Hospitals and health systems contemplating mergers should display "antitrust sensitivity" in pre-merger planning and post-merger implementation.
On August 6, 2007, the Federal Trade Commission (FTC) ruled that a consummated merger between Evanston Northwestern Healthcare (ENH) and Highland Park Hospital was an anticompetitive acquisition in violation of Clayton Act Section 7, which prohibits transactions that may substantially lessen competition. Part I of this On the Subject summarizes the FTC’s decision. Part II focuses on the key lessons to be drawn from the ENH enforcement action and offers practical advice for hospitals and health systems contemplating mergers or other collaborative arrangements.
FTC Enforcement Action
Facts and Procedural History
ENH and Highland Park Hospital merged in 2000, combining ENH’s 400-bed tertiary hospital in Evanston, Illinois (Evanston Hospital) and its 125-bed community hospital in Glenbrook, Illinois (Glenbrook Hospital), with Highland Park Hospital’s 150-200 bed facility. The three hospitals form a triangle along Chicago’s North Shore; Highland Park Hospital is located approximately 14 miles north of Evanston Hospital and approximately seven miles northeast of Glenbrook Hospital.
In 2002, the FTC announced that it was conducting a retrospective review of the competitive effects of several hospital mergers. In 2004, the FTC filed an administrative complaint against ENH alleging that its acquisition of Highland Park Hospital violated Clayton Act Section 7 because it enabled ENH to raise the prices it charged health insurers above competitive levels and far above price increases of other comparable hospitals. In 2005, an Administrative Law Judge (ALJ) ruled in favor of the FTC and ordered ENH to divest Highland Park Hospital. ENH appealed the ALJ’s decision to the FTC.
The FTC’s Decision and Reasoning
The FTC affirmed the ALJ’s decision, finding that "the transaction enabled the merged firm to exercise market power and that the resulting anticompetitive effects were not offset by merger-specific efficiencies." The FTC highlighted two types of evidence as significant to its decision: statements by hospital executives and their consultants about the reasons for and likely financial effects of the merger, and econometric analysis of post-merger price increases by ENH.
First, the FTC found that executives at ENH and Highland Park Hospital attributed the merged entity’s ability to raise prices in part to increased bargaining "leverage" produced by the merger. The FTC quoted an ENH executive as saying, pre-merger, that the merger would "increase our leverage, limited as it might be, with the managed care players and help our negotiating posture;" and also quoted a consultant retained by ENH as stating that the merger would provide the opportunity to "negotiate contracts with payors from a stronger position" and would be a factor to "substantially improve ENH’s leverage" with payors. The FTC also found evidence that the parties recognized that the transaction would eliminate competition between them for payor contracts. The FTC cited a pre-merger meeting between ENH and Highland Park Hospital’s board members and medical staff leaders, at which Evanston Hospital representatives characterized the merger as an opportunity to "strengthen negotiation capability with managed care companies through merged entities" and not to "‘compete with self’ in covered zip codes (e.g., 60 percent to 70 percent market share) such as Evanston, Glenview, Highland Park and Deerfield." The FTC also quoted an ENH executive as saying, post-merger, that the "larger market share created by adding Highland Park Hospital has translated to better managed care contracts" and that "some $24 million of revenue enhancements have been achieved—mostly via managed care renegotiations," and "none of this could have been achieved by either Evanston or Highland Park alone. The ‘fighting unit’ of our three hospitals and 1600 physicians was instrumental in achieving these ends."
Second, the FTC emphasized that econometric analysis presented by both parties’ economics experts corroborated the hospital executives’ predictions of the transaction’s likely competitive effect—higher prices to payors. The evidence showed that ENH’s prices increased significantly more than those of comparable hospitals immediately following the merger. The FTC’s economist found that, post-merger, ENH increased its average net price per case for all patients by 30 percent. Because the FTC challenged the merger "after the fact," there was evidence of the transaction’s actual anticompetitive impact. Additionally, the econometric analysis effectively ruled out potentially benign (e.g., procompetitive or competitively neutral) explanations for the ENH post-merger price increases, such as changes in regulations, differences in patient mix or improvements in quality.
In a departure from its usual remedy and the remedy ordered by the ALJ (divestiture), the FTC ordered ENH to establish separate and independent managed-care contracting teams—one for the Evanston and Glenbrook Hospitals, and another for Highland Park Hospital. While the FTC acknowledged its preference for a structural remedy (divestiture), it reasoned that the time elapsed since the merger and the significant integration that had already taken place among the hospitals, particularly in the areas of cardiac surgery and information technology, called for a less drastic remedy in this case.
Practical Considerations
Pre-Merger
The ENH case highlights the need for the parties and their consultants to display "antitrust sensitivity" in their pre-merger planning. The antitrust laws are, in effect, consumer protection statutes. Accordingly, the parties to a hospital merger or other collaborative arrangement should pay particular attention to the proposed transaction’s effect on their "consumers"—that is, their patients and payors. Parties should consider the following guidelines for pre-merger planning and post-merger implementation:
Focus on Transaction Efficiencies
Because the antitrust laws are intended to protect competition, not individual competitors, the parties should examine and be able to quantify how the transaction will benefit consumers and payors through quality improvements, development of new services, expanded geographic reach, efficiency enhancements and other potential cost savings. Those procompetitive benefits will only be persuasive, however, if they are shown to be merger-specific—that is, if they could not be achieved by either party on its own, in the absence of the merger.
