Common Ownership: Solutions in Search of a Problem

Mutual funds and exchange-traded funds are the cornerstone of many Americans’ investment and retirement plans.  (For simplicity, we refer to all these investments as “mutual funds.”)  Collectively, investment companies such as BlackRock, Fidelity, State Street, and Vanguard hold more than $29 trillion on behalf of more than 47 percent of all households in the United States and account for approximately 30 percent of all U.S. corporate equity.  (2020 Investment Company Factbook, 2020 Facts at a Glance)

Yet, according to some antitrust scholars, the large size that makes these mutual funds efficient investment vehicles also makes them unlawful.  Some scholars, such as Einer Elhauge, argue that because “[a] small group of institutions has acquired large shareholdings in horizontal competitors throughout our economy,” public companies “compete less vigorously with each other.”  (See, e.g.Einer Elhauge’s article at 1267; Azar, Schmalz & Tecu; Azar, Raina & Schmalz.)  The proponents are not quite sure how holding noncontrolling shares in competing firms, often called “common ownership,” actually causes a reduction in competition.  (See, e.g., Anna Tzanaki.) Nonetheless, proponents of the theory argue that a mutual fund’s passive ownership of the stock of more than one firm in an industry violates Section 1 of the Sherman Act and Section 7 of the Clayton Act.

Others are not so sure.  Skeptics question whether the legal theory is sound, the proffered evidence sufficient, and the suggested remedy – barring mutual funds from holding shares in competing firms – wise.  (See, e.g., Edward Rock and Daniel Rubinfeld, Thom Lambert and Michael Sykuta, Menesh Patel, and Thom Lambert.)  To avoid this debate, another set of scholars has assumed antitrust liability and proceeded straight to the remedy, proposing new rules ranging from the “partial divestiture” of existing mutual funds’ holdings to new caps on how large mutual funds may grow.  (See Fiona Scott Morton and Herbert Hovenkamp and Eric Posner, Fiona Scott Morton, and Glen Weyl.)  Scott Hemphill and Marcel Kahan straddle the two camps, finding the above-mentioned arguments unconvincing but offering new lines of inquiry.

Neither of the two U.S. antitrust agencies has identified a problem with common ownership by investment managers.  FTC Commissioner Noah Phillips observed that “the empirics remain unsettled,” mutual funds “do not appear to be at the apex of a massive antitrust conspiracy,” and the claimed economic blockbuster “seems a little light on plot.” (See speech here.)  Both Makan Delrahim and Bruce Hoffman, respectively the most recent assistant attorney general for antitrust and a recent Director of the FTC Bureau of Competition, have also expressed their doubts. (See coverage here and here.)  And economists at the Antitrust Division of the U.S. Department of Justice have cast doubt on the underlying economic work, finding that “empirical results change dramatically” depending upon which dataset one uses, and therefore “are not robust.”  (See Department of Justice discussion paper by Eric Lewis and Randy Chugh at 1, 13.)

In a recently published book chapter, we offer four observations that should narrow the debate. First, it is important to distinguish between investment management and economic ownership. Although an investment manager may administer a mutual fund, the stocks held by that mutual fund are in fact owned by the millions of Americans who hold shares of that fund in their 401(k), IRA, or other investment accounts.  Thus, the investment manager is only the nominal owner, acting as a fiduciary for millions of small investors. As we show below, complaints about common ownership are really complaints about common investment management.

Recognizing this distinction, proponents defend treating investment managers as true owners by noting that an investment manager “generally” or “typically” votes the shares in all its funds the same way.  Investment managers do not always, however, have the authority to vote the shares they manage; far from it.  For example, Fidelity held voting rights for a mere 19 percent of the shares it managed at the end of 2017, including less than 2 percent of the shares it held in American Airlines.  (See Form 13F, column 8.)  Thus, while Azar, Schmalz & Tecu assumed that in 2017 Fidelity could have voted the 3.52 percent of the outstanding stock of American Airlines that it held for others, the true figure is only 0.07 percent (2 percent of the 3.52 percent).  Even without this complication, investment managers’ votes on a shareholder proposal concerning an environmental, social, lobbying, governance, or proxy procedural issue – which together account for the overwhelming majority of shareholder proposals (see Gibson Dunn’s 2020 proxy season analysis) – tell us little about whether they would urge the management of a portfolio company (by voting or otherwise) to compete less aggressively.    Finally, investment managers do not vote as a bloc; for example, a 2020 Morningstar analysis found investment managers varied widely in their support of environmental proposals, including instances in which different funds held by the same investment manager voted differently (e.g., Fidelity’s funds in a 2020 Chevron vote).

