The Prohibition on Interlocking Directors and Officers
Section 8 of the Clayton Act prohibits one person from simultaneously serving as an officer or director of two corporations if: (1) each of the “interlocked” corporations has combined capital, surplus, and undivided profits of more than $10,000,000; (2) each corporation is engaged in whole or in part in commerce; and (3) the corporations are “by virtue of their business and location of operation, competitors, so that the elimination of competition by agreement between them would constitute a violation of any of the antitrust laws.”
Section 8 provides several exemptions from the prohibition on interlocks for arrangements where the competitive overlaps “are too small to have competitive significance in the vast majority of situations.” The purpose of the prohibition is to “avoid the opportunity for coordination of business decisions by competitors and to prevent the exchange of commercially sensitive information among competitors.” While the remedy for an illegal interlock is merely to end (or “break”) the interlock, the loss of board representation can be a significant hurdle to protecting an investment in the company.
Section 5 of the FTC Act prohibits “unfair methods of competition:” “conduct which, although not a violation of the letter of the antitrust laws, is close to a violation or is contrary to their spirit.” Although the text of Section 8 suggests a relatively narrow prohibition – it prohibits only “a person” from serving as a director or board-appointed officer of corporations that are competitors – according to the Commission, Section 5 prohibits “interlocking directors and officers of competing firms not covered by the literal language” of the Clayton Act. Although the incoming FTC majority may revise the Biden administration’s policy statement on the scope of Section 5, the position articulated in the joint Statement of Interest (discussed below) suggests it is unlikely that the Commission will adopt a different position with respect to horizontal interlocks.
The Position of the DOJ and a Unanimous Federal Trade Commission Is That Board Observers Are and Should Be Subject to the Same Prohibitions as Directors and Officers
In the joint DOJ and FTC Statement of Interest filed in Elon Musk v. Samuel Altman, the agencies argue that “section 8 bars relationships that create an interlock regardless of form.” According to the agencies:
“[A]n individual cannot evade liability by serving as an ‘observer’ on a competitor’s board. . . . [A] company or individual cannot use an indirect means to a prohibited end, such as by asking another person to serve as a board observer to obtain entry to a meeting that is otherwise off limits due to Section 8’s ban on interlocks. Such misdirection would undermine Section 8’s intent to impose a clear ban on direct involvement in the management of a competitor.”
During the first Trump administration, FTC Commissioner Rebecca Slaughter, and former-FTC Commissioner Chopra argued that Section 5’s prohibition on unfair methods of competition reaches interlocks that are defined to include board observer positions. According to Slaughter and Chopra:
“Typically, a board observer is like a regular member of a board of directors, but without a formal vote. While they don’t have a vote, they certainly have a say. Like regular board members, board observers often participate in confidential discussions about strategy. Board observers can advocate for a preferred outcome. Board observers can even get access to key data. … [We] have reason to believe this arrangement undermines a key purpose of Section 8 of the Clayton Act’s prohibition on interlocking directorates and [is] therefore unlawful under Section 5 of the FTC Act.”
Potential Effect of the U.S. Government’s Position
The Statement of Interest adopts the position on board observers on behalf of both the United States and the Commission with respect to the reach of Section 8. This position was adopted by a unanimous Commission, including chair-designee Andrew Ferguson and his Commissioner colleague Melissa Holyoak.
The antitrust agencies’ efforts to identify and break interlocks, broadly defined, are not likely to dissipate in the second Trump administration. The agencies’ position, if adopted by the court hearing the Musk/Altman dispute, may trigger an expansion of derivative litigation by plaintiff shareholders of the interlocked companies. Even without adoption by the court, the antitrust agencies have articulated an enforcement principle that they may continue to advance beyond the district court.
The Second Trump Administration Will Likely Continue the Efforts of the Biden Administration to Expand the Scope of Interlocks That Raise Competitive Concerns
The first administration of President Trump had considered applying the principles underlying Section 8 to situations not directly within the scope of its prohibition, and may have initiated at least some of the investigations pursued by President Biden’s DOJ. The Biden administration’s DOJ and FTC articulated an expansive view of which interlocks may be anticompetitive; the second Trump administration may adopt some of these positions.
- Non-Horizontal Interlocks: Section 8 is limited to interlocks between competitors. A concern, present in both the Biden and earlier Trump administrations, that the antitrust agencies overlooked the likelihood of competitive harm from mergers involving one or more future competitors, firms operating upstream and downstream of each other, and from vertical integration by contract or merger, more generally suggests an increased focus on non-horizontal interlocks. The 2023 Merger Guidelines set out a marker for this theory of harm, and analyze corporate governance rights as consistent with the “incentive and ability” framework of the competitive effects analysis of a non-horizontal acquisition, or an acquisition of a minority position in a firm.
