Defense Department to Increase Role in M&A Reviews

By Ross Demain, James O’Connell and Alezeh Rauf

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The Government Accountability Office published a report Oct. 17 titled, “Defense Industrial Base: DoD Needs Better Insight into Risks from Mergers and Acquisitions.”

The report details the Defense Department’s current M&A review process and provides recommendations to proactively assess whether proposed transactions may give rise to concerns relevant to the department.

The impacts of transactions on competition are assessed by the Antitrust Division of the Department of Justice and by the Federal Trade Commission through their enforcement of the Sherman Act, the Clayton Act and the FTC Act. These agencies may review any transaction under those statutes, in any industry — although only Justice may review transactions in certain industries.

The Hart-Scott-Rodino Antitrust Improvements Act of 1976 also established a Premerger Notification Program, pursuant to which parties to transactions that exceed the relevant notification thresholds are required to notify Justice and FTC and observe a waiting period before closing their transaction.

Either agency may open an investigation during the Hart-Scott-Rodino waiting period to determine whether the proposed transaction raises substantive concerns under U.S. antitrust law and whether it should be allowed to proceed, whether the agency should seek to block the deal or whether remedies to address the identified antitrust risks should be imposed.

Whether reviewing a proposed transaction pursuant to the Hart-Scott-Rodino Act process or a consummated transaction, Justice and FTC evaluate whether a transaction may substantially lessen competition or may tend to create a monopoly.

Currently, Justice and the FTC may request that the Defense Department’s Industrial Base Policy Office — with input from defense stakeholders — provide recommendations on transactions that could affect the defense industrial base.

While the Defense Department does not have a formal role in deciding the outcome of an antitrust review of a transaction, customer views are usually a key part of such reviews, whether that customer is a private entity or a major government purchaser like the Defense Department.

The GAO report concluded that the department has, to date, had a reactive role in defense industry mergers and acquisitions review. As a result, the report observes that it has missed opportunities to identify transactions that could negatively impact the defense industrial base and to manage the full range of risks that such transactions can present for its programs. The report concluded that the Defense Department’s historically reactive posture has been due in part to a lack of sufficient guidance and resources being made available to those who are responsible for this process.

For example, the current policy, set forth in DoD Directive 5000.62, outlines the department-wide policy for assessing mergers and acquisitions in the defense industrial base, explaining that the department should consider its effect on competition for prime contracts and subcontracts, on national security and on innovation risks. However, this directive does not provide any methodology for such assessments.

Further, the report observes that the Industrial Base Policy Office historically has been resource constrained, and as a result, it has had limited capacity to look out for and monitor transactions that may be reportable under the law but do not have an obvious defense connection. The office has also been limited in its ability to look for and consider the effects of defense-related mergers and acquisitions with a value lower than the amount required for reporting under the act or to conduct macro-level trend analyses or retrospectives of the transactions in the defense industrial base. As a result, GAO notes that the office’s officials tend to focus on responding to inquiries from the Justice Department and FTC on high-value transactions, and it relies on outreach from the civilian agencies as a proxy for identifying the highest risk mergers and acquisitions in the defense industrial base, rather than taking a proactive role in assessing risks.

The report observes that between fiscal years 2018 and 2022, the Defense Department assessed approximately 40 transactions per year, accounting for approximately 10 percent of defense-related transactions. The vast majority of them subject to review were above the transaction threshold. Moreover, the department has only monitored the competition effects of two completed mergers and acquisitions transactions in the past 10 years, both at the prompting of the civilian agencies.

GAO has thus issued these four recommendations for Defense: provide direction to relevant personnel on assessing the full range of risks and benefits identified in the department’s policy; clarify which major defense suppliers’ transactions should be prioritized for assessment; assess whether the Industrial Base Policy Office is adequately resourced; and monitor the effects of concluded transactions in cases where the Pentagon had identified risks, to determine if risks were realized or if additional action is needed.

The department concurred with all four recommendations, stating it will soon promulgate new written policy to provide guidance on conducting and prioritizing assessments, as well as monitoring completed transactions. The department will also assess the design and implementation of a mergers and acquisitions monitoring mission and resources to support it. Additionally, the Industrial Base Policy Office is requesting dedicated funding to support and increase its mergers and acquisitions work.

These developments underscore that the Biden administration and Defense Department are highly focused on merger activity, including in the defense industrial base. Both defense contractors and financial sponsors operating in defense-related sectors should continue to monitor the expanded role that the department is likely to play in merger reviews going forward. 

Ross Demain and James O’Connell are partners, and Alezeh Rauf is a law clerk at Covington & Burling LLP.

Topics: Business Trends, Defense Contracting

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