The proponents of this new theory of harm to competition among portfolio companies ignore these complexities, instead assuming incorrectly that the investment manager owns the shares it holds and that its funds all face the same incentives and therefore act as one.  It is simply incorrect to say that seven mutual funds “jointly control 49.55 percent of the stock” in American Airlines (Azar, Schmalz & Tecu at 16), when in fact those shares are owned by millions of investors. The funds – as we have seen with Fidelity – do not have the authority to vote many of those shares, and the funds do not uniformly vote all of the shares they can vote.

Second, the current empirical evidence that common ownership diminishes competition is limited and hotly disputed. Indeed, only a minority of the economic studies find a correlation between the degree of common ownership and higher prices charged by portfolio companies, and even those do not establish causation. What’s more, as the Antitrust Division’s analysis indicates, the proponents’ findings are not robust across datasets.  Although the mechanism of harm, if any, is unknown, several proponents nonetheless assume a causal relationship, which, they believe, supports finding an antitrust violation and imposing a sweeping remedy. (To name one prominent example, Fiona Scott Morton and Herbert Hovenkamp find “partial divestiture . . . to be the most promising” remedy at this juncture.) This approach puts the legal cart before the economic horse. Indeed, not even every practice with anticompetitive effects is unlawful; procompetitive effects may outweigh them. Therefore, it is at best simply premature, based upon the empirical evidence available today, to declare common ownership anticompetitive, let alone an antitrust violation, and thereby to force the reorganization of an industry responsible for managing trillions of dollars in mutual fund assets.

Third, there is no clear legal basis for antitrust liability under either Section 7 of the Clayton Act or Section 1 of the Sherman Act. The argument that common ownership by investment managers violates Section 7 is hardly, as Professor Elhauge asserts, a straightforward application of existing doctrine; on the contrary, it is a novel application devised ad hoc for a single industry. Nor are we swayed by Professor Elhauge’s latest article.  As we explain in our book chapter, Professor Elhauge’s latest work only crystalizes his earlier errors.  For example, he cites several cases that, at least in his telling, have already held common ownership unlawful.  Yet those cases uniformly turn upon a single party’s acquisition of de facto control over two competing firms which, of course, bears no resemblance to the small, indirect, and non-controlling stakes dispersed among more than 100 million American mutual fund owners.  Indeed, even considering their holdings in the aggregate, no investment manager has or seeks control of the companies in which it holds shares.  Not surprisingly, therefore, the U.S. antitrust agencies jointly observed that the existing antitrust cases deal only with cross ownership, which involves different economic principles and a more obvious threat to competition than does common ownership. (See OECD Note at 1.)  The hypothesis that common ownership is a Section 1 violation, advanced principally by Elhauge, is at least equally dubious, as there is no evidence of an agreement among investment managers.

Fourth, common ownership does not require antitrust enforcers to apply an entirely new analytic framework to the purported problem; traditional antitrust principles suffice and remain applicable to the industry. The evidence cited by proponents suggests their underlying concern is with conventional types of conduct that may lessen competition, whether a hub-and-spoke conspiracy, the exchange of competitively sensitive information, or conscious parallelism in oligopoly markets. Hub-and-spoke conspiracies have long been prosecuted as violations of Section 1. See, e.g.Interstate Circuit, Inc. v. United States, 306 U.S. 208, 232 (1939). Similarly, antitrust law has long treated the exchange of competitively sensitive information as a “facilitating practice” from which a court may infer the existence of an unlawful conspiracy. See, e.g.Am. Column & Lumber Co. v. United States, 257 U.S. 377, 394-95 (1921).  As for conscious parallelism, the Supreme Court has been clear that it is “not in itself unlawful.” Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 227 (1993). If commentators believe the antitrust laws should be amended to prohibit conscious parallelism, then they should say so.

In summary, small investors saving for their retirement can sleep safely at night; there is no sound basis to declare the practices of their investment managers unlawful, let alone break them up. Complaints about those managers focus either upon conduct that is not unlawful or upon allegedly anticompetitive conduct that, if proven, could be attacked under established antitrust doctrines and addressed with more sensible (and limited) remedies.

This post comes to us from Keith Klovers, of counsel at the law firm of Wilson Sonsini Goodrich & Rosati, and from Douglas H. Ginsburg, a professor at George Mason University’s Antonin Scalia Law School and a judge on the U.S. Court of Appeals for the District of Columbia Circuit. It is based on their recent article, “Common Ownership: Solutions in Search of a Problem,” available here.