Executive Briefing on Revised Merger Guidelines: What Every Hospital Executive Needs to Know. Mark Mattioli Post & Schell, PC Philadelphia, PA

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1 Executive Briefing on Revised Merger Guidelines: What Every Hospital Executive Needs to Know. Mark Mattioli Post & Schell, PC Philadelphia, PA Summary On August 19, 2010, the Federal Trade Commission and Antitrust Division of the Department of Justice published revised Horizontal Merger Guidelines. These Guidelines are utilized by the Federal Antitrust Enforcement Agencies in analyzing the potential anticompetitive effects of hospital mergers. Notably, the Guidelines foreshadow diminished reliance upon formalized market analysis and a greater reliance upon customer opinions and testimony regarding the proposed effects of a merger. This type of reliance will result in more challenges to hospital mergers. On a positive note, the Agencies are more willing to consider the positive effects on quality of a potential merger. In addition to their use by the Federal Agencies, the Guidelines are cited frequently by courts and private litigants in antitrust lawsuits. Hence, their effects will likely reach beyond the merger enforcement context. Introduction Late this summer, the Federal Trade Commission ( FTC ) and the Antitrust Division of the United States Department of Justice ( DOJ ) (collectively the Agencies ), released revised Horizontal Merger Guidelines. The Guidelines were originally published in 1968 and periodically updated, with the last update occurring in While these Guidelines are utilized by the Agencies in evaluating the potential antitrust implications of mergers between horizontal competitors (entities at the same level of competition), they are frequently cited by courts and litigants in private antitrust lawsuits. As a result, their significance often goes beyond Agency investigations of proposed mergers. The Agencies stated reason for releasing the new Guidelines is to reflect, accurately, current Agency practice in the evaluation of mergers. Many of the ideas were foreshadowed in comments to the 1992 Guidelines by the Agencies released in However, some critics would argue that the emphasis on less formal market definition approaches in the new Guidelines is an effort to reverse past Agency losses in challenging hospital merger cases. In this regard, the 2010 Guidelines foreshadow a trend away from a formalized assessment of the potential anticompetitive effects of a merger utilizing a rigid market analysis to a flexible approach using a variety of techniques such as merger simulation and upward pricing pressure tests. In addition, the Agencies will look more at pricing effects and the effects of a merger on quality and innovation. The result will be increased scrutiny of hospital mergers.

2 Traditionally, based on the 1992 Guidelines, the Agencies had analyzed mergers in the hospital context by first defining the relevant product and geographic markets. This analysis often involved the utilization of patient migration data where the market is defined by examining the zip codes of patients. In the hospital merger context, however, this approach did not prove successful, and the Agencies suffered a string of defeats in their efforts to block hospital mergers. Interestingly, despite the language in the 2010 Merger Guidelines regarding less reliance on market definition, officials in the FTC have informally emphasized that they will continue to utilize market definition in their investigations, especially when there is the potential that the case will be litigated in court. 1 Evidence of Adverse Competitive Effects As discussed, the Agencies will utilize evidence of competitive effects to determine the potential ability of a merger to harm competition. The 2010 guidelines reference the following types of evidence: Post-Merger Price Increases or Other Adverse Changes The Agencies will examine whether the merging parties increased prices or imposed other adverse changes (or plan to) upon customers after a merger. Direct Comparisons from Other Transactions The Agencies may also examine historical events, or natural experiments, to determine the competitive effects of a merger. These may include the impact of recent mergers, entry, expansion, or exit in the relevant market and effects in similar analogous markets to those in which the merging parties compete. Market Share and Concentration The Agencies will scrutinize those mergers that result in increased market shares and concentrations within a market and may presume that such mergers will enhance the market power of the parties, enabling them to act in an anticompetitive manner. Whether the Parties are in Head-to-Head Competition Where the parties to the merger compete with each other head-to-head, the Agencies will more closely scrutinize the merger for potential anticompetitive effects that will result from the future lack of competition between the parties. This analysis closely follows the emphasis on unilateral effects which is discussed below. 1 As discussed above, the Guidelines are not binding on the courts. While some judges have utilized the framework set forth in the 1992 Guidelines to analyze cases, such framework was consistent with the multiple court cases which emphasized the need to define appropriate product and geographic markets. Thus, absent direct evidence of anticompetitive effects (which would be difficult to develop in a proposed merger case), the Agencies may be hard-pressed to enjoin a merger without first defining the relevant antitrust markets. 2

