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In my Heritage Foundation Legal Memorandum published yesterday, I call for elimination of the Consumer Financial Protection Bureau (CFPB), on constitutional and economic policy grounds.  As I explain:

The new Consumer Financial Protection Bureau (CFPB), created by the Dodd–Frank Wall Street Reform and Consumer Protection Act, is living up to its billing as one of the most powerful—and unaccountable—federal agencies ever created.  After just 18 months—and with a staff exceeding 1,000 and funding of $600 million—the bureau is restructuring the mortgage market; devising restrictions on credit bureaus, education loans, overdraft policies, payday lenders, credit card plans and prepaid cards; and amassing unverified complaints with which to assail creditors and bankers. This inordinate control over consumer finance is constraining credit and harming the economy. . . .

The bureau was designed to evade the checks and balances that apply to most other regulatory agencies. Its very structure invites expansive rulemaking, as does its misappropriation of the emergent theory of behavioral economics that drives bureau decision making. It deems consumers prone to financial irrationality and thus ill-equipped to act in their self-interest. Consequently, the CFPB is compelled to intervene in consumers’ personal financial transactions.

Government interference in the financial market does not come without consequences. In the case of the CFPB, the rule of law is being supplanted by regulatory whim, producing deep uncertainty in the consumer financial market. And, the new regulatory strictures will increase consumers’ costs and reduce consumers’ choices of financial products and services.

Lawmakers must curtail the bureau’s unconstrained powers. Outright elimination of the CFPB is the best option. Consumer protection can be advanced instead through better coordination among [other existing and more accountable] financial regulator[y] [agencies]. Proceeding toward bureau dissolution, bureau funding should be controlled by Congress, and the vague language of the CFPB’s statutory mandate must be tightened to stop bureaucrats from defining—and expanding—their own powers.

In sum, elimination of the CFPB, accompanied by reallocation of its essential functions to other agencies and the paring back of excessive financial services regulation, would promote a sounder economy and greater constitutional accountability.

The Heritage Foundation’s Index of Economic Freedom is an annual data compilation that provides an ordinal ranking of economic freedom in nations throughout the world, based on such country-specific measures of economic liberty as commitment to limited government, strong protection of private property, openness to global trade and financial flows, and sensible regulation.

The 2016 edition, released on February 1, found that the “United States continues to be mired in the ranks of the ‘mostly free,’ the second-tier economic freedom category into which the U.S. dropped in 2010.  Worse, with scores in labor freedom, business freedom, and fiscal freedom notably declining, the economic freedom of the United States plunged 0.8 point to 75.4, matching its lowest score ever.”  In addition to a detailed statistical breakdown of country scores, this edition included six essays on various topics related to the nature of economic freedom and its assessment (see here, here, here, here, here, and here).

Those readers who are interested in the economic effects of anticompetitive regulatory distortions around the world may wish to turn to the essay entitled “Anticompetitive Policies Reduce Economic Freedom and Hurt Prosperity,” co-authored by Shanker Singham (Director of Economic Policy at the Legatum Institute) and me, whose key points are as follows:

Excessive government regulation interferes with individual economic freedom. It also imposes a substantial burden on national economies, reducing national wealth and slowing economic growth. Over the past decade, The Heritage Foundation has documented the large and rising cost to the United States economy stemming from overregulation. Regrettably, however, sizable regulatory burdens continue to characterize many (if not all) economies, as documented by the Organisation for Economic Co-operation and Development (OECD) and the World Bank.

One regulatory category that has garnered increased attention in recent years is government rules that distort and harm the competitive process. Competition everywhere faces restraints imposed by governments, either through laws, regulations, and practices or through hybrid public–private restrictions by which government sanctions or encourages private anticompetitive activity. Government-imposed restrictions on competition, which we term anticompetitive market distortions (or anticompetitive regulations), are especially pernicious because they are backed by the power of the state and may be largely impervious to attenuation through market processes. Often, these restrictions—for example, onerous licensing requirements—benefit powerful incumbents and stymie entry by innovative new competitors.

In recent years, recognizing the harm caused by anticompetitive regulations, international institutions have attempted to identify and categorize various types of harmful regulations and to estimate the consumer welfare costs that they impose. The intent of these efforts is to help governments move away from anticompetitive regulations. Such efforts, however, are often stymied by producer lobbies that tend to underplay the harmful effects of such regulations on consumers.

Ferreting out and publicizing the economic impact of these regulatory abuses should be given a higher priority in order to promote economic freedom and prosperity. In this chapter, we first outline the concept of anticompetitive regulations and the arguments for combatting them more vigorously, suggesting the importance of developing a neutral measure (a metric) to estimate their harmful impact. We then describe efforts by two major international organizations, the OECD and the International Competition Network (ICN), to develop methodologies for identifying anticompetitive regulations and to provide justifications for elimination of those restrictions. We then briefly summarize research (much of it supported in recent years by the World Bank) that estimates the nature and size of the economic welfare costs of anticompetitive regulations. Finally, we turn to ongoing research that focuses on a broad metric to measure the economic impact of these regulations on property rights, international trade, and domestic competition.

On Wednesday, the International Center for Law & Economics, along with the Competitive Enterprise Institute, filed an amicus brief in the Ninth Circuit Court of Appeals supporting the appellants in Fox Television Stations, Inc. v. Aereo Killer LLC. The case arose out of Aereo Killer’s Internet video platform, from which it would retransmit content without either the consent of the broadcast stations or permission from the holders of copyrights in the content it distributed.

Aero Killer essentially seeks to engage in regulatory arbitrage by, on the one hand, claiming that it qualifies for compulsory licenses as a “cable system” under Section 111 of the Copyright Act, while on the other hand seeking to avoid applying for “retransmission consent” under the Cable Act.

