Antitrust for Institutional Investors

• Author: Edward B. Rock and Daniel L. Rubinfeld
• Position: Martin Lipton Professor of Law and Director of the Institute for Corporate Governance and Finance at NYU School of Law/Robert L. Bridges Professor of Law and Professor of Economics, Emeritus, U.C. Berkeley, and Professor of Law, NYU School of Law
• Pages: 221-278

ANTITRUST FOR INSTITUTIONAL INVESTORS

E

DWARD

B. R

OCK

D

ANIEL

L. R

UBINFELD

*

Imagine a hypothetical portfolio manager, PM, who works for an airline

sector fund that has a substantial shareholding in each of the major airlines.

1

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 pres-

sure 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 de-

cades 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

* Edward Rock is Martin Lipton Professor of Law and Director of the Institute for Corporate

Governance and Finance at NYU School of Law. Daniel Rubinfeld is Robert L. Bridges Profes-

sor of Law and Professor of Economics, Emeritus, U.C. Berkeley, and Professor of Law, NYU

School of Law. Rock has worked as a consultant with the Antitrust Division of the U.S. Depart-

ment of Justice on a variety of cross ownership and common ownership cases, including United

States v. Northwest Airlines and United States v. Dairy Farmers of America, discussed below.

From June 1997 through December 1998, Rubinfeld served as Deputy Assistant Attorney Gen-

eral for antitrust in the U.S. Department of Justice. He has consulted for Delta Airlines on its

acquisition of Northwest Airlines and for United Airlines on its merger with Continental Air-

lines. The authors thank Emiliano Catan, Scott Hemphill, Eric Posner, Fiona Scott Morton, Mar-

tin Schmalz, and Glen Weyl for thoughtful comments on earlier drafts of the article. An earlier

version was posted on SSRN as Edward B. Rock & Daniel L. Rubinfeld, Defusing the Antitrust

Threat to Institutional Investor Involvement in Corporate Governance (unpublished manuscript)

(Mar. 1, 2017), ssrn.com/abstract=2925855.

1

See, e.g., Fidelity Select Air Transportation Portfolio, F

IDELITY

.

COM

.

221

82 Antitrust Law Journal No. 1 (2018). Copyright 2018 American Bar Association. Reproduced

by permission. All rights reserved. This information or any por tion thereof may not be copied

or disseminated in any form or by any means or downloaded or stored in an electronic

database or retrieval system without the express written consent of the American Bar

Association.

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persistent, focused on these issues in every earnings call, every investor rela-

tions 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 main-

taining but not expanding capacity, few empty seats, approximately 10 per-

cent 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 “con-

tract, combination in the form of trust or otherwise, or conspiracy, in restraint

of trade” in violation of Section 1 of the Sherman Act.

2

Indeed, on these facts,

a plaintiff’s lawyer could argue that this is a classic “hub and spoke” conspir-

acy, 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 scena-

rio—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 an-

ticompetitive outcome more likely because it creates a potential for tacit col-

lusion, and is, or should be, a violation of Section 7 of the Clayton Act.

3

Antitrust law and policy are suddenly highly relevant for institutional inves-

tors because of the interaction of two forces: the increasing size and concen-

tration 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

2

15 U.S.C. § 1.

3

15 U.S.C. § 18.

2018]

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otherwise.

4

Moreover, we believe that the policy issues raised by the two sce-

narios are sufficiently important that counsel for institutional investors and

portfolio companies should view them with concern. In particular, large insti-

tutional 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.

5

As we detail in Part II with

respect to the airline industry, we are intrigued but ultimately unconvinced by

the analysis of Jos´e Azar, Martin Schmalz, and Isabel Tecu and related arti-

cles, 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 ar-

gument, based on Azar et al.’s findings, that the existing ownership patterns

violate Section 7 of the Clayton Act.

6

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 “so-

lution” 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.

7

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, institu-

tional investors will comply with Posner et al’s alternative proposal—com-

plete 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 in-

4

In re Domestic Airline Travel Antitrust Litig., 221 F. Supp. 3d 46 (D.D.C. 2016).

5

Jos´e Azar, Martin C. Schmalz & Isabel Tecu, Anti-Competitive Effects of Common Owner-

ship, 73 J. F

IN

. (forthcoming 2018) [hereinafter Azar et al., Airlines article], ssrn.com/abstract

=2427345 (May 13, 2018); Jos´e Azar, Sahil Raina & Martin Schmalz, Ultimate Ownership and

Bank Competition (July 23, 2016) (unpublished manuscript), ssrn.com/abstract=2710252 [here-

inafter Azar et al., Bank Competition paper].

6

Einer Elhauge, Horizontal Shareholding, 129 H

ARV

. L. R

EV

. 1267 (2016).

7

Eric A. Posner, Fiona Scott Morton & E. Glen Weyl, A Proposal to Limit the Anticompeti-

tive Power of Institutional Investors, 81 A

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L.J. 669 (2017).