Coal Age

NOV 2012

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transport tips Berkshire's Purchase of BNSF: Inadequate Review or Sloppy Due Diligence? BY DAVE GAMBREL On September 27, 2012, Senator Jay Rockefeller, chairman of the Committee on Commerce, Science and Transportation, wrote an eight-point letter to Daniel R. Elliott Jr., chairman of the Surface Transportation Board (STB). He was concerned about "criti- cal information recently brought to light regarding the regulatory review and approval of Berkshire Hathaway's acquisition of the BNSF Railroad." The issue, it seemed, was the omission of critical facts that would have required a review by the STB. Instead, Berkshire filed only with the SEC, FTC and DoJ, obtaining "early termination" of the mandatory waiting period under the Hart- Scott-Rodino Act, thus effectively approving the transaction under federal anti-trust laws. What was the "critical information"? Simply, Berkshire had not disclosed that they owned two railroads when they were seeking approval to buy BNSF. When confronted by the allegation, Berkshire had withheld impor- tant facts, former STB Chairman Roger Nober (now executive vice president of law at BNSF) admitted Berkshire did indeed own two short line railroads. Why was he answering for Berkshire? Didn't know they owned two railroads? How difficult was that to discover, anyway? As a matter of fact, who discovered it and told Rockefeller? Surely it wasn't a Rockefeller staffer. Considering they were getting ready to buy one of the largest railroads in the nation, and would be under the microscope of STB, wouldn't one expect the lawyers to find out if Berkshire owned any railroads or railroad assets? Wouldn't that have been ele- mentary due diligence work? Neither the FTC, DoJ nor SEC was copied on letters between Rockefeller and Elliott, so one must conclude their input was not considered important. Is it safe to assume they will know nothing about the non-disclosure issue until a staffer reads it on the STB website? What Happened? Chairman Elliott quickly responded to Sen. Rockefeller's letter, answering the eight ques- tions that Rockefeller's letter had posed. The highlights were as follows: 1. Since no party had brought the transac- tion before the Board, the STB approval 20 www.coalage.com process was not engaged (What does "not engaged" mean, exactly?); 2. Since only one Class I railroad was involved, the Board would probably have approved the acquisition (Having heard from no potential objectors, how could he know?); 3. The Board will not conduct its own review unless Berkshire does not divest promptly; 4. The Board directed Berkshire to suggest a remedy, and Berkshire replied they would divest the two railroads (WCTU and CBEC) by December 31, 2012; 5. Taking Rockefeller's strong hint that pub- lic comment should be sought, Elliott said STB would seek public comment in Docket No. FD 35506(In other words, if no one reads the STB website before the two short lines are sold, they are home free.); 6. The applicable statute provides "acquisi- tion of control of a rail carrier by a person that is not a rail carrier, but that controls any number of rail carriers, may be car- ried out only with the approval and authorization of the Board." [49 USC 11323 (a)(5)] (Having not been "engaged," how could the STB give its approval?) 7. Docket No. FD 35506 will also solicit pub- lic opinion regarding the effect of Berkshire's non-compliance on its $8 bil- lion acquisition premium, as well as the legal and accounting principles that should govern acquisition premiums within rail mergers; and 8. Revenues from the sale of the two short line railroads will have no impact in determining whether BNSF is revenue adequate. Unscrambling the Eggs When the current chairman of the STB asks the past chairman of the STB what the cure should be, that is bothersome, particularly when the past chairman works for Berkshire's BNSF. Have these guys never heard of conflict of interest, or does that only occur in the purely corporate world? What is there about a quick sale of the short line railroads that is sort of bother- some? It simply assumes nothing more is required than the quick sale of two short line railroads. If no one goes on the STB website and catches the public comment opportuni- ty, it relieves the STB of the obligation to thor- oughly question Berkshire Hathaway on all of the facts regarding their purchase of BNSF. Apparently, a quick sale of the two short lines obviates a need for a re-review by the FTC, DoJ and SEC to determine if their previous "early termination" findings were still valid. Possibly most bothersome is the feeling that no agency did a serious review in the first place, if at all. Elliott admits "the (STB) approval process was not engaged." The FTC, DoJ and SEC, knowing they had no authority in railroad competition matters, quite possibly punted and rendered their "early termination" verdicts. In other words, nobody did anything. This not an indict- ment, but simply a reaction to what appears to have been a legal method of preventing concerned parties from participation. The Potential Entrant Theory In July 1965, Kennecott purchased a small Utah coal reserve from Knight-Ideal Coal Co. Kennecott acquired Peabody Coal Co. on March 19, 1968. Frank Milliken, then president of Kennecott, learned the hard way in 1970 a term used by the FTC when reviewing a potential complaint charging that the merger had violated Section 7 of the Clayton Act. What were they talking about? The Knight-Ideal reserve was a measly 34.1 million tons; Peabody at that time owned 5.5 billion tons. Was the FTC actually going to cause a flap over this tiny coal reserve? You bet they were, and they did. Kennecott was forced to sell Peabody in 1977. The FTC found not only that Kennecott was a substantial "potential entrant" into the coal industry, but it was an actual competi- tor. The Commission relied on the "toe hold" theory, citing the acquisition of Knight-Ideal reserves as a toe-hold acquisition. Frank Milliken had learned another FTC term: "toe hold." As Milliken fought the FTC up to the Supreme Court over the next seven years, he would learn more FTC terms, such as "deep pocket theory." That means Kennecott had the financial strength to build upon their tiny coal reserve acquisition and develop their company as a competitor in the coal busi- November 2012

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