In our brief we explore the issue of the interplay between “retransmission consent” and “compulsory licenses,” and on Aereo Killer’s unjust and illegal attempt to create a carve out for itself in violation of Congressional intent:

Defendants seek a compulsory license under Section 111 of the Copyright Act, which would allow them to sell a service that retransmits copyrighted television shows without permission from the program owners—while paying only statutorily determined royalties that do not come close to market rate for Plaintiffs’ programming. At the same time, however, Defendants have configured their service so that they do not need to obtain consent from the broadcasters whose signals they wish to retransmit, because Internet-based retransmission services do not meet the Communications Act’s definition of an MVPD. On the latter point Defendants are correct: Internet-based retransmission services are not MVPDs. However, treating their service as a “cable system” under the Copyright Act, but not under the Communications Act, is contrary to the statutory framework Congress created.

In practice, and by design, therefore, a service that retransmits television programming is subject to both provisions, or neither of them, depending on the technical details of the service. Congress affirmed its intent that these provisions go hand-in-hand in 1994

Congress crafted the statutory regime as it did precisely to prevent the unjust enrichment of television resellers at the expense of broadcasters and copyright owners. Defendants do not operate a cable system and are thus ineligible for the compulsory copyright license. If they wish to retransmit plaintiffs’ television programming, they are free to bargain for a copyright license, as so many other Internet-based video distributors have done.

Politicians have recently called for price controls to address the high costs of pharmaceuticals. Price controls are government-mandated limits on prices, or government-required discounts on prices. On the campaign trail, Hillary Clinton has called for price controls for lower-income Medicare patients while Donald Trump has recently joined Clinton, Bernie Sanders, and President Obama in calling for more government intervention in the Medicare Part D program. Before embarking upon additional price controls for the drug industry, policymakers and presidential candidates would do well to understand the impacts and problems arising from existing controls.

Unbeknownst to many, a vast array of price controls are already in place in the pharmaceutical market. Over 40 percent of outpatient drug spending is spent in public programs that use price controls. In order to sell drugs to consumers covered by these public programs, manufacturers must agree to offer certain rebates or discounts on drug prices. The calculations are generally based on the Average Manufacturer Price (AMP–the average price wholesalers pay manufacturers for drugs that are sold to retail pharmacies) or the Best Price (the lowest price the manufacturer offers the drug to any purchaser including all rebates and discounts). The most significant public programs using some form of price control are described below.

  1. Medicaid

The Medicaid program provides health insurance for low-income and medically needy individuals. The legally-required rebate depends on the specific category of drug; for example, brand manufacturers are required to sell drugs for the lesser of 23.1% off AMP or the best price offered to any purchaser.

The Affordable Care Act significantly expanded Medicaid eligibility so that in 2014, the program covered approximately 64.9 million individuals, or 20 percent of the U.S. population. State Medicaid data indicates that manufacturers paid an enormous sum — in excess of $16.7 billion — in Medicaid rebates in 2012.

  1. 340B Program

The “340B Program”, created by Congress in 1992, requires drug manufacturers to provide outpatient drugs at significantly reduced prices to 340B-eligible entities—entities that serve a high proportion of low-income or uninsured patients. Like Medicaid, the 340B discount must be at least 23.1 percent off AMP. However, the statutory formula calculates different discounts for different products and is estimated to produce discounts that average 45 percent off average prices. Surprisingly, the formulas can even result in a negative 340B selling price for a drug, in which case manufacturers are instructed to set the drug price at a penny.

The Affordable Care Act broadened the definition of qualified buyers to include many additional types of hospitals. As a result, both the number of 340B-eligible hospitals and the money spent on 340B drugs tripled between 2005 and 2014. By 2014, there were over 14,000 hospitals and affiliated sites in the 340B program, representing about one-third of all U.S. hospitals.

The 340B program has a glaring flaw that punishes the pharmaceutical industry without any offsetting benefits for low-income patients. The 340B statute does NOT require that providers only dispense 340B drugs to needy patients. In what amounts to merely shifting profits from pharmaceutical companies to other health care providers, providers may also sell drugs purchased at the steep 340B discount to non-qualified patients and pocket the difference between the 340B discounted price and the reimbursement of the non-qualified patients’ private insurance companies. About half of the 340B entities generate significant revenues from private insurer reimbursements that exceed 340B prices.

  1. Departments of Defense and Veterans Affairs Drug Programs

In order to sell drugs through the Medicaid program, drug manufacturers must also provide drugs to four government agencies—the VA, Department of Defense, Public Health Service and Coast Guard—at statutorily-imposed discounts. The required discounted price is the lesser of 24% off AMP or the lowest price manufacturers charge their most-favored nonfederal customers under comparable terms. Because of additional contracts that generate pricing concessions from specific vendors, studies indicate that VA and DOD pricing for brand pharmaceuticals was approximately 41-42% of the average wholesale price.

  1. Medicare Part D

An optional Medicare prescription drug benefit (Medicare Part D) was enacted in 2005 to offer coverage to many of the nation’s retirees and disabled persons. Unlike Medicaid and the 340B program, there is no statutory rebate level on prescription drugs covered under the program. Instead, private Medicare Part D plans, acting on behalf of the Medicare program, negotiate prices with pharmaceutical manufacturers and may obtain price concessions in the form of rebates. Manufacturers are willing to offer significant rebates and discounts in order to provide drugs to the millions of covered participants. The rebates often amount to as much as a 20-30 percent discount on brand medicines. CMS reported that manufacturers paid in excess of $10.3 billion in Part D rebates in 2012.

The Medicare Part D program does include direct price controls on drugs sold in the coverage gap. The coverage gap (or “donut hole”) is a spending level in which enrollees are responsible for a larger share of their total drug costs. For 2016, the coverage gap begins when the individual and the plan have spent $3,310 on covered drugs and ends when $7,515 has been spent. Medicare Part D requires brand drug manufacturers to offer 50 percent discounts on drugs sold during the coverage gap. These required discounts will cost drug manufacturers approximately $41 billion between 2012-2021.

