited to the US. Nor is it limited to mergers. It is also something that the UK Competition and Markets Authority (CMA) has been grappling with in its recent Liothyronine and Hydrocortisone abuse of dominance decisions.
CMA Liothyronine and Hydrocortisone decisions include hefty fines for former PE owners
The CMA’s Liothyronine excessive pricing decision sets out how HgCapital and Cinven were party to the underlying antitrust breach under the laws on parental liability. HgCapital was fined £8.6m and Cinven was fined £51.9m. This is despite their involvement with the pharma company selling Liothyronine having ended in 2015 and 2018 respectively. The PE firms’ appeals to the Competition Appeal Tribunal (CAT) will be heard in September 2022.
In the CMA’s Hydrocortisone decision, the CMA fined Cinven £35.1m in total. Again, Cinven’s relationship with the underlying pharma business ended in 2018. Cinven will be at the CAT appealing this decision in November 2022.
The size of a CMA fine is generally a mechanical exercise based on turnover and other agreed parameters. But the CMA does have discretion under its rules to increase or reduce fines. The total fine levied on Cinven across the two cases is £86m – a significant fine for the CMA. For context, the largest fine that the CMA has imposed on an individual company was £109m for Allergan, in the same Hydrocortisone decision.
Neither HgCapital nor Cinven has any ongoing connection with the underlying pharma business. And yet they are recipients of large fines for conduct that took place in the past.
To non-European lawyers, this so called ‘piercing of the corporate veil’ may come as a shock. But since the Prysmian case this point of law – that a former owner can be part of the same ‘undertaking’ as an old subsidiary and so jointly and severally liable for a past UK or European antitrust infringement – is relatively uncontroversial.
If the law is uncontroversial, establishing the facts to meet the evidential standard where a PE firm owned less than 100% of the subsidiary remains a time-consuming exercise. Parental liability took up nearly a quarter of the 406 pages in the CMA’s Liothyronine decision.
The HgCapital and Cinven appeals in the autumn will test the current state of the law but it seems unlikely the CAT will depart from the established Prysmian position.
CMA decisions include extensive discussion of PE firms’ active role
What is perhaps more interesting about the Liothyronine and Hydrocortisone decisions is that the CMA appears to go further in describing the conduct of the PE firms than is strictly needed for parental liability purposes.
In Liothyronine, the CMA describes Cinven’s involvement over 50 pages. The CMA pulls no punches. PE is not a pure financial advisor:
‘In this case, Cinven’s ‘active’ and ‘engaged’ ownership; its ‘targeted, systematic and on-going’ operational input; its instigation of ‘the transformative merger’ of two corporate groups; its success in generating a very substantial profit drawing on its knowledge of the pharmaceutical sector and in particular its understanding of the opportunities presented by the ‘little jewellery boxes’ of ‘unloved’ niche generic drugs such as Liothyronine Tablets, demonstrate that it was no pure financial investor in the AMCo group’.
The CMA quotes from the investment recommendation Cinven used to justify its initial acquisition and investment in the company.
It goes into the details of how much Cinven knew about what was going on at the underlying pharma business. The Cinven investment recommendation described ‘price increases’ as possible in markets where ‘competitive forces may not work to suppress prices’ including for ‘niche products’ if you operated ‘below the radar’. The CMA finds that rationale was used by Cinven in justifying its initial investment.
The same Cinven investment recommendation was also quoted at length in the related Hydrocortisone decision. Delivering on the strategy in the investment recommendation would allow Cinven to sell its stake in the portfolio business for a significant profit. Indeed that is what happened. Cinven sold the business that sold Liothyronine and Hydrocortisone for $3.5bn in 2018 in what was described as ‘one of the most successful deals we have ever done’.
In Hydrocortisone, again the CMA quotes from Cinven documents at length. The Hydrocortisone decision has 132 references to quotes or input from Cinven ‘Senior Employees’ with four senior Cinven individual employees quoted extensively.
The names of these individuals have been redacted from the CMA’s infringement decisions. Their identities may though be revealed at the CAT hearings in September and November 2022: in a November 2021 ruling, the CAT highlighted the importance it attaches to open justice, criticising the CMA for redacting names unnecessarily and indicating it would not be bound at a hearing by the stance the CMA has taken on confidentiality in the administrative phase.
PE firms should take note of the fact that the CMA carried out an in-depth analysis of the structure and business model of Cinven, as well as its involvement in the business of the portfolio company, and laid this out in a public decision. It is clear that in this type of case, almost all of the strategy documents in relation to portfolio companies are fair game. There is a significant risk that individuals’ names will be disclosed in hearings at the CAT.
Policies specific to PE firms should recognise the ability that active owners have to instil a genuine culture of competition law compliance
Of course an awareness of how a lack of competition can be good for business is not something that is confined to PE. Warren Buffett has been talking about ‘moats’ around ‘business castles’ in his shareholder letters since 1986. Identifying and investing in businesses that face less competition for whatever reason is completely legitimate.
But the short ownership periods of PE firms (they typically aim to sell businesses within five years) mean their incentives may be different to those of longer-term investors.
Cinven owned its stake in the pharma companies the CMA found acted unlawfully in Liothyronine and Hydrocortisone for around three years and made one of its best ever returns. A fact that was not lost on the CMA (as set out above).
The company Warren Buffett most famously associates with a protective moat is Coca-Cola. His investment in Coca-Cola has lasted more than thirty years.
The Liothyronine and Hydrocortisone decisions show that the tone set by the PE investor can be key to the conduct subsequently adopted by the company. But incentives are not only key to commercial decisions that may lead to infringements, they can also be key to developing a genuine culture of compliance. The incentives within a PE-owned company are different to those of companies with long-term passive investors as shareholders. PE investors should therefore adopt compliance programs that are not only specific to the line of business the portfolio company is in, but are also sensitive to the specific circumstances that a PE investment creates for the portfolio company.
Conclusion: PE around the world already under greater antitrust scrutiny
In the US, the current debate is focused on mergers. But in the UK, the CMA’s Liothyronine and Hydrocortisone cases also consider how incentives at PE firms can impact competition law compliance in a way that is not necessarily true for longer term investors.
The Prysmian case law means that there is a far greater scope in the UK and Europe for competition authorities to claw back profits from PE firms than would be the case in the US. Any assumption that PE firms are ‘pure financial investors’ can be put aside – at least for now.
For PE firms the shift in competition authority mindset around the world should be noted. Deal teams and Investment Committees at PE firms may be surprised to find their documents, even those created before they acquired a business, may need to be provided to competition authorities several years down the line.
It will be interesting to see whether the CAT backs up the CMA in the Liothyronine and Hydrocortisone appeals – we will get a glimpse of that in September and November 2022.
In the meantime, PE firms should make sure their compliance policies are up to date and they are fully aware of the risk of liability being imposed on them for conduct at their portfolio businesses.
[Disclosure: the writer previously worked at the CMA but left in 2019]
[Photo by Samuel Sweet on pexels.com]