Antitrust Exam Question: Do the Major Institutional Investors Have an Antitrust Problem?

Thom Lambert —  30 March 2010

The Wall Street Journal is reporting that major institutional investors — CalPERS, CalSTRS, the Teacher Retirement System of Texas, etc. — have collectively adopted a set of recommended practices that is “rankling” private equity firms. Had I not discussed the article in my Antitrust class, I’d use it as the basis for an exam question. Here are the basics:

Private equity funds are normally organized as limited partnerships, where the investors are the limited partners (i.e., they lack management control, but their liability is limited to the amount of their investment in the firm) and the managers that make investment decisions are affiliated with a general partner, whose liability is unlimited. The rights of limited and general partners are set forth in a limited partnership agreement. The limited partners — largely institutional investors like pensions, endowments, etc. — typically compensate the managers by paying annual management fees and allowing them to collect “carried interest,” which is a share of the profits of the fund’s investment (assuming that the investment reaches a minimum rate of return or “hurdle rate”). Because limited partnerships are creatures of contract, all these arrangements are agreed upon from the outset. So are the rights of the limited partners.

In the last few months, a group of major institutional investors, the Institutional Limited Partners Association (ILPA), promulgated a set of investor principles that call for certain caps on fees, increased disclosure, particular methods for calculating carried interest, and greater investor oversight. The ILPA has 215 members controlling $1 trillion in private equity assets. In addition, the ILPA seems to be soliciting other (non-member) private equity investors to endorse its principles.

On first glance, this resembles a buyers’ side conspiracy: Multiple “buyers” of investment services have agreed not to purchase from “sellers” who do not adhere to preferred terms, including preferred pricing terms. If that’s what’s going on, then the arrangement among the institutional investors violates Section 1 of the Sherman Act, even if the parties to the agreement collectively lack market power. (See Footnote 59 of Socony-Vacuum.)

Not surprisingly, the members of ILPA insist that they haven’t “agreed” to withhold investments from funds that decline to follow the recommended principles. Instead, they say, their principles simply “reflect suggested best practices and are intended to serve as a basis for continued discussion among and between the general partner and limited partner communities with the goal of improving the private equity industry for the long-term benefit of all its participants.” They further maintain that “the authors, sponsors and the groups … that have provided an endorsement of these Principles are not specifically committing to (nor seeking the commitment of) [sic] any private equity investor to each and every outlined term.” Thus, they conclude, their mutual endorsement of a set of best practices does not constitute a contract, combination, or conspiracy to withhold investment funds from fund managers who fail to adhere to the recommended practices.

According to the Journal, though, the most prominent institutional investors are using these widely endorsed principles for more than just “a basis for continued discussion” with fund managers:

The nation’s two largest pension funds — the California State Teachers’ Retirement System and Calpers — have held discussions with each other about whether to insist that private-equity firms agree to the principles, according to people familiar with the talks. Texas Teachers has told at least one firm that the principles were non-negotiable and had to be accepted, according to people familiar with the situation.

Lawyers for private-equity firms also point to a public remark made by Calpers spokesman Clark McKinley in trade publication Pension & Investments. “We are collaborating with other investors in an effort to get better alignment with private-equity partners, including more favorable fees. This requires more than a unilateral action by any one investor,” Mr. McKinley said.

If the point of the principles is merely informational — i.e., to set forth a set of best practices that will minimize agency costs — then why solicit public “endorsements” of the principles? On this question, Mr. McKinley’s remarks are pretty revealing. They suggest that a single investor’s insistence on adherence to the principles wouldn’t work; fund managers would find other, more accommodating investors. But if all the major institutional investors adopted the same stance, the fund managers might have to give in to their demands. Could we infer an Interstate Circuit-like agreement from institutional investors’ parallel action in adhering to the principles?

If there’s no “agreement” to adhere to the principles themselves, could liability arise from the concerted action of signing on to the principles, thereby creating a “facilitating device”? I’m analogizing here to the data exchange cases, where the mere exchange of cost or price information among competitors can create antitrust liability even if there’s no agreement to adhere to specified prices. Data exchanges, unlike horizontal agreements to adhere to price schedules, are not per se illegal; instead, they are evaluated under a rule of reason that looks hard at the nature of the information exchanged (the degree to which it could facilitate price-fixing) and the structure of the market in which the competitors participate (the degree to which it is susceptible to cartelization). If a court were to analyze the principles as a facilitating device, it would likely examine their content — e.g., the degree to which they are specific enough to form the basis for price-fixing — and the “cartelizability” of investors in private equity funds. Under such a rule of reason analysis, liability is unlikely.

Even if a court were to conclude that actual price-fixing had occurred, it’s hard to imagine that it would impose liability on the institutional investors:

Buyout executives acknowledge that even if there are legal problems with ILPA members’ conduct, there is likely to be little sympathy for the plight of private-equity firms.

“Even if there was an antitrust problem from a legal perspective,” said one senior private-equity executive at a large firm, “I don’t see the Justice Department coming to the rescue of Henry Kravis and Stephen Schwarzman.”

