The Under Secretary of Defense for Acquisition, Technology, & Logistics, Frank Kendall, made seismic remarks last week announcing that the U.S. Department of Defense (DoD) will seek independent authority from Congress to approve or disapprove M&A transactions in the defense industrial base for national security reasons, creating potential shock waves among the companies in that market.

Coming on the heels of Lockheed Martin’s acquisition of Sikorsky Aircraft, the helicopter division of United Technologies Corporation, Mr. Kendall stated that a review focused exclusively on the competitive impact of a transaction does not guard against other mischief caused in the industrial base by the absorption of a smaller company into one of the major DoD prime contractors.  Specifically, Mr. Kendall noted while the absorption of a smaller DoD platform provider into a larger company may not technically reduce competition, the transaction may not be in the best interests of the Defense Department or the taxpayer.  He expressed concern that the largest companies in the defense industrial base use their size — and accompanying clout — to their economic advantage, which, according to Mr. Kendall, has the potential to reduce competition and innovation, limit sources of supply, increase barriers to entry for newcomers to the market, and result in increased costs to the American taxpayers.  According to Mr. Kendall, as the largest companies become larger, the negative impacts on the Defense Department are exacerbated.

Mr. Kendall announced that DoD will seek independent legislative authority to review transactions affecting the defense industrial base from a national security perspective, something not currently a stand-alone consideration in the competitive reviews performed by the antitrust agencies.  While Mr. Kendall acknowledged that the specifics of such a legislative proposal would need to be developed, he stressed the importance of maintaining a robust and innovative defense industrial base, where, he reasons, competition breeds innovation.  Not surprisingly, Mr. Kendall’s remarks have been met with criticism from the industry.

Whether such a legislative request for independent review authority would ever make it to the Hill remains to be seen.  The proposal would have to be vetted through the Executive Branch, where the Department of Justice’s Antitrust Division would certainly raise questions about the interaction of its authority to conduct antitrust reviews with this new authority based on defense industrial base concerns.  The national security standard used to block an otherwise competitively acceptable transaction would also need to be crafted carefully.

Significantly, DoD will need to explain why additional authority is required.  DoD has heretofore been an active participant in antitrust reviews of transactions involving companies in the defense industrial base.  While the ultimate decision-maker in the transactions has been the antitrust authority (either the Department of Justice or the Federal Trade Commission), the national security needs of the DoD have always been addressed.  A notable example was the creation of United Launch Alliance, a Boeing-Lockheed Martin joint venture that at the time established a monopoly for heavy-lift space launch vehicles.  The transaction, reviewed by the Federal Trade Commission, was permitted to move forward because DoD argued strenuously that the transaction was essential for national security.  DoD will need a strong justification explaining why the existing authorities held by the antitrust agencies are not adequate to meet our national security.

DoD leadership has for some time been expressing its concern about excessive consolidation in the defense industrial base generally, and in particular at the prime contractor level.  Mr.Kendall’s remarks reflect an expansion of that concern, extending it to major prime contractors absorbing lower tier contractors, particularly when the antitrust authorities have identified no competitive concerns.  Defense contractors at all levels should take serious note of this new development and be prepared to respond to what may be a new era of defense industrial base market management by the Defense Department.