Earlier this year, we highlighted an academic critique of the current state of European competition law as it applies to parent companies and financial investors. Andriani Kalintiri of the London School of Economics has argued that the approach of the European courts lacks a rational theoretical foundation and should be given a re-think. But, over the summer, the EU General Court – delivering judgment in Goldman Sachs’ appeal in the Prysmian case – declined to take the opportunity to do that. Its confirmation of the fine imposed on a financial investor who had no knowledge of, or involvement in, anti-competitive behaviour was not surprising, but it was disappointing nonetheless.
The General Court did little more than repeat its long-standing view of the meaning of the articles of the EU Treaty that deal with cartels: that if a parent company (whether itself a trading entity, or a mere investor) has “decisive influence” over a subsidiary, then it is jointly and severally liable with it for any penalties, on the basis that the entities together form a “single undertaking”. For wholly-owned (or near wholly-owned) subsidiaries, there is a presumption of “decisive influence”. The European Commission and the General Court insist that this presumption is rebuttable – but it never has been, and it is hard to see on what basis it could be. For other investors, including Goldman Sachs for some of the time that it was held liable for Prysmian’s infringements, decisive influence will be determined on the basis of the factual circumstances. Even a minority investor can be found to have decisive influence if, for example, it controls the board or has significant board representation; its representatives are involved in management decision-making; it is in receipt of regular updates and financial reports. The factual matrix is always crucial, and there is no bright-line test that can be applied, but the governance mechanisms employed by many private equity firms could fall foul of the Commission’s assessment in any individual case. Importantly, there is no need for the parent to have influence over the specific behaviour that constitutes the offence; only to have decisive influence more generally.
Of course, many private equity practitioners will argue that this approach is flawed in principle, while also risking unintended (and undesirable) policy outcomes. Imposing liability on wrongdoers is one thing, and even clawing back ill-gotten gains from innocent beneficiaries may be regarded as a fair response to illegal behaviour. But the principle of limited liability for investors facilitates investment activity, and is fundamental to the private equity model. Private equity investors can be expected to undertake extensive due diligence before they invest, and to oversee the implementation of policies and procedures designed to prevent and detect wrongdoing. But they do not manage the companies into which they invest, and cannot provide a guarantee that an investee will never break the law. Forcing them to accept the regulatory risk (as well as the business risk) of illegal conduct could put them off investing in certain industries in the first place, and the potential benefits of responsible, active investment will be lost. The law should encourage and facilitate appropriate behaviour, and not punish those who behave diligently and responsibly.
Still, there seems little imminent prospect of a change of heart by the Commission in this area. That means that GPs must take these risks on board when evaluating investments and designing governance structures. They should also re-examine fund documents to make sure that they know where any financial liability falls and make sure it is appropriately allocated.
And the industry should work hard to persuade legislators and regulators that breaches of the principle of limited liability must remain the exception, and do not become the rule.