Increased scrutiny of government contractor M&A deals likely on the horizon
In March 2024, Senators Elizabeth Warren and Mike Rounds issued a letter to the Secretary of Defense highlighting key issues identified in Department of Defense (DoD) and Government Accountability Office (GAO) reports addressing matters related to DoD deals in mergers and acquisitions (M&A). This Senate letter marks the latest in a series of government reports or comments on DoD M&A that began with the DoD in 2022.
While no new policies have been introduced yet, these developments suggest a future in which M&A transactions involving DoD contractors could face increased regulatory scrutiny and oversight.
This alert will explore key findings from these reports and what changes they might foreshadow.
Background
Since the release of the DoD’s report on the State of Competition within the Defense Industrial Base in 2022, there has been growing scrutiny of M&A involving DoD contractors. In late 2023, the GAO released its own report in response to DoD’s State of Competition report, entitled, DOD Needs Better Insight into Risks from Mergers and Acquisitions. Not to be outdone, the US Senate has taken note of this increasing chorus of government reports warning of the potential impact of DoD-related M&A on the defense industrial base. In the most recent development in March 2024, Senators Elizabeth Warren and Mike Rounds issued a letter to the Secretary of Defense highlighting what they considered the most salient issues at play in DoD’s and GAO’s reports, adding to these developments over the past few years.
DoD’s State of Competition report – 2022
In its State of Competition report, DoD emphasized the importance of competition to the vitality of the defense industrial base, highlighting the positive impact that competition has on innovation, prices, and contract performance. The report said that DoD considers competition to be a key indicator of “industrial capability and capacity to deliver the systems, key technologies, materials, services, and products the Department requires to support its mission.” State of Competition at 1. In response to what it sees as a consolidation of market players, DoD laid out five recommendations to increase competition. The first of these recommendations is to strengthen DoD’s oversight of M&A corporate transactions, including supporting antitrust investigations on the part of the Federal Trade Commission (FTC) and the Department of Justice. In this regard, DoD underscored its commitment to actionable objectives.
GAO’s report on increasing oversight of DoD M&A – 2023
GAO’s report assessed the extent of DoD’s insight into defense-related M&A, how DoD interacts with antitrust agencies, and the level to which DoD monitors the after-effect of completed M&A deals on competition.
GAO concluded that DoD has limited insight into the potential risks associated with the majority of defense-related M&A transactions, stemming from DoD's current focus on only high-dollar-value transactions. For example, although DoD has identified approximately 400 defense-related M&A transactions on average year-over-year, it has only reviewed an average of 40 deals per year between 2018 and 2022. See DOD Needs Better Insight at 13. In part, this is due to mandatory US antitrust filings only being triggered for transactions with a value greater than $119.5 million (for 2024) and filings with CFIUS (The Committee on Foreign Investment in the United States) still being largely voluntary in nature. Outside of these filings, the US government will typically only learn of transactions involving the change of control of a government contractor after the closing has occurred (outside of carveout deals, most M&A deals involving a government contractor are structured as a change of control versus a sale of assets to avoid the novation of prime contracts).
According to GAO, the risks associated with this limited insight are amplified by the absence of a clear policy from the DoD Office of Industrial Base Policy (IBP) addressing the review of government contractor M&A transactions, as well as a general understaffing of IBP. Moreover, GAO observed that IBP – when it does review M&A transactions – does not consistently review them for the full range of risks identified in DoD policy, instead focusing almost exclusively on whether the contemplated deal will impact competition.
GAO also remarked that DoD has limited access to information to assist antitrust agencies in assessing and reviewing government contractor M&A transactions. For example, although IBP can pull data from DoD internally to ascertain how much a given contractor works with DoD, it cannot access broader competition data that agencies like the FTC use to assess the wider competition impacts of a proposed transaction. As a result, according to GAO, DoD cannot effectively identify potential deals requiring review prior to closing, nor does DoD have independent input on how antitrust agencies structure mitigation plans that buyers and sellers can implement to save a deal from being put on hold. Instead, it must wait for a request from an antitrust agency to recommend mitigation actions.
Finally, GAO observed that DoD rarely revisits M&A transactions after they have been assessed and reviewed to determine whether any of the contemplated competition risks actually occurred. As above, DoD only does this when specifically requested by an antitrust agency.
As a result of these findings, GAO issued four recommendations to DoD:
- Provide clear direction for IBP to know which defense-related M&A transactions require assessment
- Consider whether IBP’s M&A office is adequately resourced to carry out its responsibilities
- Provide additional guidance on how to assess the full range of risks and benefits that may arise in M&A (for example, reviewing a deal for national security risk and not just competition risk), and
- Implement a monitoring policy for completed M&A transactions to determine if risks arose, and if additional action is required.
Senators Warren and Round’s comments on DoD M&A – 2024
In the Senate letter, Senators Warren and Round highlighted what they saw as several salient aspects of GAO’s report, while also citing extensively DoD’s State of Competition report. Although the Senate letter did not provide much in the way of additional findings or recommendations, it did pose a series of questions that indicate the shape that new DoD M&A oversight initiatives could take.
Senators Warren and Round asked (1) whether large contract requirements could be broken up, (2) whether DoD had plans to use the US President’s power under the Defense Production Act to “influence domestic industry,” (3) what questions and stakeholders are involved in when DoD gathers internal data to assess an M&A transaction, and (4) what DoD has done to address staffing needs to increase its capacity to review government contractor M&A deals. See Senate letter at 5.
These questions point towards a growing interest in Congress to break up contract requirements, thereby shrinking the slice of the pie that any single contractor can secure via a single contract, intervening in the free market, formalizing DoD’s M&A-review process, and increasing funding for IBP.
Conclusion
As the GAO report remarked, “DOD has not effectively aligned its concerns about continued industrial base consolidation with the resources and robustness of its efforts to assess M&A risks to its industrial base.” DoD Needs Better Insight at 34. However, both the GAO report and the recent Senate letter indicate that there is growing executive and legislative interest throughout the government to take a more exhaustive look at DoD-adjacent M&A transactions.
If the recommendations of DoD, GAO, and Senators Warren and Round take root, M&A transactions involving government contractors are likely to face increased oversight from better funded government offices with a mission to assess and review M&A deals for a broader range of potential issues. Large defense contractors may also face greater competition as procurement opportunities are broken up. This trajectory towards greater scrutiny and less tolerance of market consolidation activity highlights the importance of engaging subject matter specialists in federal procurement policy, especially DoD policy. As pressure on the backend of a deal grows, competent and thorough diligence on the frontend will serve to mitigate the risk of a deal that is subject to DoD or antitrust enforcement or mitigation.
Engaging with subject matter professionals reduces risk and costs, as such individuals use their experience to identify and overcome barriers to deal consummation. M&A professionals utilize this knowledge early in the M&A process to advise on the efficacy of a potential transaction involving a government contractor and any associated risks (including any potential economic impact of lost contracts). M&A in the government contracting space will likely remain robust as valuations remain attractive, so engaging with professionals that understand shifting regulatory tides is key.
If you have any questions regarding the content of this alert, or if you are contemplating a government contractor M&A transaction, please reach out to the authors or your DLA Piper relationship partner.