3 Disruptive Role of a Maverick The Agencies will examine whether the merger will result in the elimination of a maverick firm that previously kept the parties in check. In investigating the actual or potential competitive effects of a merger, the Agencies will evaluate information collected from the merging parties, customers, and other industry participants. While utilization of these sources is not new, the emphasis on such evidence in place of a formulaic market definition approach will likely increase the importance of customer testimony. Unilateral Effects Analysis New to the 2010 Guidelines is an increased emphasis on unilateral effects analysis. This is important for hospital mergers and dovetails with the increased relevance on evidence of anticompetitive effects. Health care services involve differentiated products which by definition cannot be identical. Stated simply, no two patient encounters can ever be the same. If the hospitals involved in the merger are close competitors, where anticompetitive conduct by hospital X would cause patients to switch to hospital Y, the merger of hospitals X and Y is more likely to have anticompetitive effects because they no longer compete with each other. One tool to measure the effects of such mergers on competition is the upward pricing pressure model whereby a price increase by hospital X results in a significant number of patients switching to hospital Y. This approach involves a calculation of the effects of the price increase by hospital X taking into account that a portion of the patients would switch to hospital Y, decreasing the actual loss of revenue to both. In addition to examination of diversion patterns, the Agencies may also employ merger simulation models to determine the potential anticompetitive effects of a merger involving differentiated products. Indeed, the Agencies have shown an increased willingness to utilize such simulations. Implications for Hospitals Contemplating Mergers Although the 2010 Guidelines are not binding on the courts, and merely provide guidance on how the Agencies will evaluate mergers going forward, there are some implications, pro and con, for hospitals contemplating mergers: The lack of reliance on formal market definition may result in more investigations of proposed hospital mergers. It may also result in increased scrutiny of proposed mergers by the Agencies and requests for additional information and data from the parties. Increased reliance on evidence of anticompetitive effects will place a greater emphasis on the statements of competitors, customers, and especially payers regarding the effects of a merger. This will be especially true with regard to 3

4 payers who contend that one hospital is a must have for a network and in situations where a payer would attempt to play off one hospital in negotiations against the other. Consideration of the effects on mavericks could result in an increased reliance on opinions and statements by ambulatory surgery centers and physician owned specialty hospitals that may be harmed by a potential merger. This would be likely if one of the merger parties previously supported the surgery center, but as a result of the merger, would not do so going forward. The 2010 Guidelines raise the thresholds for determining whether a transaction will enhance market power. This measure continues to rely upon the Herfindahl-Hirschman Index (HHI), which compares concentration before and after a proposed merger. It is not anticipated that this change will have any appreciable impact on hospital mergers. On the positive side, the 2010 Guidelines continue to allow the agencies to consider efficiencies in the merger context. This is important for hospitals that contend that a merger will allow them to develop new services that could not have been developed absent the merger. More importantly, in statements regarding the Guidelines, the FTC (which handles the majority of hospital mergers) is inclined to consider increases in quality as part of the efficiencies matrix. Thus, merging parties with a strong argument that a merger will increase quality may utilize such evidence in seeking agency approval of a merger. However, a hospital seeking to utilize such evidence must be prepared to demonstrate the increase in quality by something more than vague references or speculation. Some potential avenues are the following: Showing that a merger will allow hospitals to develop and test clinical protocols that will improve quality; Demonstrating that hospitals can combine some high risk but lower volume procedures performed at one hospital with those performed at the partner hospital, especially where there is evidence that complications are related to the number of procedures performed; Developing new facilities or services that could not be developed by one hospital on its own; Creating efficiencies by the development of Accountable Care Organizations or other organizations such as clinically integrated networks that mandate a critical mass of patient encounters. While efficiencies alone will never justify a merger to a monopoly or near monopoly, demonstrating an increase in quality can help parties gain Agency approval in otherwise close cases. 4

5 Conclusions While the 2010 Guidelines are proffered as statements of current Agency practice in the evaluation of mergers, the new focus on flexibility may create additional expenses for hospitals seeking to consummate a merger. Under the flexible approach, the Agencies will not make determinations based solely upon market data, and will instead seek to utilize a variety of mechanisms and techniques such as merger simulation. These types of analyses can be costly to rebut, and their acceptance in the courts has not been without some controversy. Given the emphasis on flexibility, it is critical for hospitals contemplating a merger, or other significant transaction, to retain antitrust counsel early in the process to create the appropriate record that will assist them in presenting their case to the Agencies. Moreover, while the Guidelines govern only the Agencies evaluation of mergers, the principles behind the Guidelines will likely be utilized by the Agencies in other enforcement contexts. Finally, private parties seeking to challenge potential anticompetitive practices will likely cite the Guidelines emphasis on flexibility to defeat dispositive motions based on arguments that the parties lack market power. 2 2 Increasingly, defendants in antitrust cases have been successful in having antitrust cases dismissed where the plaintiff offers only conclusions and formulaic recitations of antitrust elements. See Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007). The Guidelines may reverse that trend. 5