For businesses and dealmakers, possible changes to the 17-year-old Horizontal Merger Guidelines may align them with current agency practice and provide greater clarity for evaluating future transactions. This fall, the Department of Justice and the Federal Trade Commission initiated a process to explore the possibility of updating the guidelines, which provide the analytical framework employed by both the DOJ and FTC to assess whether a transaction will lead to a substantial lessening of competition prohibited by U.S. antitrust laws.

The two agencies posted questions for public comment from attorneys, economists, academics, consumer groups and the business community, and they hosted workshops around the country ending this month. The agencies' goals are to determine whether (and if so, to what extent) the guidelines should be revised to reflect current merger review practice and to take into account significant legal and economic developments since they were last revised in 1992 and 1997.

This article discusses needed Horizontal Merger Guidelines revisions in four areas critical to dealmakers: market concentration, customer-provided evidence, efficiencies and remedies, and it further recommends that the agencies' focus on the 26-year-old vertical merger guidelines, desperately in need of an update.

The current market concentration predictor employed by the guidelines, Herfindahl-Hirschman Index, or HHI, thresholds, provide inaccurate guidance to companies and counsel who are not familiar with the agencies' actual practice, which varies significantly from the guidelines. The guidelines use HHI values -- the sum of the squares of the individual market shares of all market participants -- to measure levels of, and changes in, market concentration. The guidelines establish three HHI thresholds and corresponding presumptions of the resulting competitive impact of the merger: 1) With a post-merger HHI below 1,000, a transaction is unlikely to have adverse competitive effects, and no further analysis is usually required; 2) with a post-merger HHI between 1,000 and 1,800 and an HHI increase greater than 100, a transaction potentially raises significant competitive concerns and must be analyzed under the factors set forth in the guidelines; and 3) with a post-merger HHI above 1,800 and an HHI increase greater than 100, a transaction is presumed likely to create or enhance market power or facilitate its exercise.

According to agency statistics, mergers resulting in HHI concentrations below 1,800 are challenged very rarely and below 2,500, rarely. Moreover, mergers within the petroleum industry fall outside this general norm. Petroleum mergers have been challenged with post-merger HHI's below 1,800 and moderate increases in HHI. The commentary to the guidelines provides that HHI concentration and market shares offer some predictive value and are used as a "starting point" for merger analysis but are not conclusive. Nonetheless, because the DOJ and FTC do not adhere to the HHI thresholds, the value of the HHI thresholds and presumptions, even as starting points for further analysis, has become highly questionable.

To provide more transparency to dealmakers, the guidelines should be revised to reflect the agencies' application of HHI thresholds and presumptions. Moreover, where the DOJ and FTC plan to diverge from the HHI thresholds for particular industries, as they historically have for the petroleum industry, and apply more stringent HHI standards, those standards and the reason for the divergence from the general norm should be explained.

A second area for revision is customer-provided evidence. The agencies routinely rely on evidence from customers of the merging parties. The investigating agency will commonly solicit information from customers regarding market structure, competitive process, market participants, customer preferences and the merging parties as well as the anticipated effects of the merger. The guidelines offer no indication as to what weight such evidence should be given; the commentary, however, states that the decision to challenge a transaction is not the simple result of a tally of the number of customers that oppose a transaction and the number of customers that support it. Instead, the DOJ and FTC state that they carefully consider customer-supplied evidence and credit customer testimony only to the extent they conclude that there is a sound foundation for the testimony.

Because customers typically are the best source, and in some cases, they may be the only source, of critical information, the nature, weight, and import of customer-supplied evidence should be carefully explained in the guidelines, especially since many courts have questioned the value of such evidence. Customer views should complement integrated economic analysis of market data rather than serve as dispositive evidence that a merger will create or exacerbate conditions conducive to the exercise of market power. Effort should be made to determine whether complaining customers are marginal or inframarginal customers in the relevant market. Moreover, historical information and data from customers should be given more weight than opinions regarding future potential effects unless a customer articulates solid reasons for its concerns that are consistent with past behavior. Most importantly, customer evidence should not be conclusive on the issue of competitive effects.

A third issue is efficiencies. Horizontal mergers can enable the combined company to realize substantial reductions in variable and fixed costs as well as to produce more innovative products. While purporting in the guidelines to recognize and credit such efficiencies, the agencies have been openly skeptical of and even hostile to claims of merger efficiencies, especially in mergers where customers and/or competitors complain about the merger and the agencies challenge the merger in court. The current guidelines establish a hierarchy of efficiencies viewing production (or marginal cost) efficiencies as "cognizable and substantial" and reductions in fixed costs as less significant. While there is some evidence that the DOJ and the FTC, in practice, have recently accorded weight to fixed-costs efficiencies, the official justification for not giving much credit to reductions in capital costs, management costs and other overhead is that those reductions are not likely to be passed on to consumers in the form of lower prices.

During the comment period, many economists pointed out that this belief has little foundation in economics and, indeed, has been refuted by empirical studies. One positive outcome from the review process would be an explicit formal statement of what types of efficiencies the agencies will recognize and an explanation of why, in some circumstances, some are accorded less weight than others. The agencies' guidance should also address why, when they choose to challenge a merger in court, they maintain a "double standard" for the government's and the merging parties' burdens of proof -- a "more-likely-than-not" standard for the government's proof of anticompetitive effects and a higher (some say, impossibly higher) standard for the defendants' proof of the verifiability of the claimed efficiencies.

Another welcome outcome for dealmakers from the merger guidelines review process would be guidance as to what remedies -- for example, divestiture, firewalls, conduct, intellectual property license -- the DOJ and FTC view as adequate "fix-it-first" approaches to problematic horizontal mergers. Time is often of the essence in obtaining agency clearance, especially when the target's fortunes are rapidly declining. The guidelines now provide no guidance on preferred remedies, and dealmakers must resort to "reading the tea leaves" in past consent decrees to ascertain whether the agencies will likely deem a proffered remedy to be adequate.

Because merger enforcement is shared by the FTC and the DOJ, tea leaf reading may also have to be employed to predict which agency will review the merger. Guidance as to what remedies are sufficient and, if the guidance varies by industry, how the agencies' acceptance of the remedy will be affected by the particular industry would enable dealmakers to assess with greater certainty what fix-it-first approaches will resolve the perceived competition problem. Armed with that knowledge, dealmakers will be in a better position to assign a value to the transaction and negotiate deal documents that impose obligations to agree to certain remedies if the agencies object to the deal.

The agencies' current interest in revising the guidelines is limited to horizontal mergers, leaving their vertical merger guidelines, now more than 26 years old, intact. That approach would make sense only if the DOJ and the FTC no longer object to vertical mergers or to the vertical aspects of a primarily horizontal merger. But they do and do so without any apparent adherence to their 1984 vertical merger guidelines. If the agencies intend to continue to object to vertical mergers or to the vertical aspects of horizontal mergers, they should turn next to revising their vertical merger guidelines to reflect the past 26 years of theoretical and empirical economic research on the competitive effects of vertical mergers.

Revisions to the horizontal and vertical guidelines will arm businesses and dealmakers with much-needed tools to better predict the competitive impact of potential transactions and the likelihood of government clearance. Increased clarity and transparency are particularly important in the case of merger analysis where two distinct regulatory agencies exercise jurisdiction and the risk of inconsistent standards looms.

Geraldine M. Alexis is a partner at Perkins Coie LLP who focuses her practice on antitrust and trade regulation. Marta Miyar Palacios is of counsel at the firm and specializes in antitrust counseling and litigation.