Smoke billows up from a derailed Canadian Pacific Railway train near Guernsey, Sask., on Feb. 6, 2020. TCI is the largest shareholder in Canadian Pacific Railway Ltd.Matt Smith/The Canadian Press
Pierre Lortie is a senior business adviser at Dentons Canada LLP.
The Canadian government is faced with a very unhealthy situation in which a foreign hedge fund that holds significant equity positions in both CN and CP has engaged in anti-competitive behaviour affecting Canadian railways and then increased its shareholding in CN in an attempt to reshape its board and redirect its business strategy.
The stakes are high.
The saga in which Canadian National Railway Co. is embroiled involves a relatively new and unaddressed competition policy challenge. The issue is brought to the fore by the overlapping share ownership and conduct of an activist investor, TCI Fund Management Ltd., in Canada’s only two national railways. A growing body of empirical work indicates that, even when held by passive institutional investors, common share ownership in concentrated markets more often leads to higher prices, reduced market output, and lower product and service quality than would otherwise be the case.
TCI is the largest shareholder in Canadian Pacific Railway Ltd. , and in the midst of the bidding process for the acquisition of Kansas City Southern Railway, TCI attempted to halt CN’s bid and urged the company to refrain from intervening in regulatory proceedings relating to CP’s offer. In September, TCI announced it had increased its stake in CN to 5 per cent of its outstanding shares in order to gain the right to call a special meeting of the shareholders under the Canada Business Corporation Act. It also said it was launching a proxy fight with CN for the election of a slate of directors and the appointment of a new chief executive officer designated by TCI.
The basic premise of Canada’s Competition Act is that competitive markets provide the greatest opportunities for lower prices, better product quality and business innovation, all of which benefit not only individuals, but the economy as a whole. While transactions that may substantially reduce competition are prohibited, enforcement of the law in situations involving minority ownership is less straightforward. However, the merger provisions of the act can and clearly should be used to deal with anti-competitive behaviour of this kind.
In a seminal 2018 paper, researchers found that the higher the concentration of common ownership by institutional funds in the airline industry, the less competition there was and the higher fares were. Subsequent empirical studies of other industries in the United States and Western Europe reached the same conclusion. The point is that if common ownership of competing firms by passive investors has anti-competitive consequences, what should be expected from an activist hedge fund that must generate returns high enough to compensate its investors on a risk-adjusted basis, given the high management fees they charge? We don’t have to look too far for an answer. In applying U.S. antitrust law, the Federal Trade Commission describes six types of conduct – virtually all of which apply to TCI’s campaign against CN, including nominating candidates for election to the board – that take it out of the realm of passive investing and into a more active mode that would warrant regulatory intervention.
Should TCI get its nominees elected to CN’s board, it would be in a position to exert significant influence over the company’s management. Since TCI’s interests in CP and CN overlap, there is no reason for them to be pro-growth, since increasing the growth rate of one company would be largely at the expense of the other.
Despite TCI’s comment in a statement that CN should be the “fastest-growing railroad in the industry,” TCI is focused on increasing margins. In TCI’s view, “CN has a pricing problem.” In these circumstances, both railways’ management teams could be driven to pursue anti-competitive and self-serving strategies that we could reasonably expect to lead to higher prices and reduced investment to increase profitability in the short run without jeopardizing each other’s market position. One possible outcome is that TCI’s influence over both companies could be deployed to advance the interests, not of one railway over the other, but of both at the expense of shippers, rail safety, resiliency and the public.
The authorities should not be swayed by the argument that directors are bound by their fiduciary duty to all stakeholders. Certainly, there is no reason to expect TCI-designated directors to engage in egregious actions. However, several studies show that the behaviour and objectives of a company are dependent on its owners and that, even in the absence of co-ordinated mechanisms with common shareholders, management, on its own initiative, pre-emptively aligns its conduct with what it considers to be the interest of the most influential shareholder.
There is no valid reason that the upheaval caused by short-term financial objectives affecting a critical piece of Canadian infrastructure should not be subject to an antitrust investigation by Canadian authorities.
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