While existing price controls do produce lower prices for some consumers, they may also result in increased prices for others, and in the long-term may drive up prices for all.  Many of the required rebates under Medicaid, the 340B program, and VA and DOD programs are based on drugs’ AMP.  Calculating rebates from average drug prices gives manufactures an incentive to charge higher prices to wholesalers and pharmacies in order to offset discounts. Moreover, with at least 40% of drugs sold under price controls, and some programs even requiring drugs to be sold for a penny, manufacturers are forced to sell many drugs at significant discounts.  This creates incentives to charge higher prices to other non-covered patients to offset the discounts.  Further price controls will only amplify these incentives and create inefficient market imbalances.

 

I urge Truth on the Market readers to signal their preferences and help select the 2016 antitrust writing awards bestowed by the prestigious competition law and policy journal, Concurrences.  (See here for the 2015 winners.)

Readers and a Steering Committee vote for their favorite articles among those nominated, which results in a short list of finalists (two per category).  The Concurrences Board then votes for the award-winning articles from the shortlist.  (See here for detailed rules.)

Readers can now vote online until February 15 for their favorite articles at http://awards.concurrences.com/.

Among the nominees are three excellent papers written by former FTC Commissioner Joshua D. Wright (including one written with Judge Douglas H. Ginsburg) and one paper co-authored by Professor Thom Lambert and me (the four articles fall into three separate categories so you can vote for at least three of them):

  1. Academic Article IP Category: Douglas H. Ginsburg, Koren W. Wong-Ervin, and Joshua D. Wright, Product Hopping and the Limits of Antitrust: The Danger of Micromanaging Innovation, http://awards.concurrences.com/articles-awards/academic-articles-awards/article/product-hopping-and-the-limits-of-antitrust-the-danger-of-micromanaging.
  2. Academic Article General Antitrust Category: Joshua D. Wright & Angela Diveley, Unfair Methods of Competition after the 2015 Commission Statement, http://awards.concurrences.com/articles-awards/academic-articles-awards/article/unfair-methods-of-competition-after-the-2015-commission-statement.
  3. Academic Article Unilateral Conduct Category: Derek Moore & Joshua D. Wright, Conditional Discounts and the Law of Exclusive Dealing, http://awards.concurrences.com/articles-awards/academic-articles-awards/article/conditional-discounts-and-the-law-of-exclusive-dealing.
  4. Academic Article General Antitrust Category: Thomas A. Lambert and Alden F. Abbott, Recognizing the Limits of Antitrust:  The Roberts Court Versus the Enforcement Agencies, http://jcle.oxfordjournals.org/content/early/2015/09/14/joclec.nhv020.abstract and  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2596660 (downloadable version).

All four of these articles break new ground in important areas of antitrust law and policy.

(Full disclosure:  Wright and Ginsburg are professors at George Mason Law School. I am on the adjunct faculty at that fine institution and Wong-Ervin is Director of George Mason Law School’s Global Antitrust Institute.)

On January 26 the Heritage Foundation hosted a one-day conference on “Antitrust Policy for a New Administration.”  Featured speakers included three former heads of the U.S. Department of Justice’s Antitrust Division (DOJ) (D.C. Circuit Senior Judge Douglas Ginsburg, James Rill, and Thomas Barnett) and a former Chairman of the U.S. Federal Trade Commission (FTC) (keynote speaker Professor William Kovacic), among other leading experts on foreign and domestic antitrust.  The conference addressed developments at DOJ, the FTC, and overseas.  The entire program (which will be posted for viewing very shortly at Heritage.org) has generated substantial trade press coverage (see, for example, two articles published by Global Competition Review).  Four themes highlighted during the presentations are particularly worth noting.

First, the importance of the federal judiciary – and judicial selection – in the development and direction of U.S. antitrust policy.  In his opening address, Professor Bill Kovacic described the central role the federal judiciary plays in shaping American antitrust principles.  He explained how a few key judges with academic backgrounds (for example, Frank Easterbrook, Richard Posner, Stephen Breyer, and Antonin Scalia) had a profound effect in reorienting American antitrust rules toward the teachings of law and economics, and added that the Reagan Administration focused explicitly on appointing free market-oriented law professors for key appellate judgeships.  Since the new President will appoint a large proportion of the federal judiciary, the outcome of the 2016 election could profoundly influence the future direction of antitrust, according to Professor Kovacic.  (Professor Kovacic also made anecdotal comments about various candidates, noting the short but successful FTC experience of Ted Cruz; Donald Trump having once been an antitrust plaintiff (when the United States Football League sued the National Football League); Hillary Clinton’s misstatement that antitrust has not been applied to anticompetitive payoffs made by big drug companies to generic producers; and Bernie Sanders’ pronouncements suggesting a possible interest in requiring the breakup of large companies.)

Second, the loss of American global economic leadership on antitrust enforcement policy.  There was a consensus that jurisdictions around the world increasingly have opted for the somewhat more interventionist European civil law approach to antitrust, in preference to the American enforcement model.  There are various explanations for this, including the fact that civil law predominates in many (though not all) nations that have adopted antitrust regimes, and the natural attraction many governments have for administrative models of economic regulation that grant the state broad enforcement discretion and authority.  Whatever the explanation, there also seemed to be some sentiment that U.S. government agencies have not been particularly aggressive in seeking to counter this trend by making the case for the U.S. approach (which relies more on flexible common law reasoning to accommodate new facts and new economic learning).  (See here for my views on a desirable approach to antitrust enforcement, rooted in error cost considerations.)

Third, the need to consider reforming current cartel enforcement programs.  Cartel enforcement programs, which are a mainstay of antitrust, received some critical evaluation by the members of the DOJ and international panels.  Judge Ginsburg noted that the pattern of imposing ever- higher fines on companies, which independently have strong incentives to avoid cartel conduct, may be counterproductive, since it is typically “rogue” employees who flout company policies and collaborate in cartels.  The focus thus should be on strong sanctions against such employees.  Others also opined that overly high corporate cartel fines may not be ideal.  Relatedly, some argued that the failure to give “good behavior” credit to companies that have corporate compliance programs may be suboptimal and welfare-reducing, since companies may find that it is not cost-beneficial to invest substantially in such programs if they receive no perceived benefit.  Also, it was pointed out that imposing very onerous and expensive internal compliance mandates would be inappropriate, since companies may avoid them if they perceive the costs of compliance programs to outweigh the expected value of antitrust penalties.  In addition, the programs by which governments grants firms leniency for informing on a cartel in which they participate – instituted by DOJ in the 1990s and widely emulated by foreign enforcement agencies – came in for some critical evaluation.  One international panelist argued that DOJ should not rely solely on leniency to ferret out cartel activity, stressing that other jurisdictions are beginning to apply econometric methods to aid cartel detection.  In sum, while there appeared to be general agreement about the value and overall success of cartel prosecutions, there also was support for consideration of new means to deter and detect cartels.