Partial acquisitions that do not result in control may nevertheless present significant competitive concerns. The acquisition of a minority interest may permit influence of the target firm, implicate strategic decisions of the acquirer with respect to its investment in other firms, or change incentives so as to otherwise dampen competition. . . . [Additionally] specific governance rights, such as the right to appoint members to the board of directors, influence capital budgets, determine investment return thresholds, or select particular managers, can create such influence. . . .
Although there is a significant possibility that the FTC will revise the November 2022 Policy Statement on Unfair Methods of Competition, a future application of Section 5 may be a challenge to an interlock between firms in a non-horizontal relationship: (i) firms operating in adjacent markets where there is a possibility of future competition between the firms; or (ii) firms operating in an upstream / downstream relationship where one firm is a significant and important supplier to one or more competitors of the other interlocked firm. On the right facts, the FTC may see the potential for significant harm from the interlock.
- Horizontal Interlocks That Meet the De-Minimis Exception of Section 8: Section 8 does not reach interlocks where (i) the competitive sales of either corporation are less than $1,000,000 (as presently adjusted to $5,138,000), or (ii) the competitive sales of either corporation are less than 2 percent of that corporation’s total sales, or (iii) the competitive sales of each corporation are less than 4 percent of each corporation’s total sales. However, these de-minimis thresholds do not apply to challenges under Section 5. The antitrust agencies continued interest in protecting “nascent” competition provided by small firms, firms expanding into new markets, or in markets that are just developing suggests that the FTC may rely on Section 5 to investigate and prohibit interlocks that could stifle such competition.
- Interlocks Involving Non-Corporate Entities: The Commission recently challenged private equity firm Quantum Energy Partners’ investment in EQT Corporation, restricting QEP from taking a board seat at EQT. There, the Commission recognized that “Section 8’s specific prohibition of interlocks among competitor ‘corporations’ pre-dates the development of other commonly used corporate structures, such as limited liability companies, [and] we must update our application of the law to match the realities of how firms do business in the modern economy. [This] action makes clear that Section 8 applies to businesses even if they are structured as limited partnerships or limited liability corporations.” The Department of Justice, during President Trump’s first term, suggested that Section 8, notwithstanding its text, may also be applicable to horizontal interlocks involving non-corporate entities.
- Broad Reading of “Competitors:” Consistent with some case law, and some legislative comments, the Department and the FTC define competitors to include firms that produce a similar class of products, but not necessarily products that operate as substitutes. For example, according to the FTC:
Section 8 applies to “competitors” in the sense that “the elimination of competition by agreement between them” would violate the antitrust laws. But courts have rejected the argument that this is the same as the market definition analysis found in other antitrust cases. . . . [E]specially in emerging industries, competition in the Section 8 sense can encompass more than an assessment of the cross-elasticity of demand for existing products. In a developing industry in which product variation is just beginning and customer needs are not yet standardized, it is unlikely that two companies will produce products nearly equivalent in their ability to satisfy the needs of a range of customers. Nonetheless, these companies compete. Their competition consists of the struggle to obtain the patronage of the same prospective customers, accompanied by representations of a willingness to modify their respective products. Competition also consists of efforts to make a sale, even if neither succeeds in persuading the buyer to purchase.
This position is not entirely consistent with the law or the statute, but the courts, in considering whether a person or corporation has violated Section 8, have not usually evaluated whether the interlocked corporations are competitors. This is an area where the agencies may look to expand the law through a broader definition of what constitutes competitors, thus diminishing the “safe-harbors” of Section 8’s de-minimis exemptions.
- Present Service May Not Be Required: The Department has enforced Section 8 against firms (or persons) who do not presently “serve” as a director or officer of competing corporations, but who have the future right to a board seat, that would, if exercised, create an interlock. In doing so, the Department has acted to prohibit or prevent a potential interlock from coming to fruition.
- Two Individuals/Same Entity?: The agencies read “person” to include different individuals associated with the same entity. On that basis, the Department recently forced the resignation of certain individuals associated with investment firm Thoma Bravo from the board of SolarWind and forced the resignation of another individual, also associated with Thoma Bravo, from the board of Solar Wind’s purported competitor N‑able.
An Expansive Prohibition on Interlocks Raises Risks for Affected Parties
Section 8 is usually “enforced” by proper board and officer selection screening, not by government enforcement action or private actions. Because the interlocked company is also subject to liability for violating Section 8 and Section 5, director and officer selection efforts should adopt board relationship disclosures that include board observer positions, and companies may wish to adopt guidelines that expand prohibitions on persons serving as directors (or officers) of competing companies to include prohibitions on board observer status at competing companies.
While the remedy for violating Section 8 is limited to a break of the interlock, an interlock can support the requirements of an agreement for a violation of Section 1 of the Sherman Act (agreements in restraint of trade) or create a factual inference of an ability to collude or coordinate towards anticompetitive behavior. Violations of Section 1 of the Sherman Act can result in substantial private damages and/or criminal penalties and fines.
