Private equity liable for portfolio’s antitrust breach

Author: Danielle Myles | Published: 9 Apr 2014
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The European Commission (EC) has held a Goldman Sachs-sponsored fund jointly liable for a portfolio company’s cartel infringement.

It’s only the second time Europe’s antitrust authority has pierced the corporate veil of a company owned by a private equity (PE) fund and imposed liability on its financial sponsor.

In its April 2 decision the EC ruled that the world’s major cable manufacturers, including Italy-based Prysmian which was once owned by Goldman Sachs Capital Partners, ran a cartel between 1999 and 2009.

The decision is a reminder that PE houses must pay close attention to portfolio companies’ antitrust risks. But the most effective ways to minimise these risks may not be compatible with PE investment strategies.

"The best mitigant is having comprehensive and compelling evidence that the private equity house exerts no strategic or operational influence over the business of the portfolio company," said Stephen Mavroghenis, co-head of Shearman & Sterling’s global antitrust group.

"But given these firms generally want to get involved in the business, a hands-off approach may not be realistic," he added.

Other sources, however, believe fund structures might be analysed to further reduce these risk of fund investors.

Key takeaways
  • The EC has held a Goldman Sachs-sponsored fund jointly liable for a portfolio company’s infringement
  • The decision is a reminder that PE houses must pay close attention to portfolio companies’ antitrust risks
  • The EC differs from the UK and US in its approach, and often pierces the corporate veil
  • The Commission held that Goldmans exercised a 'decisive influence’ but how this is defined will only become clear once the final decision is released

A usable defence?

In contrast to the US and UK, the EC’s competition directorate-general often pierces the corporate veil and holds parent companies liable for their wholly or partially-owned subsidiaries.

Known as the Parental Liability Doctrine, this creates a rebuttable presumption that liability for a company’s cartel infringement may be ascribed to its parent. If an owner can prove it does not have decisive influence over the company, and that it refrained from any involvement in the entity’s management and control, it can be exonerated under the Pure Financial Investor defence.

But given PE firms are interested in turning companies around to sell at a profit, this approach is unlikely to be palatable to financial sponsors.

A Goldman Sachs spokesperson said there is no suggestion the bank or its people had any knowledge or involvement in the purported collusive behaviour. Notwithstanding this, the EC’s statement from last week notes that the Goldman fund and owners of the other cartel participants were held liable 'because they exercised a decisive influence over them’.

What amounts to 'decisive influence’ will only be clear once its final decision is released – which could be sometime. Once these details are known, PE firms will have a better idea of what interactions will lead the EC to decide the fund is directing strategic influence over the company.

But at this stage it is clear that PE firms are not immune to the EC’s willingness to pierce the corporate veil, and that the Pure Financial Investor defence is not guaranteed to absolve them from responsibility.

It is a defence incredibly difficult to establish. "Even reserving a veto right on a business plan or replacing one member of the company’s management could lose you the defence," said Markus Röehrig, a partner with Hengeler Mueller in Brussels.

Pre-acquisition mitigants

According to the EC, Prysmian was involved in the cartel activity before it was taken over by the Goldman Sachs fund in 2005.

While most large-cap PE firms already have the strictest compliance practices, a greater focus on diligence in now expected in mid and small-cap PE buyouts. But the fact cartel offences are often not apparent through document review or interviews with senior management means it’s not certain how effective this would be.

"There is only so much that due diligence can pick up, and we often recommend private equity buyers have cartel warranties and indemnities in place and, if possible, claw back provisions," said Mavroghenis.

But warranties and indemnities being subject to time limits is another shortcoming.

"It’s possible that these protections may not be useful by the time a fine is imposed, especially if liability arises after disposal of the portfolio company," said Mavroghenis.

Another approach is to interview mid-management and conduct other final reviews immediately before a deal completes.

"We might see some very rapid post-closing audits to identify any antitrust risks that couldn’t be picked up through the due diligence, because access to the necessary people wasn’t available," said Röehrig.

Educational material

The only other PE firm held liable in this way was Arques in 2009. This small firm specialises in restructuring distressed companies, and so it was closely involved in the portfolio company’s affairs.

That this latest case involves a well-known, traditional PE firm provides clearer evidence of the EC’s strong stance on portfolio company liability. Advisors are expected to educate such firms on the coming weeks of the ruling and its ramifications.

While most large-cap PE firms already have the strictest compliance practices, the case serves lessons for mid- and small-cap firms.

"It does, however, show that even firms with the highest compliance standards can get hit at times," said Hengeler partner Emanuel Strehle.

Prysmian is appealing the ruling. Goldman Sachs is considering its rights of appeal.

See also

US and UK courts tease corporate veil

Tell me before taking the seat

Regulators cooperate to target corporate governance