Fourth, the need to work to enhance due process in agency investigations and enforcement actions.  Concerns about due process surfaced on both the FTC and international panels.  A former FTC general counsel complained about staff’s lack of explanation of theories of violation in FTC consumer protection investigations, and limitations on access to senior level decision-makers, in cases not raising fraud.  It was argued that such investigations may promote the micromanagement of non-deceptive business behavior in areas such as data protection.  Although consumer protection is not antitrust, commentators raised the possibility that foreigner agencies would cite FTC consumer protection due process deficiencies in justifying their antitrust due process inadequacies (since the FTC enforces both antitrust and consumer protection under one statutory scheme).  The international panel discussed the fact that due process problems are particularly bad in Asia but also exist to some extent in Europe.  Particular due process issues panelists found to be pervasive overseas included, for example, documentary request abuses, lack of adequate access to counsel, and inadequate information about the nature or purpose of investigations.  The international panelists agreed that the U.S. antitrust enforcement agencies, bar associations, and international organizations (such as the International Competition Network and the OECD) should continue to work to promote due process, but that there is no magic bullet and this will be require a long-term commitment.  (There was no unanimity as to whether other U.S. governmental organs, such as the State Department and the U.S. Trade Representative’s Office, should be called upon for assistance.)

In conclusion, the 2016 Heritage Foundation antitrust conference shed valuable light on major antitrust policy issues that the next President will have to confront.  The approach the next President takes in dealing with these issues will have major implications for a very significant branch of economic regulation, both here and abroad.

On January 15, the Supreme Court agreed to review the Federal Circuit’s decision in Cuozzo Speed Technologies v. Lee, a case that raises the question of whether patent rights, once issued initially by the U.S. Patent and Trademark Patent Office (PTO), are to be treated as fully legitimate interests or instead as “second class citizens” in the property rights firmament.  Cuozzo also raises questions about the ability of a patent owner to obtain full judicial review of all aspects of an administrative decision that strips him of his property rights

This case turns on the construction of the American Invents Act of 2011 (AIA) provisions on post-issuance “inter partes review” (IPR) proceedings conducted by the Patent Trial and Appeal Board (PTAB), an administrative tribunal within PTO (see 35 U.S.C. § 311).  The AIA did not alter the statutory understanding that, once PTO has issued a patent, the patent holder holds a legitimate property right (“patents shall have the attributes of personal property”, 35 U.S.C. § 261).  Furthermore, post-AIA, a patent continues to be presumed to be valid, unless and until a third party meets the burden of proving it invalid (“[a] patent shall be presumed valid” and “[t]he burden of establishing invalidity of a patent or any claim thereof shall rest on the party asserting such invalidity”, 35 U.S.C. § 282).

In response to the critique that federal district court litigation took too long and made it too costly to challenge “low quality” patents, the AIA established administrative PTAB IPR proceedings as a faster and (therefore) less costly alternative to challenging patents in the courts.  The AIA did not, however, alter the statutory presumption that a patent is a valid property right for purposes of such proceedings.  Moreover, although the AIA never specifically addressed the issue, PTO decided to apply a “broadest reasonable interpretation” (BRI) approach in PTAB IPR patent claims assessments.  BRI is the standard patent examiners apply before deciding whether to issue a patent.  Because it errs on the side of reading claims very broadly, it raises the probability that particular claims will be read as unpatentable because they “claim too much” and stray into existing art.  By contrast, federal district courts have never applied BRI, instead construing claims based on the neutral standard of “correct claims construction.”  This means that IPRs are not a speedy neutral substitute for district court litigation – they are instead an inherently biased forum that fails to accord challenged patents the dignity the statutory presumption of validity merits.  This degrades the value of patents and diminishes returns to patenting.  In other words, although application of an onerous standard (BRI) may be appropriate in deciding whether to grant a patent right initially, applying that same standard to “second guess” a patent right that has been granted diminishes its status as a presumptively valid property right.

The Supreme Court in Cuozzo Speed Technologies will address the question of whether the PTAB “may construe claims in an issued patent according to their broadest reasonable interpretation rather than their plain and ordinary meaning.”  The Cuozzo case arose as follows.  Cuozzo owned a patent that discloses an interface which displays a vehicle’s current speed as well as the speed limit.  In response to a challenge by Garmin International, Inc., the PTAB applied the BRI standard in disallowing certain of the patent’s claims as “obvious.”  In February 2015, a two-judge Federal Circuit panel majority affirmed this determination (authored by Judge Timothy Dyk, writing for himself and for Judge Raymond Clevenger), finding no error in the Board’s claim construction under the BRI standard, and also held that it had no jurisdiction to review the PTO’s decision to institute the IPR.

In her dissent, Judge Pauline Newman stressed that the Federal Circuit’s approval of BRI in patent examinations “was based on the unfettered opportunity to amend in those proceedings. That opportunity is not present in I[PR]; amendment of claims requires permission, and since the inception of I[PR], motions to amend have been granted in only two cases, although many have been requested.”  She noted that Congress intended an IPR to be an “adjudicative proceeding,” and “the PT[AB] tribunal cannot serve as a surrogate for district court litigation if the PTAB does not apply the same law to the same evidence.”