Also, executives should focus their public and private comments (written and spoken) on how the proposed transaction will benefit patients and payors, not the merging parties. The FTC’s decision emphasizes the significance that the FTC places on statements by the merging parties and their consultants in the context of their pre-merger negotiations and planning.
Avoid Guilty Words
Health system executives, as well as their consultants, must carefully avoid using words that suggest the proposed transaction will have anticompetitive effects. Statements that the proposed transaction will result in the elimination of or a reduction in competition, increased bargaining "leverage," dominance in the marketplace or higher revenues based on higher reimbursement rates invite scrutiny by the antitrust enforcement agencies and likely will be cited as evidence of an antitrust violation. Rather, the parties should focus on the anticipated procompetitive effects of the transaction—that is, cost savings that may be achieved through the consolidation of under-utilized resources, the development of new services that neither hospital could afford to provide on its own, expanded geographic coverage for the combined facilities, quality improvements and other synergies that might flow from the transaction.
No Gun-Jumping
Although not an issue in the ENH enforcement action, hospitals that are actual or potential competitors should remember to avoid "gun-jumping"—that is, acting as a single entity before they consummate the transaction—by restricting their exchange of competitively-sensitive information and by refraining from coordinating their activities prior to the closing of their merger or venture. While the parties can engage in pre-merger transition planning, they must be careful not to implement their consolidation plans before the transaction has been completed.
Post-Merger
HSR Clearance Does Not Equal Immunity from Prosecution
The parties to the ENH transaction filed a pre-merger notification under the Hart-Scott-Rodino Act. Although the FTC declined to challenge the transaction when it first was proposed, four years later it filed an administrative complaint based upon ENH’s post-merger conduct. This is a reminder to parties to a merger or other combination that they should not interpret the government’s failure to challenge a merger prospectively as immunity from subsequent prosecution. The FTC or U.S. Department of Justice is entitled to—and may—bring an enforcement action against the parties at any time.
In addition, the FTC’s recent success—albeit through the cumbersome and slower administrative process—in the ENH enforcement action may result in more challenges to hospital mergers, either prospectively or retrospectively. If the FTC challenges another hospital or health system merger "after the fact," the analysis likely will focus on evidence demonstrating the transaction’s actual anticompetitive effects, as in the ENH case. That means that the primary issue, during both the investigation and trial, will be whether the transaction enabled the merged hospitals to increase their prices above competitive levels, as demonstrated by evidence of their post-transaction pricing behavior. On the other hand, if the FTC challenges a hospital merger prospectively—before it is consummated—it is more likely to focus on defining the relevant geographic market in which the merging hospitals compete and predicting the proposed transaction’s likely competitive impact on payors and patients within that market. The FTC has typically had more difficulty meeting its burden of proving anticompetitive effects prospectively in hospital merger cases (as evidenced by the federal enforcement agencies’ loss of seven consecutive challenges to hospital mergers since 1994).
Further, parties to a hospital merger should not interpret the remedy that the FTC ordered in this action—the creation of separate and independent contract negotiating teams for Evanston and Glenbrook South Hospitals on the one hand, and Highland Park Hospital on the other—as the remedy that the FTC likely would impose in any other successful merger challenge. The FTC stated that the ENH case "is the highly unusual case in which a conduct remedy, rather than divestiture, is more appropriate" and that its "rationale for not requiring divestiture in this case is likely to have little applicability to our consideration of the proper remedy in a future challenge to" an unconsummated or consummated merger, including a hospital merger. It would have been extraordinarily difficult to "unscramble the eggs" more than seven years after ENH and Highland Park Hospital consolidated their operations.
Ironically, it is not clear that the remedy imposed in this case will promote competition, especially given the absence of any incentive for the two contracting teams to price compete against one another. Also, one requirement of the remedy—that ENH may not make any contract for Evanston and Glenbrook Hospitals or Highland Park Hospital contingent upon a payor’s entering into a contract with the other, and may not make the availability of any price or term for a contract for Evanston and Glenbrook Hospitals contingent on entering into a contract for Highland Park Hospital, or vice versa—could stifle competition because it effectively prohibits ENH from offering a payor lower prices if it contracts with all three hospitals (e.g., bundling).
It appears that the FTC devised its "administrative" remedy to limit the risk of reversal if ENH decided to appeal the FTC’s decision and order to a federal circuit court of appeals. For that reason, we do not believe that the FTC’s chosen remedy in this case signals a change in the FTC’s preference for structural remedies over conduct remedies, and it is unlikely that the FTC will actively pursue this remedy in other, similar enforcement actions.
Post-Merger Conduct and Statements
The ENH case highlights the importance of the parties’ post-merger conduct. The most compelling evidence that ENH’s acquisition of Highland Park Hospital was anticompetitive was the timing and size of the price increases implemented by ENH shortly after the acquisition. The lesson is that, post-merger, the newly-merged hospitals should not get "greedy." They should avoid immediately imposing significant price increases or attempting to exercise what they might perceive to be their newly-found "bargaining clout" or "leverage" with payors. The FTC is likely to perceive any price increase greater than 5 percent to be "significant" and evidence of market power.
Finally, if the parties to a transaction successfully complete their transaction without a government challenge, the merged entity should continue to be mindful that its statements (both public and "private") about its competitive conduct or the merger’s financial impact may come to the antitrust enforcement agencies’ attention and form the basis for an investigation or post-consummation challenge. Again, the focus of any characterizations of the merger should be on the benefits it has provided to the hospitals’ consumers and constituents, not the parties to the merger themselves.
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