When we brought attorney Justin Blankenship aboard the good ship Level Up as our legal correspondent, we fully intended to have him write about subjects other than Electronic Arts' attempted takeover of Take-Two. And indeed, he has other columns in the works. But when news broke of a new dust-up between Take-Two and the Federal Trade Commission, we knew we had to ask Blankenship to explain it all for you, Dear Reader. As we've said before, Blankenship previously worked in the FTC's Mergers 2 division in Washington, D.C., from 2001-2004, which gives him tremendous insight into the FTC's methodology. In today's column, he explains why EA agreed to hold off on its acquisition of Take-Two for at least 45 days, as well as the FTC's affidavit alleging that Take-Two is stonewalling its second request for information. The law is ordinarily a dry beast, but we assure you that if you take the time to read through to the end, you'll find some juicy morsels of analysis waiting for you. Enjoy.

Two pieces of news surfaced during the past week regarding the Federal Trade Commission's review of Electronic Arts' ongoing efforts to acquire Take-Two. Here's a brief update on what exactly is going on, and where the investigation appears to be headed.

On June 4, EA announced that it would be extending its $25.74 per-share offer for Take-Two stock an additional two weeks. EA also announced that it had agreed with the FTC to hold off on its acquisition until the FTC had concluded its investigation, or the expiration of 45 days, whichever occurs first. It's worth noting that although EA may have made an arrangement with the FTC that could potentially allow the deal to move forward in 45 days, EA would be moving forward at its own peril if the FTC hasn't concluded its investigation.

If the FTC were to decide that a deal is worth stopping, it would typically seek a preliminary injunction in federal court to prevent the parties from consummating the deal. If the FTC were successful and the parties still wanted to move forward, they would then have the opportunity to make their case during an administrative trial. However, in the rare event that merging parties consummate a deal while the FTC review process is still pending, the FTC can still use the administrative trial to "unwind" the deal. It's a much steeper hill for the FTC to climb, and the difficulty of unwinding assets makes it a less than ideal remedy for consumers, but it has been done (see here).

The point here is that I wouldn't place too much stock in the 45-day agreement. It certainly doesn't mean that an EA/Take-Two deal would get the rubber stamp in 45 days. If the FTC's questions still haven't been sufficiently answered at the end of the 45 days, it's extremely unlikely that EA would move forward without the agency's blessing.

The 45-day agreement seems to have been placed in further peril by the June 11 news that the FTC asked the Federal District Court to force Take-Two to fully comply with its second request for information and documents. By way of background, every party to a merger is required to make certain automatic disclosures to the FTC and the Department of Justice to enable a preliminary review of every merger. A select few mergers that raise anticompetitive concerns after an initial investigation require a "second request" for additional information.

In an earlier post at Level Up, I described a second request as "a large discovery request asking for any and all documents, correspondence, and economic data relating to the deal." More specifically, a second request consists of both a subpoena duces tecum (a request for documents) and a civil investigation demand (a series of questions and requests for data, somewhat akin to an interrogatory in a standard civil case). By nature, the amount of materials asked for by a second request is daunting and compliance is incredibly burdensome for any company. This is why they're rarely issued. In practice, every company that receives one of these second requests immediately opens negotiations with the FTC in an effort to narrow the scope of what's required.
 
These negotiations usually begin with an organizational chart of the companies, and searches are then limited to the files of individual employees most likely to possess the relevant information while avoiding duplicative and unduly burdensome searches as much as possible. It's not a pleasant process for any company to endure--it is incredibly expensive (in excess of $1 million so far, according to Take-Two) and negotiating with a governmental agency that holds most of the leverage can be frustrating.

What's happening here is that the negotiation process between Take-Two and the FTC appears to have completely broken down, and the FTC has taken the somewhat extraordinary step of enforcing its second request in federal court. An affidavit by Reid B. Horwitz, an attorney in my former division at the FTC, has been filed in conjunction with the FTC's motion, providing a great deal of background on the nature of the dispute (see here, courtesy of GamePolitics.com).  Anyone interested in the details of the dispute can find the blow-by-blow in the affidavit itself. The gist of it appears to be that Take-Two had an agreement with the FTC to search for responsive documents in the files of certain individuals. But after hiring a new law firm, Take-Two has apparently reneged on that initial agreement, and has on several occasions narrowed the scope of the search that it is willing to perform even further.