Still, I think, this arrangement could form the basis for a pretty good Antitrust exam question.

UPDATE: Danny Sokol pointed me to this release from law firm Bingham McCutchen (or is it just “Bingham” now?). The antitrust lawyers there appear to agree that there are some tricky antitrust issues here.

Thom Lambert


I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

7 responses to Antitrust Exam Question: Do the Major Institutional Investors Have an Antitrust Problem?


    Thom, thanks for your reply.

    Effects-wise I am still struggling to see what would cause allocative inefficiency:

    a)”Some “sellers” (or potential sellers), unable to attain contract terms they find desirable, will exit (or decline to enter) the market.”
    This may well be efficiency enhancing to the extent that those “sellers” exiting the market were probably less efficient and only able to survive thanks to supra-competitive contract terms (i.e. like a price umbrella).

    b)”Those that remain may drop offerings (sets of contract terms) that other, non-colluding investors would prefer.”
    It would be odd for non-colluding investors to prefer the contract terms challenged by ILPA, to the extent that these shall be more onerous than the ones ILPA is lobbying for.

    This is to say that the agreement may well be efficiency enhancing even in the absence of sellers’ collusion on contract terms – i.e. just a bad non-cooperative equilibrium.

    Regarding the argument that the buyers’ agreement would be per se illegal, I am not familiar with antitrust law in the US, but if that was the case this would not strike me as a particularly interesting antitrust exam question – at least from an economist’s point of view.


    @ Thom. Hmm. I get your point now. The Comment from Mr. McKinley read in conjunction with what the Journal reports about Pension Funds’ discussions certainly makes it “plausible” to that there is such an “agreement”. As a corollary, the “per se ” rule seems applicable. Tx.

    As an aside, I apologize for referring your post as Professor Wright’s post in my earlier comment. I noticed only now that it is your post.



    Thanks for the comments. As I mention in the post, if the arrangement at issue gets evaluated under antitrust’s rule of reason, I suspect it would be legal — primarily because the market for investments in private equity funds (the market in which the institutional investors participate) would be extremely difficult to cartelize. I think that’s your point in your second comment, and I agree with it.

    If, however, there is an “agreement” among institutional investors to refrain from investing in funds that do not comply with the policies in the investor principles, that agreement is per se illegal, meaning that a court would condemn it without inquiring into likely market effects. The comment from Mr. McKinley suggests that there may be grounds for inferring an agreement among the institutional investors from their parallel conduct.


    @ Thom, if the securities markets is deep enough, substitutability is not really a problem. So, the allocative efficiency argument is I suspect merely academic. @ any rate, you concede that this is an off-the-cuff thought.


    Given that investor protection is, to borrow a phrase from the American Constitutional Law, a “compelling state interest”, Can this co-ordination between limited investors realistically be a “tricky antitrust issue”?

    Public Choice theory supports what the senior executive of the PE firm states, (as Professor Wright reports in his post above). Federal Agencies/federal lawmaking have been historically much more amenable to investors whereas State law generally tends to favor insiders/general partners. (cf. Lucian Bebchuk/Assaf Hamdani, Colum.L.R. (2006) for example). So, Antitrust being under the competence of DoJ, it is unlikely that GPs will get any leverage there.

    But even conceding the practical impossibility,. this could be a great antitrust question. You can even ask the students to assume that there are antitrust issues here and discuss the “pull-push” with corporate/securities law regimes this may lead to.


    Great questions, Paolo. I suppose the theory of harm would be that collusion among “buyers” (the institutional investors) as to the terms of limited partner agreements may ultimately reduce the offerings available in the fund market. Some “sellers” (or potential sellers), unable to attain contract terms they find desirable, will exit (or decline to enter) the market. Those that remain may drop offerings (sets of contract terms) that other, non-colluding investors would prefer. Taken together, these actions will lead to allocative inefficiency — i.e., investment resources being allocated other than to their highest and best uses.

    With respect to your last question — could the institutional investors’ collective action be a means of countering seller-side collusion? — I’m not aware of allegations that private equity funds have colluded as to contract terms. It would be pretty hard to do so, given the ease of entry into the market. Even if such collusion were established, I can’t imagine that a court would recognize a “necessary to counter other collusion” defense here. The institutional investors could always counter such seller-side collusion by collectively adopting a less restrictive position: We won’t invest with any fund that refuses to negotiate with us on management fees, carried interest, etc.

    In any event, these are pretty off-the-cuff thoughts on my part. It’s a complicated situation, which is why it would make for such a great antitrust exam question!


    Limited investors appear to be the final consumers here, what is the underlying theory of harm that you have in mind? Monopsony?
    If they are not final customers, what do you have in mind? Raising rival costs, waterbed effects, dowstream collusion, (vertical) rent sharing?
    What if all private equity firms generally charge limited partners according to the same terms (do general investors have a trade body as well?)- wouldn’t this amount to conspiracy in the first place?