Antitrust For Institutional Investors

Imagine a hypothetical portfolio manager, PM, who works for an airline sector fund that has a substantial shareholding in each of the major airlines. Through marketing activities and through SEC Form 13F disclosure, the fund’s holdings are well known to the industry. PM is an active participant in all communications with managers including earnings calls, investor relations calls, and industry conferences. PM is known for her sharp and intelligent focus on the details of airline operations. Beginning in 2009, as the economy came out of recession, PM followed the status of airline capacity closely. As excess capacity disappeared with the recovering economy, PM started to pressure the airlines to restrain their (historical) impulse to increase capacity in the face of increased demand. “Don’t do that,” PM argued repeatedly and to every airline in her fund’s portfolio, “you will simply end up pushing down prices as you have done historically. This time around, be smart. Maintain your current levels of capacity and raise your prices. That way, you will make money, your competitors will make money, and my investors will make money. After decades of destructive competition, we finally have an opportunity for the airline industry to make some decent profits. But it will only happen if you folks behave responsibly and stop shooting yourselves in the foot.” PM was very persistent, focused on these issues in every earnings call, every investor relations call, and at every other opportunity, public and private. To PM’s great satisfaction, her efforts seem to have paid off, with the major airlines maintaining but not expanding capacity, few empty seats, approximately 10 percent higher ticket prices, and substantially higher airline profits. Her sector fund is up 20 percent on the year and money is flooding in. What could be bad about any of this?

To an antitrust lawyer, the scenario is troubling: this is potentially a “contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade” in violation of Section 1 of the Sherman Act. Indeed, on these facts, a plaintiff’s lawyer could argue that this is a classic “hub and spoke” conspiracy, with the PM acting as a “cartel ringmaster,” who organized a cartel among the competing airlines in order to restrict output and increase prices. If proved, this would be a per se violation of Section 1 of the Sherman Act and would expose the sector fund and the airlines to treble damage liability and potentially to criminal prosecution.

Consider a second hypothetical scenario: suppose that PM and portfolio managers like her remain quiet on all airline earnings calls and remain passive in other interactions with airline executives. However, the airline executives, individually and independently, conclude that increasing capacity is not in their own airline’s profit-maximizing self-interest, and capacity is maintained but not expanded. The result might turn out to be similar to the first scenario—higher fares. Under current antitrust law, this “conscious parallelism” or “tacit collusion” outcome would not violate the Sherman Act, since it would not be a conspiracy in restraint of trade. Yet some have recently argued that the overlapping of shareholding at levels well below control makes an anticompetitive outcome more likely because it creates a potential for tacit collusion, and is, or should be, a violation of Section 7 of the Clayton Act.

Antitrust law and policy are suddenly highly relevant for institutional investors because of the interaction of two forces: the increasing size and concentration of institutional investor holdings in concentrated industries that are ripe for cartelization; and the increasing interaction between firms and their shareholders.

In this article, we address the fundamental antitrust issues presented by common ownership by large, diversified investors. In Part I, we analyze the antitrust risks posed by our opening hypotheticals. While we have no personal knowledge of any Section 1 violations, we are aware of litigation claiming otherwise. Moreover, we believe that the policy issues raised by the two scenarios are sufficiently important that counsel for institutional investors and portfolio companies should view them with concern. In particular, large institutional investors and investor relations professionals should develop serious antitrust compliance programs.

In Part II, we expand our analysis from mainstream antitrust principles to consider the more speculative challenge to institutional investor common ownership raised by the second scenario. In a series of intriguing articles, several finance economists have presented evidence that existing patterns of common ownership are correlated with and may have caused higher prices in the airline industry and in commercial banking. As we detail in Part II with respect to the airline industry, we are intrigued but ultimately unconvinced by the analysis of Jose´ Azar, Martin Schmalz, and Isabel Tecu and related articles, and we are skeptical of their claim that common ownership of airlines stocks has caused a large increase in the price of tickets.

In Part III, we turn to the legal analysis of common and cross ownership. After outlining the existing legal framework, we address Einer Elhauge’s argument, based on Azar et al.’s findings, that the existing ownership patterns violate Section 7 of the Clayton Act.

In Part IV, we turn to the policy implications of this “new learning” by focusing on Eric Posner, Fiona Scott Morton, and Glen Weyl’s proposed “solution” and likely responses to it, should it become law. Posner et al. propose forcing diversified institutional investors to choose between capping their holdings at 1 percent, investing in only one firm in any concentrated industry, or remaining entirely passive. As we discuss in detail, we do not believe that institutional investors would opt for the Posner et al. proposal that they limit their investment to 1 percent or to a single firm in a concentrated industry. Indeed, we fear that, out of an abundance of concern for legal risk, institutional investors will comply with Posner et al’s alternative proposal—complete governance passivity—because doing so would take them within Section 7’s “solely for investment” exemption. Because we think this would be an unnecessary and unfortunate response to fear of antitrust liability and would undermine the long-term effort to encourage institutional investor involvement in corporate governance, we propose a quasi “safe harbor” of 15 percent, so long as investors engage only in “normal” corporate governance activities.

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