Judge Newman also dissented from the panel majority’s conclusion that 35 U.S.C. § 314(d) (which provides that PTO’s determination to institute an IPR “shall be final and unappealable”) “must be read to bar review of all institution decisions, even after the [PTAB] issues a final decision.”  According to Judge Newman, “[t]his ruling appears to impede full judicial review of the PTAB’s final decision, further negating the purpose of the America Invents Act to achieve correct adjudication of patent validity through Inter Partes Review in the [PTAB] administrative agency.”  In particular, a failure to review IPR institution decisions even after a final IPR ruling has been rendered would, as noted patent attorney Gene Quinn explains, give “the USPTO . . . unreviewable discretion to do whatever they want with respect to instituting IPRs, even in situations where petitions are clearly defective on their face.”  Quinn also points to a broader separation of powers concern raised by such unreviewable discretion:

Even if Congress intended to forever insulate [IPR] initiation decisions from judicial review, such an intention would seem to clearly violate at least the spirit of the bedrock Constitutional principles that ensure checks and balances between and among co-equal branches of government.  If Congress could do this here with patent rights then why couldn’t Congress prevent judicial review of decisions relating to real property?

After a sharply divided Federal Circuit voted six to five to deny rehearing en banc, the Supreme granted Cuozzo’s petition for certiorari, focused on these two questions:

(1) Whether the court of appeals erred in holding that, in inter partes review (IPR) proceedings, the Patent Trial and Appeal Board may construe claims in an issued patent according to their broadest reasonable interpretation rather than their plain and ordinary meaning; and (2) whether the court of appeals erred in holding that, even if the Board exceeds its statutory authority in instituting an IPR proceeding, the Board’s decision whether to institute an IPR proceeding is judicially unreviewable.

The Cuozzo case will afford the Supreme Court an opportunity to construe the AIA in a manner that gives full protection to the property rights that have long been understood to flow from a U.S. patent grant – an understanding that accords with treatment of patents as a true form of property, not as second class statutory privileges.  Such an understanding would also strengthen the U.S. patent system and thereby promote the economic growth and innovation it engenders (see here for a description of recent research describing the economic benefits of a strong patent system).

On January 12, 2016, the California state legislature will hold a hearing on AB 463: the Pharmaceutical Cost Transparency Act of 2016. The proposed bill would require drug manufacturers to disclose sensitive information about each drug with prices above a certain level.  The required disclosure includes various production costs including:  the costs of materials and manufacturing, the costs of research and development into the drug, the cost of clinical trials, the costs of any patents or licenses acquired in the development process, and the costs of marketing and advertising. Manufacturers would also be required to disclose a record of any pricing changes for the drug, the total profit attributable to the drug, the manufacturer’s aid to prescription assistance programs, and the costs of projects or drugs that fail during development.  Similar bills have been proposed in other states.

The stated goal of the proposed Act is to ‘make pharmaceutical pricing as transparent as the pricing in other sectors of the healthcare industry.’ However, by focusing almost exclusively on cost disclosure, the bill seemingly ignores the fact that market price is determined by both supply and demand factors. Although costs of development and production are certainly an important factor, pricing is also based on factors such as therapeutic value, market size, available substitutes, patent life, and many other factors.

Moreover, the bill does not clarify how drug manufacturers are to account for and disclose one of the most significant costs to pharmaceutical manufacturers: the cost of failed drugs that never make it to market. Data suggests that only around 10 percent of drugs that begin clinical trials are eventually approved by the FDA. Drug companies depend on the profits from these “hits” in order to stay in business; companies must use the profits from successful drugs to subsidize the significant losses from the 90 percent of drugs that fail.   AB 463 enables manufacturers to disclose the costs of failures, but is unclear if they are able to consider the total losses from the 90 percent of drugs that fail, or only failed drugs that were developed in conjunction with the drug in question. Moreover, even though profits from successful drugs are necessary to subsidize failures, AB 463 is silent on whether the losses from failures can be included in profit calculations.

It’s also worth pointing out that any evaluation of drug manufacturers’ profits should recognize the basic risk-return tradeoff. In order to willingly incur risk—and a 90 percent failure rate of drugs in development is a significant risk—investors and companies demand profits or returns greater than the return on less risky endeavors. That is, if investors or companies can make a 5% return on a safe, predictable investment that has little variation in returns, why would they ever engage in a risky endeavor (especially one with a 90% failure rate) if they don’t earn a substantially higher return?  The market resolves these issues by compensating risky endeavors with a higher expected return. Thus, we should expect companies engaged in the risky business of drug development to receive higher profits than businesses engaged in more conservative businesses.

It will also prove difficult, if not impossible, for drug manufacturers to disclose information about even the “hits” because many of the costs that manufacturers incur are difficult to attribute to a specific drug. Much pre-clinical research is for the purpose of generating dozens or hundreds of possible drug candidates; how should these very expensive research costs be attributed?  How should companies allocate the costs of meeting regulatory requirements; these are rarely incurred independently for each drug? And the overhead costs of operating a business with thousands of employees are also impossible to allocate to a specific drug.  By ignoring these shared costs, AB 463 does little to illuminate the full costs to drug manufacturers.

Instead of providing useful information to make drug pricing more transparent, AB 463 will impose extensive legal and regulatory costs on businesses. The additional disclosure directly increases costs for manufacturers as they collect, prepare, and present the required data. Manufacturers will also incur significant costs as they consult with lawyers and regulators to ensure that they are meeting the disclosure requirements. These costs will ultimately be passed on to consumers in the form of higher drug prices.

Finally, disclosure of such competitively-sensitive information as that required under AB 463 risks harming competition if it gets into the wrong hands. If the confidentiality provisions prove unclear or inadequate, AB 463 may permit the broader disclosure of sensitive information to competitors. This will, in turn, facilitate collusion, raise prices, and harm the very consumers AB 463 is designed to protect.

In sum, the incomplete disclosure required under AB 463 will provide little transparency to the public. The resources could be better used to foster innovation and develop new treatments that lower total health care costs in the long run.

It is a bedrock principle underlying the First Amendment that the government may not penalize private speech merely because it disapproves of the message it conveys.

The Federal Circuit handed down a victory for free expression today — in the commercial context no less. At issue was the Lanham Act’s § 2(a) prohibition of trademark registrations that

[c]onsist[] of or comprise[] immoral, deceptive, or scandalous matter; or matter which may disparage or falsely suggest a connection with persons, living or dead, institutions, beliefs, or national symbols, or bring them into contempt, or disrepute.

