Saturday, December 19, 2020
I’ve previously discussed the common ownership problem in this space, and it basically comes down to the fact that common ownership – institutional investors who own stock in a broad swath of companies, including competing companies – is a mixed bag. On the one hand, it may incentivize investors to address systemic risks, like climate change. On the other, it operates in tension with a corporate governance framework predicated on shareholder wealth maximization, and may incentivize anticompetitive behavior to the extent investors care less about competition within an industry than maximizing profits for the industry as a whole. And on the third hand, the mere fact that this kind of vast power over our economic system is exercised by only a handful of private players – whether used for good or for ill – may represent a political/democracy problem.
As a result, there have been proposals to break up the power of the largest fund families. For example, Lucian Bebchuk and Scott Hirst have proposed that fund families be limited to investing in 5% of any particular target company.
That’s not what’s on the table, however.
In two new releases, the FTC has proposed reinterpreting the Hart Scott Rodino Act. That Act requires pre-review by the government whenever an acquirer proposes to obtain a significant amount of the voting securities of another company to ensure that the acquisition would not be anticompetitive. How significant? It’s a numerical test that varies every year. For our purposes, though, what’s critical is that the requirements are softened when the investor is obtaining the securities “solely for the purpose of investment,” meaning, the acquirer “has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.” Institutional investors like mutual fund companies are exempt from HSR reporting if they obtain securities “solely for the purpose of investment” and hold less than 15% of the target.
The FTC is looking into whether it should redefine what “solely for the purpose of investment” means. Among other things, it is considering whether shareholders who participate in activities like “discussions of governance issues, discussions of executive compensation, or casting proxy votes” should no longer count as passive (and related rulemaking would ensure that holdings are considered at the family, rather than fund, level).
What the FTC is looking into, then, is whether the ordinary engagement activities of index funds (or indeed, any shareholder) would make them active holders subject to the full range of HSR reporting. They would not be prohibited from acquiring stock in companies that compete with each other. They would simply be required to file paperwork with the government and await the outcome of a review before they could complete sizeable transactions. Unless, of course, they agree to cease all attempts to engage with management.
Now, in general, I support the FTC’s attention to the problem of common ownership. But I think the level on which we need to be thinking is consolidation in the asset management industry, and to some extent, the statutory framework may not be well-suited to deal with that problem. I.e., from a consumer/retail investor standpoint, there are more mutual fund choices than ever, and fees are often quite low, so there may not be room for regulators to attack the problem by claiming asset management consolidation is itself anticompetitive. Which means, regulators may be stuck with focusing on how asset managers deal with portfolio companies, and the HSR Act itself draws a distinction between acquisitions “solely for the purpose of investment” and acquisitions for other purposes, so it’s a natural avenue for the FTC to pursue.
That said, though much of the research into common ownership does not try to explain why or how common ownership results in anticompetitive behavior by portfolio companies, at least one explanation is that shareholders in such companies are passive – i.e., they don’t prod management to improve their competitive position, leading to a lack of competition.
If that’s right, narrowing the definition of “solely for the purpose of investment” could be the opposite of a solution. It could reward the very disengagement that facilitates the antitrust problem, and disincentivize mutual funds from participating in the kind of oversight that might prod greater competition.
Plus, I really cannot help but notice, it would also take mutual funds out of the business of policing executive pay, and ESG issues like climate change and diversity. Which would be well in keeping with the general Trump Administration hostility to these kinds of shareholder interventions.