United States: Antitrust Risks To Private Equity Firms And Institutional Investors With Common Ownership Of Competitors

Common ownership of stock by large institutional investors has been identified by federal advisors as a "potential area" for additional regulation.¹ The Department of Justice Antitrust Division has confirmed that this is an area it is investigating, as confirmed by the investigation of the major airlines last year.² Private equity firms and large institutional investors that hold interests in multiple entities in the same industry, and particularly competing entities, need to be aware of the risks and uncertainty they face, and act to mitigate those risks.

What Antitrust Law Prohibits

The federal antitrust laws prohibit conduct that is anticompetitive. Two statutes, the Sherman Act and the Clayton Act, cover most of the conduct that the federal antitrust laws restrict. Section 1 of the Sherman Act prohibits agreements among competitors that unreasonably restrain trade. Section 1 may be implicated, for example, if the competing businesses limit their competition to advantage their common investor. Section 7 of the Clayton Act prohibits the acquisition of stock when the effect of the acquisition or the use of the stock "may be to substantially lessen competition." It may be implicated, for example, if a common investor in competing entities uses its voting power to direct the competing companies in such a way as to limit the competition between them.

The Risk to Private Equity Firms

There are two primary risks to private equity firms that have concentrated investments in particular industries: (1) the immediate risk of a government investigation or a civil suit; and (2) the more generalized risk of an uncertain regulatory environment and an unpredictable political environment.

Investigation or Civil Suit

By investing in competing entities, a private equity firm runs the risk of executing a classic hub-and-spoke conspiracy in violation of Section 1 of the Sherman Act. In such a conspiracy, the common investor (the hub) coordinates an anticompetitive agreement among the competitors (the spokes); for example, the competitors might agree to refrain from competing on price or to divide the market. Agreement among the competitors might be inferred from the conduct of the parties or the exchanges between the common investor and the competitors. This is the conduct that resulted in a court finding Apple liable for price fixing in the market for ebooks.

Alternatively, simply acquiring the stock of competing companies implicates Section 7 of the Clayton Act—though it does not automatically render the conduct illegal. Section 7 explicitly exempts "persons purchasing stock solely for investment," which has been interpreted by courts to mean that the "investor" must not have been engaged in an effort to obtain control of the company in which it acquired stock. The mere fact that the "investor" had, in the past, typically used stock acquisitions to gain control of companies could hurt a firm attempting to claim the "investor" exemption. Even if the firm is not an "investor", the question remains whether a plaintiff can produce evidence that the investment could substantially lessen competition. If the private equity firm has board representation at both companies or has veto powers over corporate actions that could be evidence of a likelihood of lessened competition. Similarly, if the private equity firm could be used as a conduit for the competitors to share competitively sensitive information such as customer pricing or strategic information, that could also be used as evidence of a likelihood of lessened competition.

Uncertainty

Recent scholarship has indicated that common ownership of competitors, on its own, is a driver of price increases. Some have even urged that this impact on consumers justifies its own per se rule against common ownership.³ Last year, the White House Council of Economic Advisors suggested that "common ownership of stock by large institutional investors" is a "potential area" for additional regulation.⁴ The recent change of administrations, however, may reverse this recent trend as there is an early suggestion of decreased regulatory scrutiny for large investors.

How to Mitigate Your Risk

If your firm is already heavily concentrated in a particular industry or industries, it would be well advised to maintain clear policies on how it will handle investment in competing companies to prevent facilitating collusion between the competitors. Avoid exercising control over competing companies where possible, and limit common investment in competing companies to pure investor roles to take advantage of Section 7's "investor" exception. Policies should also explicitly avoid the sharing of confidential and actionable sensitive business information. Contact counsel to learn more about how to mitigate the risks in your specific situation.

Footnotes

1. White House Council of Economic Advisors Issue Brief, Benefits of Competition and Indicators of Market Power (April 15, 2016).

2. U.S. Senate Judiciary Subcommittee on Antitrust, Competition Policy, and Consumer Rights. Hearings Mar. 9, 2016. Testimony of William J. Baer.

3. Professor Einer Elhauge, Horizontal Shareholding, 109 Harvard L. Rev. 1267 (2016).

4. White House Council of Economic Advisors Issue Brief, Benefits of Competition and Indicators of Market Power (April 15, 2016).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.