October 11, 2006
Private Equity Auctions and Antitrust
The Justice Department's Antitrust Division has started an investigation into the bidding practices of the players in the private equity markets. Private equity funds often group together to make bids for companies (in LBOs). At issue is whether the players are rigging auctions -- agreeing not to compete with each other for selected companies -- like Persian rug buyers. This will be a difficult investigation. To get a sense of the history one must understand the underwriting game -- the private equity players take their cue from the underwriters. In 1953 the Supreme Court held, in United States v Morgan, that underwriters could pool to do firm underwritings, spreading the risk among a "syndicate." Pooling makes sense but it very quickly degenerates into quiet "understandings" about structuring competition, which pose antitrust problems. The 1953 case has led to an American underwriting fee structure that is the highest in the world and that has "understood" levels -- large companies are charged 7 percent and so on. Similarly the private equity fund groups could led to similar competition "understandings." At issue is how the legal system allows what makes business sense, the pooling of capital, and disallows what is destructive to competition -- understandings among potential competitors to reduce competition. This is a very difficult problem for legal process. Our approach in the past is to turn a blind eye to the competitive problems until a "smoking gun" series of exchanges appears in a deal, then we prosecute based on the letters (emails). Smart players know how not to write smoking guns, so we catch the dumb ones and the market structuring continues apace. My preference would be to be less hospitable to the players who want to pool, putting the burden on those who pool to justify the pooling and keep accurate records of how the deal was put together (and of communications with competitors). In other words, we should be suspicious inherently of such deals not openly and unquestioningly accepting (as we are now).
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