Index Fund Giants Draw Antitrust Scrutiny in U.S. Mergers

(Bloomberg) -- U.S. antitrust officials have begun asking companies about communications with their biggest shareholders as part of merger investigations, according to people familiar with the matter, adding to the growing scrutiny of the power of giant index funds.

The Federal Trade Commission wants buyers and sellers to identify their largest shareholders, the extent of their influence over the companies and any communications they’ve had, said the people, who declined to be named because the matter is confidential.

The requests represent a new development in U.S. antitrust enforcement and could pose yet another hurdle to companies seeking regulatory approval for mergers. While the agency routinely digs into the reasons why companies are pursuing mergers, the new inquiry shows investigators are going further to determine the amount of influence of institutional investors.

Behind the scrutiny lies growing worries about the power of giant money managers such as BlackRock Inc., Vanguard Group Inc. and State Street Corp.

Those fund companies are often called the Big Three because they are the largest index-fund companies and also the largest owners of many U.S. publicly traded firms. Economists and antitrust lawyers are raising concerns that the fund houses are harming competition among the companies whose shares they jointly own.

“This is evidence they’re taking it seriously,” said Martin Schmalz, a finance professor at the University of Oxford, referring to the FTC. Schmalz is a co-author of one of the seminal papers on the effect of index-fund ownership on competition.

Read More: Index Fund Takeover Makes ‘Big Three’ Into Corporate Overlords

Thanks to the runaway growth of funds that passively track stock indexes like the S&P 500, the Big Three collectively own about 22% of the typical S&P 500 company, according to Bloomberg data. That could give them significant influence over major decisions like mergers.

Their dominance also means they own companies that compete with one another in the same industry. As a result, the fund companies are better off, in theory, when mergers increase consolidation and reduce competition in a market.

BlackRock Chief Executive Officer Larry Fink nodded to the concerns about index fund companies in an interview with Bloomberg in Davos Tuesday, when he said that there should be a “conversation” about the issue. One option to consider, he said, is having different funds within BlackRock vote on proxy matters rather than the parent company voting all the aggregated shares for its indexed products.

“We’re growing a lot,” he said. “If there is a societal view that there’s too much power rested on these few companies, then we could find a solution to mitigate that risk. I don’t believe it’s a risk, but I’m willing to have that conversation.”

FTC Commissioner Rohit Chopra raised concerns about the influence of institutional investors in mergers when he dissented in November against approval of Bristol-Myers Squibb Co.’s acquisition of Celgene Corp. He said Bristol-Myers’s “incentives might also be distorted, given overlaps in ownership” between the two companies.

Vanguard, BlackRock and State Street are among the four biggest owners of Bristol-Myers, collectively holding about 14% of the shares, according to data compiled by Bloomberg. They were also the top three owners of Celgene, with 19% of the shares.

The fund companies have similar overlapping stakes in AbbVie Inc. and Allergan Plc, whose merger proposal the FTC is now reviewing. They own 19% of Abbvie and 18% of Allergan, according to Bloomberg.

Anticompetitive Evidence

Academics have found evidence to back up the idea that ownership of competitors by institutional investors -- known as horizontal shareholding or common ownership -- harms competition. A widely cited 2014 paper, by José Azar, an economist at the University of Navarra in Barcelona, along with Schmalz and Isabel Tecu, concluded that airline fares are 3% to 7% higher because of common ownership by big funds.

The fund companies dispute the claim that their ownership stakes represent a threat to competition. They say they are minority shareholders, often holding less than 10% of a company, and thus critics vastly overstate their influence. Barbara Novick, a vice president at BlackRock, lobbied the FTC on the issue in 2018 and 2019.

BlackRock, Vanguard and State Street declined to comment. The FTC also declined to comment.

The question regulators will have to consider is how large asset managers wield their ownership stakes in public companies, said Erik Gordon, clinical assistant professor at the University of Michigan Ross School of Business.

Antitrust authorities may have more cause for concern around activist investors than index funds, he said.

“The people with anti-competitive motives are more likely to be activists than passive managers,” Gordon said.

Researchers have also found that common ownership increases the likelihood of companies merging and reduces the premiums that sellers receive -- both possible signs of conflicts among large shareholders. That scenario is playing out in real life in a lawsuit involving Elon Musk’s 2016 merger of his Tesla electric-vehicle company with SolarCity, a financially troubled maker of solar panels.

SolarCity was founded by two Musk cousins and Musk was its chairman and largest shareholder. Industry experts panned the $2.6 billion deal, alleging that SolarCity, drowning in debt, was basically insolvent and that Tesla itself was cash-strapped and struggling to meet production goals. The two companies had little in common beyond that 25 institutional investors -- holding almost 46% of Tesla’s shares -- stood on both sides of the transaction. Because of that and the family conflicts, dissident Tesla shareholders alleged in a lawsuit, a bad deal won overwhelming shareholder approval.

Tesla sought what is called business-judgment protection, which says courts shouldn’t second-guess the votes of disinterested stockholders. The dissidents then presented the novel argument that the ownership overlap meant the shareholders weren’t disinterested parties at all. While the court dismissed that argument on the grounds that Musk’s controlling interest in Tesla is what ultimately swung the vote on the merger, the judge predicted the common-ownership issue would one day resurface. The three-year-old case is ongoing.

Earlier Inquiries

The FTC’s inquiry isn’t the first time antitrust enforcers have weighed in on the controversy. The European Union cited common ownership as one reason that two agricultural-chemical companies had to spin off assets to win approval to merge. The Justice Department’s antitrust division, which shares antitrust enforcement with the FTC, asked major airlines about communications with their biggest shareholders in 2015. The probe didn’t result in an enforcement action.

Schmalz, the Oxford finance professor, said only antitrust enforcers have the power to determine whether index funds are influencing merger decisions, but he warned that even if the FTC doesn’t find evidence of overt pressure, common ownership of companies still raises significant antitrust worries.

“Suppose you don’t find anything?” he said. “That doesn’t mean there’s no problem. That’s the danger.”

--With assistance from Annie Massa.

To contact the reporter on this story: David McLaughlin in Washington at dmclaughlin9@bloomberg.net

To contact the editors responsible for this story: Sara Forden at sforden@bloomberg.net, Paula Dwyer

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