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Collusion probe brings club deals to fore

A widened US court case against some of the buyout industry’s biggest names is raising questions over the legality of joint-bidding.

Last week, a US federal judge has widened an investigation into some of private equity’s biggest names, including Kohlberg Kravis Roberts and The Blackstone Group, over allegations the firms worked together to depress the sale prices of target portfolio companies.

Eleven firms have been brought under court examination for their use of club deals during the market peak of 2005 to 2008. The original suit, filed in 2007, included 17 transactions; but now an additional 10 unnamed deals can be used by plaintiffs to argue their case.

The plaintiffs – which include a Detroit police and fire pension fund and shareholders of chip maker Freescale Semiconductor prior to its buyout in 2006 – have until April 2012 to complete their scrutiny.

The firms involved failed to convince the court a widened investigation would be “unduly burdensome or prejudicial”.

In 2006, the US Department of Justice launched its own investigation into the joint-bidding practices of private equity firms with no government action taken

Club deals, in which private equity firms combine bids to acquire a company, have been used to limit the number of bidders in a deal and thus reduce sale prices, argued the plaintiffs in court papers. 

They go on to say club deals are not used to diversify risk, as argued by defenders of the model, because the defendants all pursued acquisitions on their own of similar size during the alleged conspiracy period. This suggests “capital constraints or diversification concerns are unlikely to be first-order motivations for club deals”.

As an example of possible collusion, the plaintiffs pointed to the $27.5 billion leveraged buyout of pipeline operator Kinder Morgan in 2006. A consortium of investors in part led by The Carlyle Group acquired the company with no competing offers made – something the plaintiffs interpret to mean the defendants were implicitly agreeing to not compete on exclusive deals.

In 2006, the US Department of Justice launched its own investigation into the joint-bidding practices of private equity firms with no government action taken. In 2008, a federal court dismissed an antitrust case brought against private equity firms Vector Capital and Francisco Partners in their joint take-private of WatchGuard, a technology company.

The decision was the “first to ever conclude that the practice of combining bids for corporate control does not violate the Sherman Act,” said law firm Wilson Sonsini Goodrich & Rosati, in a client memo.

However, the WatchGuard case ruling is not binding across all US districts, explained a US antitrust lawyer. More importantly, “the two cases are different enough to avoid any inconsistency in law,” he said.