The court, sitting en banc, held that the “disparaging” provision is an unconstitutional violation of free expression, and that trademarks will indeed be protected by the First Amendment. Although it declined to decide whether the other prohibitions actually violated the First Amendment, the opinion contained a very strong suggestion to future panels that this opinion likely applies in that context as well.

In many respects the opinion was not all that surprising (particularly if you’ve read my thoughts on the subject here and here ). However given that it was a predecessor Court of Customs and Patent Appeals decision, In Re McGinley, that once held that First Amendment concerns were not implicated at all by § 2(a) because “it is clear that the … refusal to register appellant’s mark does not affect his right to use it” — totally ignoring of course the chilling effects on speech — it was by no means certain that this decision would come out correctly decided.

Today’s holding vacated a decision from a three-judge panel that, earlier this year, upheld the ill-fated “disparaging” prohibition. From just a cursory reading of § 2(a), it should be a no-brainer that it clearly implicates the content of speech — if not a particular view point — and should get at least some First Amendment scrutiny. However, the earlier three-judge opinion  gave all of three paragraphs to this consideration — one of which was just a quotation from McGinley. There, the three-judge panel rather tersely concluded that the First Amendment argument was “foreclosed by our precedent.”

Thus it was with pleasure that I read the Federal Circuit as it today acknowledged that “[m]ore than thirty years have passed since the decision in McGinley, and in that time both the McGinley decision and our reliance on it have been widely criticized[.]” The core of the First Amendment analysis is fairly straightforward: barring “disparaging” marks from registration is neither content neutral nor viewpoint neutral, and is therefore subject to strict scrutiny (which it fails). The court notes that McGinley’s First Amendment analysis was “cursory” (to put it mildly), and was decided before a fully developed body of commercial speech doctrine had emerged. Overall, the opinion is a good example of subtle, probing First Amendment analysis, wherein the court really grasps that merely labeling speech as “commercial” does not somehow magically strip away any protected expressive content.

In fact, perhaps the most important and interesting material has to do with this commercial speech analysis. The court acknowledges that the government’s policy against “disparaging” marks is targeting the expressive aspects of trademarks and not the more easily regulable “transactional” aspects (such as product information, pricing, etc.)— to look at § 2(a) otherwise would not make sense as the government is rather explicitly trying to stop certain messages because of their noncommercial aspects. And the court importantly acknowledges the Supreme Court’s admonition that “[a] consumer’s concern for the free flow of commercial speech often may be far keener than his concern for urgent political dialogue” ( although I might go so far as to hazard a guess that commercial speech is more important that political speech, most of the time, to most people, but perhaps I am just cynical).

The upshot of the Federal Circuit’s new view of trademarks and “commercial speech” reinforces the notion that regulations and laws that are directed toward “commercial speech” need to be very narrowly focused on the actual “commercial” message — pricing, source, etc. — and cannot veer into controlling the “expressive” aspects without justification under strict scrutiny. Although there is nothing terrible new or shocking here, the opinion ties together a variety of the commercial speech doctrines, gives much needed clarity to trademark registration, and reaffirms a sensible view of commercial speech law.

And, although I may be reading too deeply based on my preferences, I think the opinion is quietly staking out a useful position for commercial speech cases going forward—at least to a speech maximalist like myself. In particular, it explicitly relies upon the “unconstitutional conditions” doctrine for the proposition that the benefits of government programs cannot be granted upon a condition that a party only engage in “good” or “approved” commercial speech.  As the world becomes increasingly interested in hate speech regulation,  and our college campuses more interested in preparing a generation of”safe spacers” than of critically thinking adults, this will undoubtedly become an important arrow in a speech defender’s quiver.

Scolding teacher

I have small children and, like any reasonably competent parent, I take an interest in monitoring their Internet usage. In particular, I am sensitive to what ad content they are being served and which sites they visit that might try to misuse their information. My son even uses Chromebooks at his elementary school, which underscores this concern for me, as I can’t always be present to watch what he does online. However, also like any other reasonably competent parent, I trust his school and his teacher to make good choices about what he is allowed to do online when I am not there to watch him. And so it is that I am both interested in and rather perplexed by what has EFF so worked up in its FTC complaint alleging privacy “violations” in the “Google for Education” program.

EFF alleges three “unfair or deceptive” acts that would subject Google to remedies under Section 5 of the FTCA: (1) Students logged into “Google for Education” accounts have their non-educational behavior individually tracked (e.g. performing general web searches, browsing YouTube, etc.); (2) the Chromebooks distributed as part of the “Google for Education” program have the “Chrome Sync” feature turned on by default (ostensibly in a terribly diabolical effort to give students a seamless experience between using the Chromebooks at home and at school); and (3) the school administrators running particular instances of “Google for Education” have the ability to share student geolocation information with third-party websites. Each of these violations, claims EFF, violates the K-12 School Service Provider Pledge to Safeguard Student Privacy (“Pledge”) that was authored by the Future of Privacy Forum and Software & Information Industry Association, and to which Google is a signatory. According to EFF, Google included references to its signature in its “Google for Education” marketing materials, thereby creating the expectation in parents that it would adhere to the principles, failed to do so, and thus should be punished.

The TL;DR version: EFF appears to be making some simple interpretational errors — it believes that the scope of the Pledge covers any student activity and data generated while a student is logged into a Google account. As the rest of this post will (hopefully) make clear, however, the Pledge, though ambiguous, is more reasonably read as limiting Google’s obligations to instances where a student is using  Google for Education apps, and does not apply to instances where the student is using non-Education apps — whether she is logged on using her Education account or not.

The key problem, as EFF sees it, is that Google “use[d] and share[d] … student personal information beyond what is needed for education.” So nice of them to settle complex business and educational decisions for the world! Who knew it was so easy to determine exactly what is needed for educational purposes!

Case in point: EFF feels that Google’s use of anonymous and aggregated student data in order to improve its education apps is not an educational purpose. Seriously? How can that not be useful for educational purposes — to improve its educational apps!?

