United States: FTC Administrative Law Judge Orders Divestiture — Finds Hospital Merger "Substantially Lessened Competition"

In 2000, Evanston Hospital and Glenbrook Hospital merged with Highland Park Hospital and merged the combined entity into Evanston Northwestern Healthcare Corporation ("ENH"). The total value of the merger was in excess of $200 million. The merger was subject to the filing requirements of the Hart-Scott-Rodino Act, and was not challenged prospectively by the antitrust enforcement authorities.

Almost four years later, however, in February 2004, the FTC staff commenced this antitrust enforcement action, alleging that the merger had substantially lessened competition, and, therefore, caused the price of health care services to rise. Invoking principally Section 7 of the Clayton Act, which prohibits transactions "where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly," the FTC alleged that the merger had substantially lessened competition by aggregating the hospitals . market power resulting in increased prices for health care services.

This was the first FTC challenge to a hospital merger since 1997. Instead of suing in federal court, the FTC chose to proceed administratively, and the case was tried to an ALJ over the course of several months.

There are several interesting, and potentially important, aspects of the ALJ’s decision.

The ALJ’s decision may be viewed as validating the FTC’s shift in focus in the field of hospital mergers from prospectively attempting to prevent mergers to its retroactive review of consummated mergers, a move that was first announced in 2002. After suffering a string of defeats in prospective challenges to hospital mergers, the FTC changed its focus to review consummated mergers, to determine whether: (a) the promised efficiencies had actually come to fruition and (b) consumers ultimately benefited, as the merging parties represented they would.

By focusing on a completed merger, the FTC obtains the benefit of post-acquisition evidence, which arguably allows for a better empirical evaluation of the merger’s actual competitive effects. Here, post-acquisition evidence played a significant role in the ALJ’s ENH decision. Based on the extensive economic analysis offered by both parties’ economist experts and statistical analyses of price increases (which revealed significantly higher rates of increase for"ENH than for comparable hospital systems), the ALJ found that .ENH exercised its enhanced post-merger market power to obtain price increases significantly above its premerger prices and substantially larger than the price increases obtained by other comparison hospitals."

The ALJ analyzed and ultimately rejected each of ENH’s proffered explanations for its price increases (again relying on statistical evidence), and also rejected the procompetitive justifications offered by ENH, including quality of care improvements.

The ALJ relied on the Joint Commission on Accreditation of Healthcare Organizations’ survey data to find that after the merger there had been no overall improvement in the quality of care at the implicated hospitals.

The ALJ also rejected ENH.s fairly vague defense that its non-profit status reduced the potential for competitive harm, and cited the fact that ENH managers received larger bonuses and higher pay increases after the merger.

Finally, the ALJ was not persuaded by ENH’s claim that Highland Park Hospital was a failing entity that would have perished had it not been acquired by ENH.

In many of its unsuccessful hospital merger challenges, the FTC’s principal problem has been its inability to prove a relevant geographic market.

Over the past few years, the FTC has been signaling its intention to move away from traditionally accepted means for determining the appropriate geographic market for a hospital, such as patient flow data and the use of the Elzinga-Hogarty test. In an advisory opinion dated April 1, 2003, concerning the Acquisition of Slidell Memo- rial Hospital by Tenet Healthcare Cooperation, the FTC engaged in an analysis of the health plans available in a town where the only two hospitals were proposing a merger. It found that employers were unlikely to select health plans that did not include the two hospitals, and therefore the merged hospitals would have the ability to raise prices after the merger.

The ALJ’s decision in the ENH case adopted this reasoning. He concluded that the real question is not competition for patients, but rather, competition to be included in managed care or other health insurance plans. He accepted the FTC’s position that "market realities demonstrate that managed care organizations cannot "practicably" turn outside the ENH geographic triangle for substitute hospitals."

The ALJ also reasoned that patient flow data is unhelpful to the analysis. "[A]lthough patients may use hospitals outside of the geographic market, the evidence demonstrates that, in this market, these outlying hospitals do not constrain [ENH’s] pricing and they are not hospitals to which managed care organizations can turn to construct viable hospital networks."

The ALJ defined the geographic market to include an area largely contiguous with the area surrounding the ENH hospitals (a fairly gerrymandered region), and ignored many hospitals in the northern Chicago area, which ENH urged should have been included in the relevant geographic market. The ALJ also found that his geographic hospital market was highly concentrated, and that the merger had significantly increased that concentration.

The ALJ’s opinion is littered with references to pre-merger communications suggesting that one of the purposes of the merger was to increase market power in order to obtain the ability to negotiate higher prices from payors. The fact that this (and not efficiency or improvements in the quality of care) appeared to have been the primary driver for the merger undoubtedly affected the ALJ’s analysis.

For example, Highland Park.s CEO said to his board:

Similarly, the CEOs of Evanston and Highland Park included as a strategic recommendation the objective of strengthening "negotiating positions with managed care through merged entities and one voice."

Post-merger actions and comments by ENH management reinforced this view. For example, management characterized the merger as a success based on "$24 million of revenue enhancements . . . achieved – mostly via managed care renegotiations." Likewise, ENH’s tactics in renegotiating managed care contracts may have caused raised eyebrows, particularly its approach of always selecting the higher reimbursement rate between Evanston and Highland Park when setting rates for the new merged entity.

As a remedy for the violation of Section 7, the ALJ ordered the divestiture of Highland Park hospital within 180 days. The ALJ noted that the burden rested with ENH to show that some remedy other than divestiture was appropriate and would adequately redress the violation. The ALJ rejected the alternative remedies proposed by ENH, and did not engage in a very deep analysis of the "unscrambling of the eggs" problem.

First, it is important to understand that this case is not yet over. ENH has already announced its intent to appeal the ALJ’s decision to the full Commission, and will no doubt seek a stay of the divestiture order pending that appeal. We understand that the FTC staff also intends to appeal certain aspects of the ALJ’s decision.

The Commission’s ultimate decision is also appealable by any party against which an order is issued, and a petition for review may be filed with any court of appeals within whose jurisdiction the party "resides or carries on business or where the challenged practice was employed."

Second, ENH represents a carefully crafted win for the Commission. All indications are that ENH’s exercise of market power was fairly blatant and quite aggressive, and that its anti-competitive intentions were documented. The statistical evidence upon which the ALJ relied to determine that ENH raised prices at a more rapid rate than comparable hospitals may be difficult to replicate in other markets, and it is impossible to know whether the result would have been the same without the subjective, anti-competitive intent evidence discussed above.

Third, hospitals should give consideration to the following issues in light of the decision:

• Any hospital system with significant mergers over the past five years should look closely at the competitive effects of the merger, especially if there have been significant prices increases. Increased scrutiny is also warranted if there have been complaints from payors regarding their contracts.

• Hospitals should make sure they are delivering on any pro-competitive promises they made in justifying a merger.

• Hospitals should be prepared to analyze prospective mergers based on the competitive impact on managed care contracting, and not just think in terms of patient flow data.

• Hospitals must have, and accurately articulate, procompetitive justifications for mergers. A merger that is justified internally as a way to improve bargaining power with payors will attract more intensive scrutiny.

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