Although the target of an FTC investigation has some grounds to object to a second request on the basis that it's unduly burdensome, the Horwitz affidavit tells the story of a corporation that's gone beyond making good-faith objections based on scope. Take-Two appears to be simply stonewalling. Take-Two's current position is that it shouldn't have to incur the expense of complying with a burdensome second request in this case because it's an unwilling participant in the merger. While it's a sympathetic position from a business standpoint, it's likely to fall on deaf ears. The FTC has the clear legal authority to issue its own subpoenas. While a federal court can be used to ensure that the FTC doesn't abuse that power, those subpoenas certainly can't be completely ignored, either. The sequence of negotiations described in the Horwitz affidavit, frankly, reeks of bad faith on the part of Take-Two, which will make it incredibly difficult for the company to obtain any relief from the subpoena in federal court. The Federal District Court has issued a show cause order to Take-Two requiring it to explain its non-compliance on June 24.

The Horwitz affidavit describes a somewhat curious scenario. I would echo Wedbush Morgan analyst Michael Pachter's comments to GamePolitics.com that you wouldn't expect Take-Two to be stonewalling in this situation. You would think that as the unwilling target of EA, it would be in Take-Two's best interests to hand everything over to the FTC as soon as possible with every incriminating quote already highlighted, complete with its own commissioned economic study about how EA would destroy competition in sports videogames, all wrapped up with a pretty red bow.

I would quibble with Mr. Pachter's comments, however, where he states that "the process won't be delayed if Take-Two's failure to comply with the subpoena results in the FTC granting approval without looking at these documents." Although he is absolutely correct that "there is NOT a presumption of anti-competitiveness," I'm also not aware of any merger sneaking through the FTC because the parties were successful in stonewalling. Instead, you'll most likely see the FTC doing everything in its power to enforce its subpoena and delay the transaction until its review is complete, possibly going so far as to seek a preliminary injunction.

The most fascinating aspect of the Horwitz affidavit, however, would have to be the glimpse it provides into the early thinking behind an otherwise non-public investigation. Without patting myself on the back too hard, if you've been following this story on Level Up, you won't be shocked by some of the affidavit's revelations. Not surprisingly, the FTC's investigation appears to be focused on "competing titles for simulated sports games, including basketball, football, hockey, and baseball." (Horwitz Affidavit, paragraph 6). Some of the specific documents sought by the FTC include "databases and copies of its licensing agreements with the various professional and college sports leagues and associations" (Horwitz Aff., paragraph 18) and "marketing and pricing documents relating to basketball and hockey video games" (Horwitz Aff., paragraph 20). This seems to confirm our own speculation that the focus would be on the overlapping basketball and hockey simulation games, since Take-Two already has a Major League Baseball exclusive and EA has the well-publicized Madden exclusive (although one could argue that Take-Two's All-Pro Football is its closest competitor).

The affidavit also revealed a dispute between the FTC and Take-Two as to whether Take-Two should produce documents relating to boxing and tennis videogames. Take-Two's counsel has argued that "the Commission need not investigate whether this transaction would reduce competition in this group of video games because he believed that these games did not constitute markets that implicated antitrust concerns" (Horwitz Aff., paragraph 31). This little nugget not only reveals that the FTC is also interested in boxing and tennis--the language also seems to suggest that the FTC is considering market definitions as narrow as simulations for individual sports, rather than a broader definition of sports videogames as a whole, or simply videogames. My past posts about this transaction discuss the importance of market definition in greater detail. What's important to understand is that narrowly defined markets, such as "hockey simulation videogames," make it far easier to find an anticompetitive effect.

While it's fun for a former FTC lawyer like myself to read the tea leaves found in a document like this, it's important to note that it's only a snapshot representation of the FTC's thinking at this moment in time, and there may be a certain amount of posturing occurring at this stage. One can't read the Horwitz Affidavit, however, and walk away without feeling like the FTC is deadly serious about taking a hard look at this deal. It strikes me that as this deal is continually delayed, the EA/Take-Two merger that once seemed inevitable seems less and less likely. Although we've been given a glimpse into what the FTC is thinking, it's still impossible to be sure what the FTC will eventually do. But the more this drags out, the more likely we are to see a white knight (Activision? Ubisoft?) enter the ring on Take-Two's behalf.