And, according to EFF, the fact that Chrome Sync is ‘on’ by default in the Chromebooks only amplifies the harm caused by the non-Education data tracking because, when the students log in outside of school, their behavior can be correlated with their in-school behavior. Of course, this ignores the fact that the same limitations apply to the tracking — it happens only on non-Education apps. Thus, the Chrome Sync objection is somehow vaguely based on geography. The fact that Google can correlate an individual student’s viewing of a Neil DeGrasse Tyson video in a computer lab at school with her later finishing that video at home is somehow really bad (or so EFF claims).

EFF also takes issue with the fact that school administrators are allowed to turn on a setting enabling third parties to access the geolocation data of Google education apps users.

The complaint is fairly sparse on this issue — and the claim is essentially limited to the assertion that “[s]haring a student’s physical location with third parties is unquestionably sharing personal information beyond what is needed for educational purposes[.]”  While it’s possible that third-parties could misuse student data, a presumption that it is per se outside of any educational use for third-parties to have geolocation access at all strikes me as unreasonable.

Geolocation data, particularly on mobile devices, could allow for any number of positive and negative uses, and without more it’s hard to really take EFF’s premature concern all that seriously. Did they conduct a study demonstrating that geolocation data can serve no educational purpose or that the feature is frequently abused? Sadly, it seems doubtful. Instead, they appear to be relying upon the rather loose definition of likely harm that we have seen in FTC actions in other contexts ( more on this problem here).  

Who decides what ambiguous terms mean?

The bigger issue, however, is the ambiguity latent in the Pledge and how that ambiguity is being exploited to criticize Google. The complaint barely conceals EFF’s eagerness, and gives one the distinct feeling that the Pledge and this complaint are part of a long game. Everyone knows that Google’s entire existence revolves around the clever and innovative employment of large data sets. When Google announced that it was interested in working with schools to provide technology to students, I can only imagine how the anti-big-data-for-any-commercial-purpose crowd sat up and took notice, just waiting to pounce as soon as an opportunity, no matter how tenuous, presented itself.

EFF notes that “[u]nlike Microsoft and numerous other developers of digital curriculum and classroom management software, Google did not initially sign onto the Student Privacy Pledge with the first round of signatories when it was announced in the fall of 2014.” Apparently, it is an indictment of Google that it hesitated to adopt an external statement of privacy principles that was authored by a group that had no involvement with Google’s internal operations or business realities. EFF goes on to note that it was only after “sustained criticism” that Google “reluctantly” signed the pledge. So the company is badgered into signing a pledge that it was reluctant to sign in the first place (almost certainly for exactly these sorts of reasons), and is now being skewered by the proponents of the pledge that it was reluctant to sign. Somehow I can’t help but get the sense that this FTC complaint was drafted even before Google signed the Pledge.

According to the Pledge, Google promised to:

  1. “Not collect, maintain, use or share student personal information beyond that needed for authorized educational/school purposes, or as authorized by the parent/student.”
  2. “Not build a personal profile of a student other than for supporting authorized educational/school purposes or as authorized by the parent/student.”
  3. “Not knowingly retain student personal information beyond the time period required to support the authorized educational/school purposes, or as authorized by the parent/student.”

EFF interprets “educational purpose” as anything a student does while logged into her education account, and by extension, any of the even non-educational activity will count as “student personal information.” I think that a fair reading of the Pledge undermines this position, however, and that the correct interpretation of the Pledge is that “educational purpose” and “student personal information” are more tightly coupled such that Google’s ability to collect student data is only circumscribed when the student is actually using the Google for Education Apps.

So what counts as “student personal information” in the pledge? “Student personal information” is “personally identifiable information as well as other information when it is both collected and maintained on an individual level and is linked to personally identifiable information.”  Although this is fairly broad, it is limited by the definition of “Educational/School purposes” which are “services or functions that customarily take place at the direction of the educational institution/agency or their teacher/employee, for which the institutions or agency would otherwise use its own employees, and that aid in the administration or improvement of educational and school activities.” (emphasis added).

This limitation in the Pledge essentially sinks EFF’s complaint. A major part of EFF’s gripe is that when the students interact with non-Education services, Google tracks them. However, the Pledge limits the collection of information only in contexts where “the institutions or agency would otherwise use its own employees” — a definition that clearly does not extend to general Internet usage. This definition would reasonably cover activities like administering classes, tests, and lessons. This definition would not cover activity such as general searches, watching videos on YouTube and the like. Key to EFF’s error is that the pledge is not operative on accounts but around activity — in particular educational activity “for which the institutions or agency would otherwise use its own employees.”

To interpret Google’s activity in the way that EFF does is to treat the Pledge as a promise never to do anything, ever, with the data of a student logged into an education account, whether generated as part of Education apps or otherwise. That just can’t be right. Thinking through the implications of EFF’s complaint, the ultimate end has to be that Google needs to obtain a permission slip from parents before offering access to Google for Education accounts. Administrators and Google are just not allowed to provision any services otherwise.

And here is where the long game comes in. EFF and its peers induced Google to sign the Pledge all the while understanding that their interpretation would necessarily require a re-write of Google’s business model.  But not only is this sneaky, it’s also ridiculous. By way of analogy, this would be similar to allowing parents an individual say over what textbooks or other curricular materials their children are allowed to access. This would either allow for a total veto by a single parent, or else would require certain students to be frozen out of participating in homework and other activities being performed with a Google for Education app. That may work for Yale students hiding from microaggressions, but it makes no sense to read such a contentious and questionable educational model into Google’s widely-offered apps.

I think a more reasonable interpretation should prevail. The privacy pledge is meant to govern the use of student data while that student is acting as a student — which in the case of Google for Education apps would mean while using said apps. Plenty of other Google apps could be used for educational purposes, but Google is intentionally delineating a sensible dividing line in order to avoid exactly this sort of problem (as well as problems that could arise under other laws directed at student activity, like COPPA, most notably). It is entirely unreasonable to presume that Google, by virtue of its socially desirable behavior of enabling students to have ready access to technology, is thereby prevented from tracking individuals’ behavior on non-Education apps as it chooses to define them.

What is the Harm?

According to EFF, there are two primary problems with Google’s gathering and use of student data: gathering and using individual data in non-Education apps, and gathering and using anonymized and aggregated data in the Education apps. So what is the evil end to which Google uses this non-Education gathered data?

“Google not only collects and stores the vast array of student data described above, but uses it for its own purposes such as improving Google products and serving targeted advertising (within non-Education Google services)”

The horrors! Google wants to use student behavior to improve its services! And yes, I get it, everyone hates ads — I hate ads too — but at some point you need to learn to accept that the wealth of nominally free apps available to every user is underwritten by the ad-sphere. So if Google is using the non-Education behavior of students to gain valuable insights that it can monetize and thereby subsidize its services, so what? This is life in the twenty-first century, and until everyone collectively decides that we prefer to pay for services up front, we had better get used to being tracked and monetized by advertisers.

But as noted above, whether you think Google should or shouldn’t be gathering this data, it seems clear that the data generated from use of non-Education apps doesn’t fall under the Pledge’s purview. Thus, perhaps sensing the problems in its non-Education use argument, EFF also half-heartedly attempts to demonize certain data practices that Google employs in the Education context. In short, Google aggregates and anonymizes the usage data of the Google for Education apps, and, according to EFF, this is a violation of the Pledge:

“Aggregating and anonymizing students’ browsing history does not change the intensely private nature of the data … such that Google should be free to use it[.]”

Again the “harm” is that Google actually wants to improve the Educational apps:  “Google has acknowledged that it collects, maintains, and uses student information via Chrome Sync (in aggregated and anonymized form) for the purpose of improving Google products”

This of course doesn’t violate the Pledge. After all, signatories to the Pledge promise only that they will “[n]ot collect, maintain, use or share student personal information beyond that needed for authorized educational/school purposes.” It’s eminently reasonable to include the improvement of the provisioned services as part of an “authorized educational … purpose[.]” And by ensuring that the data is anonymized and aggregated, Google is clearly acknowledging that some limits are appropriate in the education context — that it doesn’t need to collect individual and identifiable personal information for education purposes — but that improving its education products the same way it improves all its products is an educational purpose.

How are the harms enhanced by Chrome Sync? Honestly, it’s not really clear from EFF’s complaint. I believe that the core of EFF’s gripe (at least here) has to do with how the two data gathering activities may be correlated together. Google has ChromeSync enabled by default, so when the students sign on at different locations, the Education apps usage is recorded and grouped (still anonymously) for service improvement alongside non-Education use. And the presence of these two data sets being generated side-by-side creates the potential to track students in the educational capacity by correlating with information generated in their non-educational capacity.

Maybe there are potential flaws in the manner in which the data is anonymized. Obviously EFF thinks anonymized data won’t stay anonymized. That is a contentious view, to say the least, but regardless, it is in no way compelled by the Pledge. But more to the point, merely having both data sets does not do anything that clearly violates the Pledge.

The End Game

So what do groups like EFF actually want? It’s important to consider the effects on social welfare that this approach to privacy takes, and its context. First, the Pledge was overwhelmingly designed for and signed by pure education companies, and not large organizations like Google, Apple, or Microsoft — thus the nature of the Pledge itself is more or less ill-fitted to a multi-faceted business model. If we follow the logical conclusions of this complaint, a company like Google would face an undesirable choice: On the one hand, it can provide hardware to schools at zero cost or heavily subsidized prices, and also provide a suite of useful educational applications. However, as part of this socially desirable donation, it must also place a virtual invisibility shield around students once they’ve signed into their accounts. From that point on, regardless of what service they use — even non-educational ones — Google is prevented from using any data students generate. At this point, one has to question Google’s incentive to remove huge swaths of the population from its ability to gather data. If Google did nothing but provide the hardware, it could simply leave its free services online as-is, and let schools adopt or not adopt them as they wish (subject of course to extant legislation such as COPPA) — thereby allowing itself to possibly collect even more data on the same students.

On the other hand, if not Google, then surely many other companies would think twice before wading into this quagmire, or, when they do, they might offer severely limited services. For instance, one way of complying with EFF’s view of how the Pledge works would be to shut off access to all non-Education services. So, students logged into an education account could only access the word processing and email services, but would be prevented from accessing YouTube, web search and other services — and consequently suffer from a limitation of potentially novel educational options.

EFF goes on to cite numerous FTC enforcement actions and settlements from recent years. But all of the cited examples have one thing in common that the current complaint does not: they all are violations of § 5 for explicit statements or representations made by a company to consumers. EFF’s complaint, on the other hand, is based on a particular interpretation of an ambiguous document generally drafted, and outside of the the complicated business practice at issue. What counts as “student information” when a user employs a general purpose machine for both educational purposes and non-educational purposes?  The Pledge — at least the sections that EFF relies upon in its complaint — is far from clear and doesn’t cover Google’s behavior in an obvious manner.

Of course, the whole complaint presumes that the nature of Google’s services was somehow unfair or deceptive to parents — thus implying that there was at least some material reliance on the Pledge in parental decision making. However, this misses a crucial detail: it is the school administrators who contract with Google for the Chromebooks and Google for Education services, and not the parents or the students.  Then again, maybe EFF doesn’t care and it is, as I suggest above, just interested in a long game whereby it can shoehorn Google’s services into some new sort of privacy regime. This isn’t all that unusual, as we have seen even the White House in other contexts willing to rewrite business practices wholly apart from the realities of privacy “harms.”

But in the end, this approach to privacy is just a very efficient way to discover the lowest common denominator in charity. If it even decides to brave the possible privacy suits, Google and other similarly situated companies will provide the barest access to the most limited services in order to avoid extensive liability from ambiguous pledges. And, perhaps even worse for overall social welfare, using the law to force compliance with voluntarily enacted, ambiguous codes of conduct is a sure-fire way to make sure that there are fewer and more limited codes of conduct in the future.